Adams Rug Company makes two types of rugs, seasonal and all-purpose. Both types

Question

Adams Rug Company makes two types of rugs, seasonal and all-purpose. Both types of rugs are handmade, but the seasonal rugs require significantly more labor because of their decorative designs. The annual number of rugs made and the labor hours required to make each type of rug follow: Number of rugs Number of direct labor hours Seasonal Al1-Purpose Totals 4,020 293,000 1,120 124,000 2,900 169,000 Required a. Assume that annual overhead costs total $73,250. Select the appropriate cost driver and determine the amount of overhead to b. Adams automates the seasonal rug line, which results in a dramatic decline in labor usage and allows the company to make 1,120 allocate to each type of rug rugs in only 12,500 hours. Adams continues to make the all-purpose rugs the same way as before. The number of rugs made and the labor hours required to make them after automation follow: Number of rugs Number of direct labor hours Seasonal All-Purpose Totals 4,020 181,500 1,120 12,500 2,900 169,000 Overhead costs are expected to increase to $90,750 as a result of the automation. Allocate the increased overhead cost to the two types of rugs using diect labor hours as the allocation base

Explanation / Answer

A.

The appropriate cost driver to allocate the overhead to each type of product is direct labor hours because seasonal rugs use more labor than all-purpose and if number of rugs is used to allocate the overhead a greater amount of overhead will be allocated to all-pupose rugs which would be incorrect.

Therefore,

Overhead allocated to seasonal

= Overhead x Labor hours used by seasonal/Total labor hours

= $73,250 x 124,000/293,000

= $31,000

And,

Overhead allocated to all-purpose

= Overhead x Labor hours used by all-purpose/Total labor hours

= $73,250 x 169,000/293,000

= $42,250

B.

The increased overhead cost will be allocated to the two types of rugs as follows:

Overhead allocated to seasonal

= Overhead x Labor hours used by seasonal/Total labor hours

= $90,750 x 12,500/181,500

= $6,250

And,

Overhead allocated to all-purpose

= Overhead x Labor hours used by all-purpose/Total labor hours

= $90,750 x 169,000/181,500

= $84,500

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