Engineering Economic Analysis

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Traditional Cost Accounting 549

Number of units per year

Labor cost (each)

Materials cost (each)

Standard

750

$400

$550

SOLUTION

Premium

400

$500

$900

First, the labor and material costs for the standard product, the premium product, and in total are

calculated.

Number of units per year

Labor cost (each)

Materials cost (each)

Labor cost

Materials cost

Standard

750

$ 400

550

300,000

412,500

Premium

400

$ 500

900

200,000

360,000

Total

$500,000

772,500

Then the allocated cost per labor dollar, $1.70, is found by dividing the $850,000 in overhead

by the $500,000 in total labor cost. The allocated cost per material dollar, $1.100324, is found

by dividing the $850,000 in overhead by the $772,500 in materials cost. Now, the $850,000 in

allocated overhead is split between the two products using labor costs and material costs.

abor cost is the burden vehicle, then 60% of the $850,000 in overhead is allocated to the

standard product. If material cost is the burden vehicle, then 53.4% is allocated to the standard
product. In both cases, the $850,000 has been split between the two products. Using total direct
costs wouldproduce another overhead allocationbetween these two values. However,for decision
making about product mix and product prices, incremental overhead costs must be analyzed. All
the allocation or burden vehicles are based on an average cost of overhead per unit of burden
vehicle.

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Problems with Traditional Cost Accounting xvi CONTENTS

Allocation of indirect costs can distort product costs and the decisions based on those costs. ii,

To be accurate, the analyst must determine which indirect or overhead expenses will be !!ii

changed because of an engineering project. In other words, what are the incremental cash 11:([' ,.J

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Standard Premium Total

Labor cost $300,000 $200,000 $500,000

Overheadllabor 1.70 1.70

Allocation by labor 510,000 340,000 850,000

Material cost 412,500 360,000 0

Overhead/material 1.100324 1.100324

Allocation by material 453,884 396,117 850,000