Allocating Overhead Versus Direct Tracing
Nixon & Ross, a Law

question 4

Essay

Allocating Overhead versus Direct Tracing
Nixon & Ross, a law firm, is about to install a new accounting system that will allow the firm to track more of the overhead costs to individual cases. Overheads are currently allocated to individual client cases based on billable professional staff salaries. Attorneys working on client cases charge their time to "billable professional staff salaries." Attorney time spent in training, law firm administrative meetings, and the like is charged to an overhead account titled "unbilled staff salaries."
The following is a summary of the costs for the current year: $$\begin{array} { | l | r | } \hline \text { Billable professional staff salaries } & \$ 4,000,000 \\\hline \text { Overhead } & 8,000,000 \\\hline \text { Total costs } & \$ 12,000,000 \\\hline\end{array}$$ The overhead costs were as follows: $$\begin{array} { | l | r | } \hline \text { Secretarial costs } & \$ 1,500,000 \\\hline \text { Staff benefits } & 2,750,000 \\\hline \text { Office rent } & 1,250,000 \\\hline \text { Telephone and mailing costs } & 1,500,000 \\\hline \text { Unbilled staff salaries } & 1,000,000 \\\hline \text { Total costs } & \$ 8,000,000 \\\hline\end{array}$$ Under the new accounting system, the firm will be able to trace secretarial costs, staff benefits, and telephone and mailing costs to specific clients.
The following are the costs incurred on the Lawson Company case: $$\begin{array} { | l | r | } \hline \text { Billable professional staff salaries } & \$ 150,000 \\\hline \text { Secretarial costs } & 25,000 \\\hline \text { Staff benefits } & 13,500 \\\hline \text { Telephone and mailing costs } & 8,000 \\\hline \text { Total costs } & \$ 196,500 \\\hline\end{array}$$ Required:
a. Calculate the current year's overhead application rate under the old cost accounting system.
b. How would this application rate change if the secretarial costs, staff benefits, and telephone and mailing costs were reclassified as direct costs instead of overhead, and overhead was assigned based on direct costs (instead of staff salaries)? Direct costs are defined as billable staff salaries plus secretarial costs, staff benefits, and telephone and mailing costs.
c. Use the overhead application rates from (a) and (b) to compute the cost of the Lawson case.
d. Nixon & Ross bills clients 150 percent of the total costs of the job. What will be the total billings to the Lawson Co. if the old overhead application scheme is replaced with the new overhead scheme?
e. Steve Nixon, managing partner, has commented that replacing the old allocation system with the direct charge method of the new accounting system will result in more accurate costing and pricing of cases. Evaluate the new system.

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