The following table presents the allocation of the $9.5 million of shared manufacturing overhead using the four proposed schemes.
Direct labor hours
Direct labor dollars
Direct material dollars
Square footage
Allocated overhead based on:
Direct labor hours
Direct labor dollars
Direct material dollars
Square footage of plant
b.
Texas
3,000,000
$60,000,000
$180,000,000
200,000
Mexico
4,000,000
$40,000,000
$200,000,000
300,000
Total
7,000,000
$100,000,000
$380,000,000
500,000
$4,085,000
5,700,000
4,465,000
3,800,000
$5,415,000
3,800,000
5,035,000
5,700,000
% Texas
43.0%
60.0%
47.0%
40.0%
$9,500,000
9,500,000
9,500,000
9,500,000
Questions involving how to allocate costs involve what input base to tax, and hence how the choice of the taxing scheme affects the firm’s cash flows. Since Massey has tax loss carry forwards, the allocation of the $9.5 million manufacturing overhead does not affect taxes, which is usually an important cash flow stream to consider.
The four allocation methods create significant differences in the dollars allocated to the two plants. In fact, the Texas and Mexico plants allocations vary by up to $1.9 million, depending on which method is used. Since the lines of business end up paying for these allocated costs through higher full cost-based transfer prices, the choice of allocation method could prove economically important if the lines of business change their prices of heat sinks to final customers based on the transfer prices that result from the four methods. Therefore, before selecting a particular allocation method, the product costs produced under each allocation scheme need to be examined in light of how the product cost impacts the pricing decision of the three lines of business.
