This paper evaluates whether Auerbach Enterprises should adopt departmental overhead rates instead of company-wide predetermined overhead rates. Using machine hour allocation methods, the analysis calculates overhead rates for four departments and applies both approaches to two products: MaxiFlow and Alaska. Results show that departmental rates produce total overhead costs of $2,200 compared to $1,680 using company-wide rates, leading to a recommendation that the company maintain its existing company-wide overhead rate system to control production costs.
Auerbach Enterprises currently uses company-wide predetermined overhead rates but is considering switching to departmental overhead rates. This case study evaluates whether departmental overhead rates would be more profitable for the company.
The first step is to compute departmental overhead rates using the machine hours method. Under this approach, each department divides its total overhead costs by the ratio of machine hours consumed. The calculation reveals the following departmental overhead rates:
The results show that departmental overhead rates vary significantly. The Compressor Parts Fabrication department has the highest overhead rate at $24 per machine hour, reflecting its high overhead costs relative to machine hours used. The Compressor Assembly & Test department has the lowest rate at $4 per hour. These variations demonstrate that using a single company-wide rate may not accurately reflect the overhead consumption patterns of individual departments.
In contrast, the company-wide predetermined overhead rate pools all overhead costs across the entire organization and divides by total machine hours. As shown in the calculation below, the company-wide overhead rate is $6 per machine hour:
This single rate of $6 per machine hour represents the average overhead burden across all departments and is applied uniformly to all products regardless of which departments they pass through.
To evaluate the impact of each costing method, overhead costs are allocated to two products: MaxiFlow and Alaska. Each product requires different machine hours in each department.
Company-Wide Rate Applied to MaxiFlow and Alaska:
Departmental Rates Applied to MaxiFlow and Alaska:
Total Cost Per Unit—Company-Wide Rate Method:
Total Cost Per Unit—Departmental Rate Method:
The calculations reveal significant differences in how the two costing methods allocate costs to each product. When using departmental rates, MaxiFlow's total overhead cost is $1,246 compared to $696 using the company-wide method—an increase of $550. Conversely, Alaska's overhead cost decreases from $984 to $954, a reduction of $30.
MaxiFlow is substantially more affected by the switch to departmental rates. This occurs because MaxiFlow requires 32 machine hours in the Compressor Parts Fabrication department, which has the highest departmental overhead rate of $24 per hour. Under the company-wide method, these 32 hours are charged at only $6 per hour. The following comparative table illustrates these differences:
The data demonstrates that adopting departmental rates would increase the total overhead costs for both products from $1,680 to $2,200—an increase of $520 or approximately 31 percent. As noted in cost accounting literature, organizations that manage production costs effectively achieve greater annual revenue. Higher production costs directly reduce profit margins and competitiveness.
Based on the comprehensive analysis, it is not advisable for Auerbach Enterprises to adopt departmental overhead rates. The calculations conclusively demonstrate that departmental rates would increase total production costs by approximately $520 per batch ($2,200 versus $1,680). Since cost management is critical to organizational profitability, switching to an overhead costing system that increases costs would be counterproductive to management's financial objectives.
"Recommending continued use of company-wide rates"
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