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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. (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. (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:                                                            

                                                                       Case 618

Direct attorney-hours                                 150          

Direct Materials andsupplies                  $5000          

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?