# Auerbach Enterprises’ Overhead Costs Allocation

## Introduction

In today’s competitive economy, manufacturing firms need to invest in areas that generate the desired gains. To determine the success of an investment, companies can make use of the cost analysis tool (Morgan, 2010). Both small and large manufacturing firms strive to gain appropriate returns. They have to make choices that directly and indirectly impact the cost of goods. Direct decisions are made in such areas as material selection, machine hours, and manufacturing processes. On the other hand, indirect considerations apply to such aspects as quality, maintenance, administration, and turnover (Schneider, 2012).

In this paper, the author will help managers at Auerbach Enterprises to allocate overhead costs in Maxi Flow and Alaska manufacturing. To this end, the author will provide calculations for various overhead rates.

## Computing Departmental Overhead Rates using Machine Hours

The calculation of most rates is similar. However, major differences emerge as a result of the driver used in each department (Hoggett, 2012). Consequently, it is important to note the specific drivers employed.

Radiator parts fabrication = \$ 80,000 ÷ 10,000

= 8

Radiator assembly, weld, and test = \$100,000 ÷ 20,000

= 5

Compressor parts fabrication = \$120,000 ÷ 5,000

= 24

Compressor assembly and test = \$180,000 ÷ 45,000

= 4

The department rate is determined by the overhead cost and the total number of machine hours used in the respective section. An analysis of the figures reveals variations between the departments. For example, assembly of parts records the highest cost. The figure stands at 24 dollars per hour.

## Calculating Overhead Variations using Machine Hours for the Entire Organization

The component is utilized to allocate all manufacturing costs to the production output. Brewer and Garrison (2013) define the concept as the amount per machine hour, labor hour, or percentage of a merchandise direct cost.

Total company-wide overhead rate = total overhead costs for all departments ÷

total machine hours for all units

= \$480,000 ÷ 80,000

= \$6 per machine hour

The figure above represents the entire organization’s overhead rate.

## Computation of Overhead Cost per Batch for Maxi Flow and Alaska

Company-wide and department-wide overhead costs can be calculated using the formula below:

### Company-Wide Rate

Overhead cost per batch is determined by assuming that:

• Company-wide rate = direct material costs × batch size + direct labor cost × batch size

Max Flow = 135 × 20 = 2700

75 × 20 = 1500

Cost per batch = \$4200

Alaska = 110 × 20 = 2200

95 × 20 = 1900

Cost per batch = \$4100

In terms of the company-wide rate per batch number, the difference between Alaska and Max flow is only \$100.

### Departmental Rates

Departmental rate = direct material costs + direct labor cost ÷ each department hour

Maxi Flow = 135 + 75 = \$ 210

Radiator parts fabrication = 210 ÷ 28

= \$7.50 per batch

Radiator assembly, weld, and test = 210 ÷ 30

= \$7 per batch

Compressor parts fabrication = 210 ÷ 32

= \$6.60 per batch

Compressor assembly and test = 210 ÷ 26

= \$8.10 per batch

Alaska = 110 + 95 = 205

Radiator parts fabrication = 205 ÷ 16

= \$12.80 per batch

Radiator assembly, weld, and test = 205 ÷ 74

= \$2.70per batch

Compressor parts fabrication = 205 ÷ 8

= \$25.60 per batch

Compressor assembly and test = 205 ÷ 66

= \$3.10 per batch

There are significant differences between Alaska and Max Flow with regards to departmental rates. On average, Maxi Flow’s rate ranges at \$7.30 per batch. On the other hand, Alaska’s rate ranges at \$11.05 per batch.

## Total Cost per Unit Assuming the Company-Wide Rate

Total cost per unit = direct material cost + direct labor cost ÷ number of units

### Maxi Flow

Direct materials cost = \$135 per unit

Direct labor cost = \$75 per unit

135 + 75 = 210

Direct materials cost = \$110 per unit

Direct labor cost = \$95 per unit

110 + 95 = 205

Total cost per unit for both Alaska and Maxi Flow = 210 + 205

= \$415

= 415+ 480,000 ÷ 40

= \$ 12,010.38 per unit

### Total cost per unit assuming departmental rates

Radiator parts fabrication= \$80,000+415 ÷ 40

=\$2010.38 per unit

=\$2510. 38

Compressor parts fabrication=120,000+415÷40

=\$3010.38

Compressor assembly and test=180,000+415÷40

=4510.38

With regards to the total cost per unit, it is evident that prices are increasing in each of the four manufacturing departments.

## Conclusion and Recommendations

Departmental rates affect one product more than others. The reason is that the manufacturing cost of merchandise is always different. Auerbach’s management should take into consideration the fact that the differences are caused by the complexity of the product and materials used. An analysis of Maxi Flow and Alaska using the calculations reveals the effect. For example, in terms of departmental costs per batch, Maxi Flow is cheaper than Alaska.

Auerbach should pay attention to cost allocation. The reason is that it helps managers to value inventory for external reporting and monitoring of expenditure on activities and processes. In addition, allocations support price where cost must be justified. The managers should understand that companies are different. Consequently, an approach that works for one firm may not suit another. Aurebach Enterprises majors on two product lines. To guarantee effective cost allocations, the managers can use process costing to calculate the manufacturing expenditure of a single product. The approach tends to be cheap and fast.

## References

Brewer, P., & Garrison, R. (2013). Introduction to managerial accounting (6th ed.). New York: McGraw-Hill/Irwin.

Hoggett, J. (2012). Accounting (8th ed.). Milton, Qld: John Wiley and Sons Australia.

Morgan, K. (2010). Strategic financial management. Jaipur: Mark.

Schneider, A. (2012). Managerial accounting: Decision making for the service and manufacturing sectors. San Diego, CA: Bridgepoint Education.

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