Alternative to Overhead Allocation

Alternative to Overhead Allocation

Crafton Carbuckle began a corporate consulting firm, Creative Consumer Consultants, Ltd., in 1994. The firm specializes in assisting corporate clients analyze markets and promotional campaigns. Most clients are mid-sized local corporations who do not have highly developed in-house marketing departments.

After placing bids on component parts for another Deere division and losing most of them to outside vendors, the Gear & Special Products Division (a component of JDCW) has realized that they are not competitive. They are beginning to realize that they cannot hope to increase production volume by supplying outside companies if they cannot even successfully bid for parts for internal divisions, as their full costs are much higher than industry standards. This division is still using the cost allocation system that was in place in the 1970's when the division was running at full capacity. With the downturn in demand and sales, the division is no longer able to sustain operations at full capacity, but they continue to use the same system, which is not effective when full capacity is not being used.

With the current system, the allocation of overhead based on machine time is 31.2% greater than the allocation for direct labor hours. Thus, products requiring more machine time will incur more of the overhead resulting in their over costing, and the under costing of products that do not require much machine time.

Activity based costing (ABC) is a very useful tool for refining a cost system to ensure that costs are assigned to products based on the activities required to complete each product. This leads to more accurate costing of products as a result of properly costing the activities associated with them. The ABC system that has been designed by Williams and Vintila is very detailed. By separating the overhead into categories that ...