Question

Thompson Instruments (TI) has proprietary technology and produces products for three market segments: commercial, defense, and international. Thompson has three profit centers organized by the same three market segments. After each profit center produces its products, they are sent to a centralized TI testing lab for final testing and certification. The TI testing lab, which is treated as a cost center, has the following cost structure: fixed costs of $ 240,000 per month and variable costs of $ 30 per testing hour performed. The $ 240,000 of fixed costs consists almost entirely of historical cost depreciation of the testing equipment. Outside testing firms can also be used to test TI products produced by the three profit centers. Each outside testing firm can only test products for one TI market segment (commercial, defense, or international). Geographic and technical differences among the outside testing vendors prevent the defense vendor from testing commercial or international TI products. Likewise, the defense vendor can only test TI defense products. And so forth. The following table summarizes the prices charged by the outside testing vendors and the number of testing hours budgeted for each month for Year One. (Assume that all 12 months in each year are identical.)


Thompson Instruments has the policy of recharging the testing department’s fixed and variable costs through a single overhead rate set at the beginning of the year based on the budgeted testing hours of all three profit centers. Each profit center has the decision- making authority to have its products tested internally by TI’s testing department or by the external vendor. Assume the only difference between TI’s testing department and the outside testing vendors is price. Quality, timeliness, confidentiality, and so forth, are identical between inside and outside testing.

Required:
a. Calculate the testing department’s overhead rate per testing hour for Year One.
b. Given the testing department’s overhead rate computed in part ( a ) for Year One, which profit centers will choose TI’s testing for their products, and which profit centers will use the outside vendor?

c. Before Year Two begins and before the TI testing department lab overhead rate is set for Year Two, TI’s defense profit center loses a government contract that involves 1,000 testing hours per month. Calculate the testing department’s overhead rate per testing hour for Year Two, assuming that the other two profit centers continue to have the same number of testing hours they used in Year One and that the TI testing department’s fixed cost and variable cost per hour do not change.
d. Given the testing department’s overhead rate computed in part ( c ) for Year Two, which profit centers will choose TI’s testing for their products, and which profit centers will use their outside vendor?
e. Based on your answer to part (d), and assuming: (1) the TI testing department’s fixed cost and variable cost per hour do not change, (2) Defense does not regain the lost contract, and ( 3) the Year Three overhead rate set in the testing department is based on the number of testing hours performed by the testing department in Year Two, calculate the testing department’s overhead rate in Year Three.
f. Given the testing department’s overhead rate computed in part (e) for Year Three, which profit centers will choose TI’s testing for their products, and which profit centers will use their outside vendor?
g. Based on your answer to part (f), and assuming: (1) the TI testing department’s fixed cost and variable cost per hour do not change, (2) Defense does not regain the lost contract, and (3) the Year Four overhead rate set in the testing department is based on the number of testing hours performed by the testing department in Year Three, calculate the testing department’s overhead rate in Year Four.
h. Given the testing department’s overhead rate computed in part (g) for Year Four, which profit centers will choose TI’s testing for their products, and which profit centers will use their outside vendor?
i. Given the sequence of events that have occurred over Years One through Four, what problem does TI face? Propose (and then critique) TWO possible solutions to resolve theproblem.


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  • CreatedDecember 15, 2014
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