Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 54

Plantwide vs. Departmental Overhead Rate

Rose Bach was recently hired as controller of Empco Inc., a sheet metal manufacturer. Empco has been in the sheet metal business for many years and is currently investigating ways to modernize its manufacturing process. At the first staff meeting Rose attended, Bob Kelley, chief engineer, presented a proposal for automating the drilling department. He recommended that Empco purchase two robots that could replace the eight direct labor workers in the department. The cost savings outlined in Bob’s proposal included eliminating direct labor cost and reducing factory overhead cost to zero in the drilling department because Empco charges factory overhead on the basis of direct labor dollars using a plantwide rate.

Empco’s president was puzzled by Kelley’s explanation of cost savings, believing it made no sense. Rose agreed, explaining that as firms become more automated, they should rethink their factory overhead systems. The president then asked her to look into the matter and prepare a report for the next staff meeting.

Required

1. Describe the shortcomings of the Empco’s current system for applying overhead.

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2. Explain the misconceptions in Bob Kelley’s statement that the factory overhead cost in the drilling department would be reduced to zero if the automation proposal were implemented.

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3. How would you improve the allocation of overhead costs?

Step 1 of 6

Allocation of manufacturing overhead

In manufacturing company, there are various manufacturing overhead incurred to produce the goods these overhead expenses are then allocated to the respective manufacturing department. There are two traditional ways in which company allocates the manufacturing overhead to department. They are plant wide overhead and departmental overhead rate. These rates are determined based on estimated manufacturing overhead and estimated direct labor hours or machine hours.