Question

Management Accounting

Hawk and Eagle Co., a law firm, had the following costs last year: Direct professional labor Overhead Total costs $15,000,000 21.000.000 $36.000.000 The following costs were included in overhead: SS.000.000 2.700.000 600,000 Fringe benefits for direct professional labor Paralegal costs Telephone call time with clients estimated but not tabulated) Computer time Photocopying Total overhead 1.800.000 900.000 SI1.000.000 The firm recently improved its ability to document and trace costs to individual cases. Revised bookkeeping procedures now allow the firm to trace fringe benefit costs for direct professional labor, paralegal costs, telephone charges, computer time, and photocopying costs to each case individually. The managing partner needs to decide whether more costs than just direct professional labor should be traced directly to jobs to allow the firm to better justify billings to clients. During the last year, more costs were traced to client engagements. Two of the case records showed the following: Client Cases 875 876 Direct professional labor $20,000 $20,000 Fringe benefits for direct labor 3.000 3,000 Secretarial costs 2.000 6,000 Telephone call time with clients 1.000 2.000 Computer time 2.000 4.000 Photocopying 1.000 2.000 Total costs 529.000 $37.000 Three methods are being considered for allocating overhead this year: Method 1: Allocate overhead based on direct professional labor cost. Calculate the allocation rate using last year's direct professional labor costs of S15 million and overhead costs of S21 million Method 2: Allocate overhead based on direct professional labor cost. Calculate the allocation rate using last year's direct professional labor costs of S15 million and overhead costs of S10 million (S21million less Sil million in direct costs that are traced this year).

Answer 1

A Overhead allocation rate

Last year Overhead Cost = $21 million

Last year Direct labor cost = $15 million

Overhead allocation rate = 21 million/15 million = $1.4 per labor cost

B Overhead allocation rate

Last year Overhead Cost = $10 million

Last year Direct labor cost = $15 million

Overhead allocation rate = 10 million/15 million = $0.67 per labor cost

C Overhead allocation rate

Last year Overhead Cost = $10 million

Last year Direct labor cost = $15 million

Last year Direct Cost = $11 million

Overhead allocation rate = 10 million/(15 million + 11 million) = $0.38 per direct cost

D

		875	876
Method 1	Direct Professional labor	20,000	20,000
	Overhead Cost @1.4 per labor cost	28,000	28,000
	Total Cost	48,000	48,000
method 2	Direct Professional labor	20,000	20,000
	Overhead cost @0.67 per labor cost	13,333	13,333
	Other Direct Cost	2,000	6,000
	Total Cost	35,333	39,333
Method 3	Direct Professional Labor	20,000	20,000
	Other direct cost	2,000	6,000
	Total direct cost	22,000	26,000
	Overhead cost @0.38 per direct cost	8,360	9,880
	Total Cost	30,360	35,880

E The Overhead allocation rate derived from three methods are on different basis. Thus, the total cost derived is different.

In Method 1, All the overheads are allocated on the basis of direct professional labor cost.

In method 2, Overheads excluding direct cost are allocated on the basis of direct professional labor cost.

In method 2, Overheads excluding direct cost are allocated on the basis of total direct cost.

F When direct cost can can be easily identified for each job then, it should not be allocated on the basis of any factor. Rather direct cost pertaining to each job should be allocated to its respective job. So, the method 1 is inappropriate.

G IN method 2 and method 3, direct cost other than professional labor cost is not allocated n the basis of direct professional labor cost. So the method 2 and method 3 are better than method 1.