PROBLEM 11B–4 Service Department Charges [LO6]
Northstar Company has two operating divisions—Machine Tools and Special Products. The com- pany has a maintenance department that services the equipment in both divisions. The costs of operating the maintenance department are budgeted at $80,000 per month plus $0.50 per machine- hour. The fixed costs of the maintenance department are determined by peak-period requirements. The Machine Tools Division requires 65% of the peak-period capacity, and the Special Products Division requires 35%.
For October, the Machine Tools Division estimated that it would operate at 90,000 machine- hours of activity and the Special Products Division estimated that it would operate at 60,000 machine-hours of activity. However, due to labor unrest and an unexpected strike, the Machine Tools Division worked only 60,000 machine-hours during the month. The Special Products Divi- sion worked 60,000 machine-hours as planned.
Cost records in the maintenance department show that actual fixed costs for October totaled
$85,000 and that actual variable costs totaled $78,000.
1. How much maintenance department cost should be charged to each division for October?
2. Assume that the company follows the practice of allocating all maintenance department costs incurred each month to the divisions in proportion to the actual machine-hours recorded in each division for the month. On this basis, how much cost would be allocated to each division for October?
3. What criticisms can you make of the allocation method used in part (2) above?
4. If managers of operating departments know that fixed service costs are going to be allocated on the basis of peak-period requirements, what will be their probable strategy as they report their estimate of peak-period requirements to the company’s budget committee? As a member of top management, what would you do to neutralize any such strategies?