Problem: Direct versus indirect costs

Jeelani Construction Company is composed of two divisions: (1) Home Construction and (2) Commercial Construction. The Home Construction Division is in the process of building 12 houses and the Commercial Construction Division is working on 3 projects. Cost items of the company follow.

Company president’s salary.

Depreciation on crane used in commercial construction.

Depreciation on home office building.

Salary of corporate office manager.

Wages of workers assigned to a specific construction project.

Supplies used by the Commercial Construction Division.

Labor on a particular house.

Salary of the supervisor of commercial construction projects.

Supplies, such as glue and nails, used by the House Construction Division.

Cost of building permits.

Materials used in commercial construction projects.

Depreciation on home building equipment (small tools such as hammers or saws).


a. Identify each cost as being a direct or indirect cost assuming the cost objects are individual products (houses or projects).

b. Identify each cost as being a direct or indirect cost, assuming the cost objects are the two divisions.

c. Identify each cost as being a direct or indirect cost, assuming the cost object is Jeelani Construction Company as a whole.

Problem: Allocating overhead costs among products

Nevin Company makes three products in its factory: plastic cups, plastic tablecloths, and plastic bottles. The expected overhead costs for the next fiscal year include the following.

Factory managers’ salary $260,000

Factory utility costs 121,000

Factory supplies 56,000

Total overhead costs $437,000

Nevin uses machine hours as the cost driver to allocate overhead costs. Budgeted machine hours for the products are as follows.

Cups 420 hours

Tablecloths 740

Bottles 1,140

Total machine hours 2,300


a. Allocate the budgeted overhead costs to the products.

b. Provide a possible explanation as to why Nevin chose machine hours, instead of labor hours, as the allocation base.

Problem: Allocating a fixed cost

Stevens Air is a large airline company that pays a customer relations representative $4,000 per month. The representative, who processed 1,000 customer complaints in January and 1,300 complaints in February, is expected to process 12,000 customer complaints during 2012.


a. Determine the total cost of processing customer complaints in January and in February.

b. Explain why allocating the cost of the customer relations representative would or would not be relevant to decision making.

Problem: Distinction between relevance and cost behavior

Leah Friend is trying to decide which of two different kinds of candy to sell in her retail candy store. One type is a name-brand candy that will practically sell itself. The other candy is cheaper to purchase but does not carry an identifiable brand name. Ms. Friend believes that she will have to incur significant advertising costs to sell this candy. Several cost items for the two types of candy are as follows.

Brandless Candy

Cost per box $6.00

Sales commissions per box 1.00

Rent of display space 1,500.00

Advertising 3,000.00

Name-Brand Candy

Cost per box $7.00

Sales commissions per box 1.00

Rent of display space 1,500.00

Advertising 2,000.00


Identify each cost as being relevant or irrelevant to Ms. Friend’s decision and indicate whether it is fixed or variable relative to the number of boxes sold.

Problem: Special order decision

Norman Concrete Company pours concrete slabs for single-family dwellings. Wayne Construction Company, which operates outside Norman’s normal sales territory, asks Norman to pour 40 slabs for Wayne’s new development of homes. Norman has the capacity to build 300 slabs and is presently working on 250 of them. Wayne is willing to pay only $2,500 per slab. Norman estimates the cost of a typical job to include unit-level materials, $1,000; unit-level labor, $600; and an allocation portion of facility-level overhead, $700.


Should Norman accept or reject the special order to pour 40 slabs for $2,500 each? Support your answer with appropriate computations.

Problem: Outsourcing decision

Roaming Bicycle Manufacturing Company currently produces the handlebars used in manufacturing its bicycles, which are high-quality racing bikes with limited sales. Roaming produces and sells only 6,000 bikes each year. Due to the low volume of activity, Roaming is unable to obtain the economies of scale that larger producers achieve. For example, Roaming could buy the handlebars for $35 each; they cost $38 each to make. The following is a detailed breakdown of current production costs.

Item Unit Cost Total

Unit-level costs

Materials $18 $108,000

Labor 12 72,000

Overhead 3 18,000

Allocated facility-level costs 5 30,000

Total $38 $228,000

After seeing these figures, Roaming’s president remarked that it would be foolish for the company to continue to produce the handlebars at $38 each when it can buy them for $35 each.