Tax Savings and Costing (The Case of TransferPricing)
Please prepare a report answering the listed questions.You may Excel to create spreadsheets and copy the answers to thisdocument.
Hansen, Kotter, and Zales is a law firm that contains oneservice department (Research & Document) and two productiondepartments (Litigation and Consulting). The firm employs ajob-order costing system to accumulate costs chargeable to eachclient. The firm uses actual costing to assign overhead.General overhead costs can be allocated based on eitherdirect attorney hours or the number of employees, depending onmanagers’ choice. At the end of the year, the recordsrevealed the actual general overheadcosts are $720,000. At the end of the year, the records revealedthe following costs and operating data for all cases handled duringthe year:
| | Research & Document | | | Litigation | | Consulting |
# of Employees | 10 | | | 8 | | 6 |
Direct Attorney Hours(# of hrs) | 3,000 | | | 8,000 | | 5,000 |
Direct Attorney Costs ($) | $150,000 | | | $400,000 | | $250,000 |
Direct Material Costs ($) | $16,000 | | | $15,500 | | $13,500 |
*** 50% of Research & Department's service isprovided to litigation department and the other 50% to consultingdepartment.
Part I Cost Allocation
- (1.5 point) Compute the overhead allocation rates for generaloverhead based on different cost drivers. What are the overheadcosts assigned to each department, using different costdrivers?
Overhead allocation based ondirect attorney hours
                           Research and development|     Litigation     |      Consulting      | Total
Direct attorneyhours                    3,000                             8,000                       5,000                16,000
Percentage of total                     18.75%                         50%                      31.25%
Allocated overheadcost                $135,000                  $360,000                 $225,000
Overhead allocation based onnumber of employees
                           Research and development|     Litigation     |      Consulting      | Total
Number ofemployees                      10                                   8                              6                       24
Percentage of total                     41.67%*                      33.33%                   25%
Allocated overheadcost                $300,000                  $240,000                 $180,000
*rounded answer but to calculate allocated overhead cost I used(10/24)*720,000 so I would get an exact answer, I just rounded299,999.999999 to 300,000
- (1.5 point) Compare the total costs of each productiondepartment after departmental cost allocation, using attorney hoursand the number of employees as cost driver, respectively. Does thechoice of cost driver affect the total costs of each productiondepartment?
Overhead cost of production departments using differentcost drivers
Based on attorney hours
                                               Litigation                    |           Consulting
Allocated costs                          $360,000                                 $225,000
Research & Development            +67,500                                   +67,500
Total OverheadCosts                    $427,500                                 $292,500
Based on number of employees
                                               Litigation                    |           Consulting
Allocated costs                          $240,000                                 $180,000
Research &Development            +150,000                                +150,000
Total OverheadCosts                    $390,000                                 $330,000
To answer your question simply: yes, choice of cost driver doesaffect the costs of each production department.
- Litigation has a total overhead cost of $427,500 whenallocating based on attorney hours and has a total overhead cost of$390,000 when allocating based on number of employees.
- Consulting has a total overhead cost of $292,500 whenallocating based on attorney hours and has a total overhead cost of$330,000 when allocating base on number of employees.
Assume that the company uses attorney hours to allocate generaloverhead costs. For litigation department, the costs charged toeach case are made up of four elements:
- Direct attorney costs (charged at $50 per hour)
- Direct materials and supplies used
- General overheads are applied by direct attorney hours
- Costs allocated from the service department is assigned tocases by direct attorney hours incurred within the department
The information on one of its cases during this period is givenas follows:Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â
                                                                       Case 618
Direct attorney-hours                                 150         Â
Direct Materials andsupplies                $5000         Â
c. (1.5 point) What are the total costs accumulated for Case618? The company charged the client $30,000 for the service, whatis the profit the company earned?
d. (0.5 point) Suppose the firm’sannual revenue is 2 million dollars. The corporate tax rate is 35%.How much taxes shall the company pay? Does the choice of costdriver affect the total taxes due?
