You often provide advice to Maria Graham, a client who is interested in diversifying her company. Maria is considering the purchase of a small manufacturing company that assembles and packages its many products by hand. She plans to automate the factory and her projections indicate that the company will once again be profitable within two to three years. During her review of the company’s records, she discovered that the company currently uses direct labor-hours to allocated overhead to its products. Because of its simplicity, Maria hopes that this approach can continue to be used.

Direct labor hours are an appropriate allocation base for manufacturing companies that assemble and package products by hand.

Once the factory is automated, however, it will be more advantageous and relevant to use machine-hours as the allocation base for overhead.

This change of allocation base, even though it will require some careful thought at the beginning, will be just as ’simple’ to apply as any other allocation base.