Cost Allocation and Apparent Profitability. Diamonds, Etc. manufactures jewelry settings and sells them to retail stores. In the past, most settings were made by hand, and the overhead allocation rate in the prior years was $12 per labor hour ($2,400,000 overhead / 200,000 labor hours). In the current year, overhead increased by $800,000 due to acquisition of equipment. Labor, however, decreased by 40,000 hours because the equipment allows rapid creation of settings. One of the company's many customers is a local jewellery store, Jasmine's Fine Jewellery. This store is relatively small, and the time to make and the time to make an order of jewelry pieces is typically less than 10 labor. On such jobs (less than 10 labor hours), the new equipment is not used, and thus the jobs are relative labor intensive.
a. Assume that in the current year, the company continues to allocate overhead based on labor hours. What would be the overhead cost of a 10-labor-hour job requested by Jasmine's Fine Jewelry? How does this compare to the overhead cost charged to such a job in the prior year?
b. Assume that the price charged for small jobs does not change in the current year. Are small jobs less profitable than they were in the past? Why or why not?
The solution discusses a Diamond case study regarding cost allocation and apparent profitability.