Question

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McKeoun Enterprises is a large machine tool company now experiencing alarming increases in maintenance expense in each of its four production departments. Maintenance costs are currently allocated to the production departments on the basis of direct labor hours incurred in the production department. To provide pressure for the production departments to use less maintenance, and to provide an incentive for the maintenance department to become more efficient, McKeoun has decided to investigate new methods of allocating maintenance costs. One suggestion now being evaluated is a form of outsourcing. The producing departments could purchase maintenance service from an outside supplier. That is, they could choose either to use an outside supplier of maintenance or to be charged an amount based on their use of direct labor hours. The following table shows the direct labor hours in each department, the allocation of maintenance cost based on labor hours, and the cost to purchase the equivalent level of maintenance service from an outside maintenance provider.

Production Department	Direct Labor Hours Allocation Base (Percent)						Cost Allocation Based on Direct Labor Hours				Outside Price
A			20	%			$	71,200			$	102,500
B			25					106,800				61,500
C			20					35,600				82,000
D			35					142,400				164,000
Total			100	%			$	356,000			$	410,000

Required:

1. As a first step in moving to the outsourcing approach, McKeoun is considering an allocation based on the price of the outside maintenance supplier for each department. Calculate the cost allocations on this basis and compare them to the current direct labor hours basis.

Answer 1

Based on the below table McKeoun can consider an allocation based on the price of the outside maintenance supplier for each department. Calculation of cost allocations on this basis and compare them to the current direct labor hours basis are shown below

Production Department	Allocation Base	Cost Allocation	Outside Price	Decision	Price
A	20%	$     71,200.00	$ 1,02,500.00	Direct labour Hours	$     71,200.00
B	25%	$ 1,06,800.00	$     61,500.00	Outside Price	$     61,500.00
C	20%	$     35,600.00	$     82,000.00	Direct labour Hours	$     35,600.00
D	35%	$ 1,42,400.00	$ 1,64,000.00	Direct labour Hours	$ 1,42,400.00
	100%	$ 3,56,000.00	$ 4,10,000.00		$ 3,10,700.00