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Essay: Celestial Artistry's Overhead Allocation Methods

A.Dayton Lighting Company Net Income Calculation

A.Dayton Lighting Company had net income for the first 10 months of the current year of $200,000. One hundred thousand units were manufactured during this period (the same as the planned pro-duction), and 100,000 units were sold. Fixed manufacturing overhead was $2,000,000 over the 10-month period (i.e., $200,000 per month). There are no selling and administrative expenses for Dayton Lighting Company. Both variable and fixed costs are expected to continue at the same rates for the balance of the year (i.e., fixed costs at $200,000 per month and variable costs at the same variable cost per unit). Twenty thousand units are to be produced and 19,000 units are to be sold in total over the last two months of the current year. Assume the unit variable cost is the same in the current year as in the previous year. (Hint: You cannot calculate revenue or cost of goods sold; you must work directly with contribution margin or gross margin.) 


1.If operations proceed as described, will net income be higher under variable or absorption costing for the current year in total? Why?

2.If operations proceed as described, what will net income for the year in total be under (a) variable costing and (b) absorption costing? (Ignore income taxes.)

3.Discuss the advantages and disadvantages of absorption and variable costing.

B.Celestial Artistry Company is developing departmental overhead rates based on direct-labor hours for its two production departments, Etching and Finishing. The Etching Department employs 20 people and the Finishing Department employs 80 people. Each person in these two departments works 2,000 hours per year. The production-related overhead costs for the Etching Department are budgeted at $200,000, and the Finishing Department costs are budgeted at $320,000. Two service departments, Maintenance and Computing directly support the two production departments. These service departments have budgeted costs of $48,000 and $250,000, respectively. The production departments’ overhead rates cannot be determined until the service departments’ costs are allocated. The following schedule reflects the use of the Maintenance Department’s and Computing Department’s output by the various departments. 

Using Department

Service Department                                             Maintenance       Computing         Etching           Finishing

Maintenance (maintenance hours) ...............            0                     1,000              1,000               8,000

Computing (minutes) ...................................        240,000              0                   840,000          120,000 


1.Use the direct method to allocate service department costs. Calculate the overhead rates per direct-labor hour for the Etching Department and the Finishing Department. 

2.Use the step-down method to allocate service department costs. Allocate the Computing Department’s costs first. Calculate  the overhead rates per direct-labor hour for the Etching Department and the Finishing Department.

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