Overhead allocation and cost distortion – Bridgeton case

Q1.The overhead allocation rate used in the 1987 model year strategy study at the ACF was 435% of direct labor cost. Calculate the overhead allocation rate using the 1987 model year budget. why do you get different numbers?

Strategy study : Overhead allocation rate : 435%

1987 model year budget :

Total direct labor costs : 24,682,000
Total overhead costs : 107,956,000

Overhead allocation rate : 107,956,000/24,682,000 = 437.38%

Possible reasons :

1. The overhead costs may be pessimistic during the budget
2. Some of the direct costs may be classified as overhead costs

Yong : rounded in calculation

Q2. Calculate the overhead allocation rate for each of the model years , 1988 through 1990. Are the changes since 1987 in overhead allocation rates significant? Why have these changes occurred?

1988	1989	1990
434%	577%	563%

Yes the overhead allocation rates are higher for 89 and 90.

The doors and mufflers products were outsourced , which reduced both the dirt labor costs as well as overhead costs as due to loss of 60 direct labor and 30 indirect labor.

This shows that the remaining product groups Fuel tanks , manifolds , and oil pans have more overhead costs than doors and muffler/exhausts.

Q3. Expected gross margins

Item	Product1	Product2
a. Selling Price	$62	$54
b. Standard Material Cost	$16	$27
c. Standard Labor Cost	$6	$3
Overhead in 1988	26.04	13.02
Overhead in 1989	34.62	17.32
Overhead in 1990	33.78	16.39
Total expenses in 1988	48.04	43.02
Total expenses in 1989	56.62	47.32
Total expenses in 1990	55.78	46.39
Gross Profit in 1988	13.96	10.98
Gross Profit in 1989	5.38	6.68
Gross profit in 1990	6.22	7.61
Gross Margin/Sales in 1988	22.51%	17.7%
Gross Margin/Sales in 1989	8.67%	12.3%
Gross Margin/Sales in 1990	10.03%	14.09%
Direct Costs/Total Costs in 1988	12.48%	6.9%
Direct Costs/Total Costs in 1989	10.6%	6.3%
Direct Costs/Total Costs in 1990	10.75%	6.46%

Q4. Are the product costs reported by the cost system appropriate for use in the strategic analysis?

The direct costs for product1 were a little more than 10% but for product2 they were less than 10%.
Since the direct costs were a small percentage of the total costs, the cost system is not appropriate to use direct costs as the allocation is distorting the product costs.