PLANTWIDE OVERHEAD RATE VERSUS DEPARTMENTAL RATES, EFFECTS ON PRICING DECISIONS Cherise Ortega, marketing manager for Romer Company

PLANTWIDE OVERHEAD RATE VERSUS DEPARTMENTAL RATES, EFFECTS ON PRICING DECISIONS Cherise Ortega, marketing manager for Romer Company, was puzzled by the outcome of two recent bids. The company’s policy was to bid 150 percent of the full manufacturing cost. One job (labeled Job 97-28) had been turned down by a prospective customer, who had indicated that the proposed price was $3 per unit higher than the winning bid. A second job (Job 97-35) had been accepted by a customer, who was amazed that Romer could offer such favorable terms. This customer revealed that Romer’s price was $43 per unit lower than the next lowest bid. Cherise has been informed that the company was more than competitive in terms of cost control. Accordingly, she began to suspect that the problem was related to cost assignment procedures. Upon investigating, Cherise was told that the company uses a Plant wide overhead rate based on direct labor hours. The rate is computed at the beginning of the year using budgeted data. Selected budgeted data are as follows:Department ADepartment BTotalOverhead$500,000$2,000,000$2,500,000Direct labor hours200,00050,000250,000Machine hours20,000120,000140,000Cherise also discovered that the overhead costs in department B were higher than those in department A because B has more equipment, higher maintenance, higher power consumption, higher depreciation, and higher setup costs. In addition to the general procedures for assigning overhead costs, Cherise was supplied with the following specific manufacturing data on Jobs 97-28 and 97-35:Job 97-28Department ADepartment BTotalDirect labor hours5,0001,0006,000Machine hours200500700Prime costs$100,000$20,000$120,000Units produced14,40014,40014,400Job 97-35Department ADepartment BTotalDirect labor hours4006001,000Machine hours2003,0003,200Prime costs$10,000$40,000$50,000Units produced1,5001,5001,500Required:1. Using a plantwide overhead rate based on direct labor hours, develop the bid prices for Jobs 97-28 and 97-35 (express the bid prices on a per-unit basis).2. Using departmental overhead rates (use direct labor hours for department A and machine hours for department B), develop per-unit bid prices for Jobs 97-28 and 97-35.3. Compute the difference in gross profit that would have been earned had the company used departmental rates in its bids instead of the plantwide rate.4. Explain why the use of departmental rates in this case provides a more accurate product cost.