Preston Department Store has a new promotional program that offers a free gift-wrapping service for its customers. Preston's customer-service department has practical capacity to wrap 5,000 gifts at a budgeted fixed cost of $4,950 each month. The budgeted variable cost to gift-wrap an item is $0.35. During the most recent month, the department budgeted to wrap 4,500 gifts. Although the service is free to customers, a gift-wrapping service cost allocation is made to the department where the item was purchased. The customer-service department reported the following for the most recent month: Department Budgeted Items Wrapped Actual Items Wrapped
Giftware 1000 1200
Women's Apparel 850 650
Fragrances 1000 900
Men's Apparel 750 450
Domestic 900 800
Total 4500 4000

Required:
1. Using the single-rate method, allocate gift-wrapping costs to different departments in these three ways:
a. Calculate the budgeted rate based on the budgeted number of gifts to be wrapped and allocate costs based on the budgeted use (of gift-wrapping services).
b. Calculate the budgeted rate based on the budgeted number of gifts to be wrapped and allocate costs based on actual usage.
c. Calculate the budgeted rate based on the practical gift-wrapping capacity available and allocate costs based on actual usage.

2. Using the dual-rate method, compute the amount allocated to each department when (a) the fixe cost rate is calculated using budgeted costs and the practical gift-wrapping capacity, (b) fixed costs are allocated based on budgeted usage of gift-wrapping services, and (c) variable costs are allocated using the budgeted variable-cost rate and actual usage.

3. Comment on your results in requirements 1 and 2. Discuss the advantages of the dual-rate method.

Preston Department Store

1) Using the single-rate method:

a. Calculation of the budgeted rate based on the budgeted number of gifts = Total overhead/budgeted number of gifts

= $6,525/4,500

= $1.45

Allocation of costs based on the budgeted use of gift-wrapping services:

Department      Budgeted Items   Budgeted   Allocation

                             Wrapped               Rate

Giftware                    1,000                $1.45         $1,450.00

Women's Apparel      850                 $1.45           1,232.50

Fragrances              1,000                 $1.45        $1,450.00

Men's Apparel           750                 $1.45        $1,087.50

Domestic                   900                 $1.45        $ 1,305.00

Total                       4,500                 $1.45       $6,525.00

b. Allocation of costs based on the actual use of gift-wrapping services:

Department        Actual Items     Budgeted        Allocation

                             Wrapped               Rate

Giftware                    1,200                $1.45          $1,740.00

Women's Apparel      650                 $1.45           $942.50

Fragrances                 900                 $1.45       $1,305.00

Men's Apparel           450                 $1.45          $652.50

Domestic                   800                 $1.45         $ 1,160.00

Total                       4,000                 $1.45       $5,800.00

c. Budgeted rate based on the practical gift-wrapping capacity:

= Total budgeted costs/practical gift-wrapping capacity

= $6,700/5,000

= $1.34

Allocation of costs based on the actual use of gift-wrapping services:

Department        Actual Items     Budgeted        Allocation

                             Wrapped             Rate

Giftware                    1,200                $1.34          $1,608.00

Women's Apparel      650                 $1.34              $871.00

Fragrances                 900                $1.34          $1,206.00

Men's Apparel           450                 $1.34            $603.00

Domestic                   800                 $1.34          $ 1,072.00

Total                       4,000                 $1.34         $5,360.00

2. Using the dual-rate method:

   Fixed cost rate = $4,950/5,000 = $0.99

   Variable cost rate = $0.35

a) Allocation of costs based on the actual use of gift-wrapping services:

Department     Budgeted Items    Actual Items          Allocation      

                          Wrapped              Wrapped         Fixed      Variable    Total

Giftware                 1,000                  1,200          $990.00    $420      $1,410

Women's Apparel   850                     650             841.50      227.5  $1,069

Fragrances           1,000                     900            990.00      315      $1,305

Men's Apparel        750                     450            742.50       157.5    $900

Domestic                900                     800             891.00      280       $1,171

Total                     4,000                                                                     $5,855

b) Allocation of fixed cost based on budgeted usage of gift-wrapping services:

   Fixed cost rate based on budgeted usage = $4,950/4,500 = $1.10

Department    Budgeted Items   Allocation of

                             Wrapped         Fixed costs

Giftware                    1,000              $1,100

Women's Apparel      850              $  935

Fragrances              1,000              $  1,100

Men's Apparel           750              $  825

Domestic                   900              $  990

Total                       4,500             $4,950

c) Allocation of variable costs using the budgeted  variable-cost rate and actual usage

Variable cost rate = $0.35

Department    Actual Items        Allocation of

                             Wrapped      Variable costs

Giftware                     1,200            $420

Women's Apparel       650             $227.50

Fragrances                  900           $ 315

Men's Apparel            450             $157.50

Domestic                    800             $280

Total                        4,000            $1,400

3. It looks as if the dual-rate method is far better than the single-rate method.  But it consumes more time during the allocation process.  It is also a bit difficult and confusing.

The dual-rate cost allocation method categorizes costs into fixed costs and variable costs. The dual-rate method gives different cost allocation rates and is a more exact cost allocation method.

Explanation:

Practical capacity = 5,000

Budgeted fixed cost = $4,950

Budgeted variable cost = $0.35

Budgeted units = 4,500

Budgeted variable cost = $1,575 ($0.35 * 4,500)

Total overhead = $6,525 ($4,950 + 1,575)

Predetermined overhead rate = $1.45 ($6,525/4,500)

Department    Budgeted Items   Actual Items

                             Wrapped           Wrapped

Giftware                    1,000                1,200

Women's Apparel      850                   650

Fragrances              1,000                   900

Men's Apparel           750                   450

Domestic                   900                   800

Total                       4,500                4,000