Both Matos Company and Stubee Corporation use predetermined overhead rates for product costing, inventory valuation, and sales quotations. The two businesses are about the same size, and they compete in the corrugated box industry. Because the overhead rate is an estimated measure, Matos Company’s management believes that the controller’s department should spend little effort in developing it. The company computes the rate annually based on an analysis of the previous year’s costs. No one monitors its accuracy during the year. Stubee Corporation takes a different approach. One person in the controller’s office is responsible for developing overhead rates on a monthly basis. All cost estimates are checked carefully to make sure they are realistic.

Accuracy checks are done routinely at the end of each month, and forecasts of changes in business activity are taken into account. Assume that Cooke Corporation, an East Coast manufacturer of corrugated boxes, has hired you as a consultant. Asimina Hiona, Cooke’s controller, wants you to recommend the best method of developing overhead rates. Based on your knowledge of Matos’s and Stubee’s practices, write a memo to Hiona that answers the following questions:

1. What are the advantages and disadvantages of Matos’s and Stubee’s approaches to developing overhead rates?

2. Which company has taken the more cost-effective approach to developing overhead rates? Defend your answer.

3. Is an accurate overhead rate most important for product costing, inventory valuation, or sales quotations? Why?

4. What is activity-based costing (ABC)? Would it be better than the two approaches discussed above? Explain.

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