Question

Tax Savings and Costing (The Case of Transfer Pricing)

Please prepare a report answering the listed questions. You may Excel to create spreadsheets and copy the answers to this document.

Hansen, Kotter, and Zales is a law firm that contains one service department (Research & Document) and two production departments (Litigation and Consulting). The firm employs a job-order costing system to accumulate costs chargeable to each client. The firm uses actual costing to assign overhead. General overhead costs can be allocated based on either direct attorney hours or the number of employees, depending on managers’ choice. At the end of the year, the records revealed the actual general overhead costs are $720,000. At the end of the year, the records revealed the following costs and operating data for all cases handled during the year:

		Research & Document			Litigation		Consulting
# of Employees		10			8		6
Direct Attorney Hours(# of hrs)		3,000			8,000		5,000
Direct Attorney Costs ($)		$150,000			$400,000		$250,000
Direct Material Costs ($)		$16,000			$15,500		$13,500

*** 50% of Research & Department's service is provided to litigation department and the other 50% to consulting department.

Part I Cost Allocation

A. Compute the overhead allocation rates for general overhead based on different cost drivers. What are the overhead costs assigned to each department, using different cost drivers?

B. Compare the total costs of each production department after departmental cost allocation, using attorney hours and the number of employees as cost driver, respectively. Does the choice of cost driver affect the total costs of each production department?

Answer 1

	OVERHEAD COST ALLOCATION BASED ON DIRECT ATTORNEY HOUR:
			Research & Development	Litigation	Consulting	Total
	A	Direct Attorney Hours	3000	8000	5000	16000
	B=A/16000	Percentage of total	18.75%	50.00%	31.25%	100.00%
	C=B*720000	Allocated Overhead Cost	$135,000	$360,000	$225,000	$720,000
	OVERHEAD COST ALLOCATION BASED ON NUMBER OF EMPLOYEES:
			Research & Development	Litigation	Consulting	Total
	A	Number of Employees	10	8	6	24
	B=A/24	Percentage of total	41.67%	33.33%	25.00%	100.00%
	C=B*720000	Allocated Overhead Cost	$300,000	$240,000	$180,000	$720,000
	B	OVERHEAD COST OF PRODUCTION DEPARTMENTS
		BASED ON ATTORNEY HOURS
			Litigation	Consulting	Total
		Allocated Costs	$360,000	$225,000	$585,000
		Research & Development Costs apprtioned	$67,500	$67,500	$135,000	(50%*135000)
		Total Overhead Costs	$427,500	$292,500	$720,000
		OVERHEAD COST OF PRODUCTION DEPARTMENTS
		BASED ON NUMBER OF EMPLOYEES
			Litigation	Consulting	Total
		Allocated Costs	$240,000	$180,000	$420,000
		Research & Development Costs apprtioned	$150,000	$150,000	$300,000	(50%*300000)
		Total Overhead Costs	$390,000	$330,000	$720,000
		YES, Choice of cost driver affects cost of each production department