Finance Allocation Exercises

Calculate the costs allocated to the production departments using each allocation base. Comment on which allocation base is preferable. Solution: Square Footage as an Allocation Base Production Department 1 Production Department 2 Direct Labor Hours as an Allocation Base Which allocation base is preferable? As indicated, the choice of the allocation base greatly affects the allocations of cost. Use of square footage as the allocation base assigns 60% of the cost to department 2 and 40% to department 1 .

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However, use of direct labor hours allocates 60% of the sots to department 1 and only 40% to department 2. Department 1 would prefer to labor hours as the base. An allocation base that results in a cause and effect allocation is preferred. If maintenance costs are mostly related to building maintenance, then square footage is more likely to result in a cause and effect allocation. However, if maintenance costs are mostly made up of machine maintenance, then machine hours might be a better allocation base. EXERCISE 2 Power Electronics manufactures portable power supply units.

Power has recently decided to use an activity-based approach to cost its products. Production line setups is a major activity at Power. Next year Power expects to perform 1,000 setups at a total cost of $1,500,000. Power plans to produce 750 units of product PEPPY, which will require two setups. How much setup cost will be allocated to each unit of PEP 50 produced?