Question

Thompson Aeronautics repairs aircraft engines. The company’s Purchasing Department supports its two departments, Defense and Commercial. The Defense division has contracts with the Department of Defense and the Commercial division works primarily with domestic airlines and air freight companies. The cost of the Purchasing Department is $7.70 million annually. Information on the activity of the Purchasing Department for the last year follows. Number of Purchase Orders Dollar Amount of Purchases Defense 9,200 $ 148,000,000 Commercial 36,800 222,000,000 Required: a. What is the cost charged to each division if Thompson allocates Purchasing Department costs based on the number of purchase orders? b. What is the cost charged to each division if Thompson allocates Purchasing Department costs based on the dollar amount of the purchases? c. Contracts with the Defense Department are on a cost-plus fixed fee basis, meaning the price is based on the cost of repairing an engine, including any overhead assigned to the division. Contracts with commercial airlines and air freight companies are almost all fixed price, meaning the price does not depend directly on the cost. Will this affect Thompson’s choice of an allocation base?

Answer 1

Answer:

a.  cost charge to each division using number of purchase orders as basis of allocation

total cost =  $7.7million

Total number of orders

Defense division =        9,200

Commercial division  = 36,800

                                       46,000

cost per order =  $7,700,000/ 46,000

                         =   $167.74

Defense division =  $167.74*9,200 = $1,540,000

Commercial division  = $167.74 * 36,800 = $6,160,000

b. Cost charge to each division using dollar amount of purchases as basis of allocation

Total amount of purchase by the departments

Defense division =       $148,000,000

Commercial division=    222,000,000

                                       370,000,000

cost per division :

Defense division    =   $148,000,000    * $7,700,000

                                     $370,000,000

                              =  $3,080,000

Commercial division =    $222,000,000    *   $7,700,000

                                        $370,000,000

                                   =   $4,620,000

c.  The method used in determining the price by each division does not have any impact in the selection of basis of allocating cost to each division.

Explanation: