Shun Electronics Company Case Solution

• Foreman salary

• Section leader’s salary

• Indirect labor salary

• Equipment repair

• Supplies

• Occupancy and Electricity

• Depreciation on equipment

• Storage and handling of material

• Miscellaneous

All of these overhead costs were incurred in all the three production departments of the company i.e. Assembly department, Fabrication Department and Finished goods department. These costs cannot be traced back to the production of goods produced because these costs are shared by different products treated in the same department at the same time. Therefore, the company allocated these costs based on an estimate of overhead costs incurred on direct labor and material cost incurred in that department for a particular type of good. The cost driver of direct labor used for the costing method does give a realizable estimate of the cost of the product, but the estimate of the overhead cost allocated is not very accurate because higher overhead cost might be consumed to produce a good that requires less direct labor hours and lower overhead costs might have been actually consumed by a product that requires relatively higher direct labor and material. Therefore, uses of the same cost driver at the same rate for both types of goods will understate the cost of the first good, while overstate the cost of second goods.

Exhibit1 shows the standard costing method used for the calculation of cost incurred per unit of all six types of outputs produced by the company. This costing method assumes that all three types of portable radios and all three types of shelf models incur costs in the assembly department in the same way. Therefore, cost estimates for three portable models are the same and similarly cost estimates for shelf models are also the same. In standard costing method, costs are allocated on department level, not on the activity level. Therefore, the company allocated overhead costs as 50% of the total direct material and labor costs incurred by the two main types of products i.e. Shelf and Portable. Total direct and material cost per unit for shelf model in the assembly department is $24 per unit. Therefore, $12 per unit of the overhead cost was allocated to every unit based on 50% cost driver rate. So the total cost incurred in the assembly department for the product becomes $36. Similarly, total direct and material cost per unit for portable model in the assembly department is $12 per unit. Therefore, $6 per unit of the overhead cost was allocated to every unit based on 50% cost driver rate. So the total cost incurred in the assembly department for the product becomes $18.

For the fabrication department, products were divided into six groups because their utilization of material and labor costs became very different. In this department, cost driver changed from the sum of direct material and labor to just direct labor. It is all based on the judgment of management to select the cost driver that they believe drives the overhead costs in a particular department. Overhead costs were allocated to all the six products at the rate of 200% cost of direct labor. Similarly, in the finished goods department, overhead costs were allocated at the rate of 100% of direct labor costs. However, for this department, products were classified in two categories only i.e. Shelf and Portable. This is because management was of the view that the three products within each of these categories consumed the same amount of resources in the finished goods department. So, the total cost per unit of all the six products was calculated by summing up costs incurred in the three departments.

Exhibit 2 shows the subdivision of overhead cost estimates into six sections and two areas. Since Ranjit wanted to use activity based costing method for the recalculation of costs, he divided overhead costs according to the activities that consumed those overhead costs. With the help of department foremen, he classified all the overhead cost categories according to their utilization in each section and area. This will certainly lead to a more accurate allocation of overhead cost because all the sub-divisions of overhead cost elements were allocated separately based on their use in sections and areas.
In exhibit 3, Ranjit recalculated costs per unit of all the six products based on allocation of overhead items “individually” rather than using the sum of overhead cost. He re-estimated percentage of overhead per dollar of direct labor cost for each section and area.

Rather than using the department wise overhead costs and then allocating the total to the individual products based on direct labor and material, Ranjit allocated costs to products on the section and area level. For example, total overhead costs incurred in the assembly department are $60,000 while total direct labor and material costs incurred were $120,000 ($12*4,000 + $24*3,000). So, according to the previous method, overhead costs were allocated at the rate of 50% ($60,000/$120,000). However, Ranjit divided further department wise over head cost of assembly and fabrication in three sections each and finished goods department overhead costs into two areas. So, rate for the allocation of overhead were calculated as follows:

Note: Reclassification of overhead costs by Ranjit showed that only certain products consumed overhead costs in each section of fabrication department. Therefore, direct labor costs of only those products were used for calculating percentage of overhead per dollar of direct labor cost.