Exam 7: Cost Allocation: Theory

Choosing Allocation Bases for Levying Taxes The town of Seaside has decided to construct a new sea aquarium to attract tourists. The cost of the measure is to be paid by a special tax. Although most of the townspeople believe the sea aquarium is a good idea, there is disagreement about how the tax should be levied. Required: Suggest three different methods of levying the tax and the advantages and disadvantages of each.

Jim Shoe, chief executive officer of Jolsen International, a multinational textile conglomerate, has recently been evaluating the profitability of one of the company's subsidiaries, Pride Fashions, Inc., located in Rochester, New York. The Rochester facility consists of a dress division and a casual wear division. Daneille's Dresses produces women's fine apparel, while the other division, Tesoro's Casuals, produces comfortable cotton casual clothing. Jolsen's chief financial officer, Pete Moss, has recommended that the casual wear division be closed. The year-end financials Shoe just received show that Tesoro's Casuals has been operating at a loss for the past year, while Daneille's Dresses continues to show a respectable profit. Shoe is puzzled by this fact because he considers both managers to be very capable. The Rochester site consists of a 140,000-square-foot building where Tesoro's Casuals and Daneille's Dresses utilize 70 percent and 30 percent of the floor space, respectively. Fixed overhead costs consist of the annual lease payment, fire insurance, security, and the common costs of the purchasing department's staff. Fixed overhead is allocated based on percentage of floor space. Housing both divisions in this facility seemed like an ideal situation to Shoe because both divisions purchase from many of the same suppliers and have the potential to combine materials ordering to take advantage of quality discounts. Furthermore, each division is serviced by the same maintenance department. However, the two managers have been plagued by an inability to cooperate due to disagreements over the selection of suppliers as well as the quantities to purchase from common suppliers. This is of serious concern to Shoe as he turns his attention to the report in front of him. Tesoro's Casuals (\ 000s) Daneille's Dresses \langle\ 000s) Sales revenue \ 500 \ 1,000 Expenses: Direct materials \langle\ 200) \langle\ 465) Direct labor (70) \langle130) Selling expenses (all variable) (100) \langle200) Overhead expenses: Fixed overhead \langle98) \langle42) Variable overhead \langle40) \langle45) Net income before taxes \ (8) \ 118 Required: a. Evaluate Pete Moss's recommendation to close Tesoro's Casuals. b. Should the overhead costs be allocated based on floor space or some other measure? Justify your answer.

If Pluton selects the cost allocation method indicated by your answer to Q7-7, how much will profits increase on this order compared with the present system?

Pluton makes particular plastics for sale to the public and the government. Basic cost data for a 100-pound drum of one particular product called Xentra appears below: Qty Cost Chemical Xeta, gals 15 \ 25.00 Chemical Thenta, gals 35 \ 27.50 Base material, Ibs 20 \ 1.00 100 -lb lined drum 1 \ 51.83 Variable factory overheads are estimated to be $1,200,000 per month, when 1,000,000 pounds of various products are produced. The plant employs 20 chemical workers who typically work 175 hours each per month and are paid $24 per hour. Other workers are classified as indirect and are included in fixed overheads. The highly automated plant typically runs 21,000 machine hours per month. The preparation of one 100 lbs batch of Xentra needs ten minutes of direct labor and 75 minutes of machine time. Fixed manufacturing overheads total $3,500,000 per month. Forty percent of these fixed manufacturing overheads are labor-related costs and the balance are machine-related costs. Assuming normal production levels, what is the direct materials and direct labor cost (i.e., the prime cost) per drum?

You are going to dinner with three friends, one who likes steak, another wine, and the third is a vegetarian (which is assumed to be the least expensive). Which is true?