4-18 Page 125 Actual Costs Construction Period Direct Materials Direct Labor Direct Labor-Hours Laguna Mission

Model Model Feb-June 2008 May-Oct 2008 $106,450 $127,604 $36,276 $41,410 900 1,010

2008 Budget Support Costs 2008 Budget DL Hrs 2008 Actual Support Costs 2008 Actual DL Hrs 1.) a.) Budgeted Indirect Cost Rate = Actual Indirect Cost Rate =

$8,000,000 160,000 $6,888,000 164,000 Budgeted indirect costs Budgeted direct labor hours Actual indirect costs Actual direct labor hours $8,000,000 160,000 $6,888,000 164,000

$50.00

b.)

$42.00

These rates differ because both the numerator and the denominator in the two calculations are different—one based on budgeted numbers and the other based on actual numbers.
2a.) Budgeted Rate * DLH Normal Costing Direct Costs Direct Materials Direct Labor Indirect costs Assembly support ($50 x 900; $50 x 1,010) TOTAL COSTS 2b.) Actual Costing Direct Costs Direct Materials Direct Labor Indirect costs Assembly support ($42 x 900; $42 x 1,010) TOTAL COSTS Laguna Model $106,450 36,276 142,726 45,000 $187,726 Actual Rate * DLH $106,450 36,276 142,726 37,800 $180,526 $127,604 41,410 169,014 42,420 $211,434 Mission Model $127,604 41,410 169,014 50,500 $219,514

Normal costing enables Anderson to report a job cost as soon as the job is completed, assuming that both the direct materials and direct labor costs are known at the time of use. Once the 900 direct labor-hours are known for the Laguna Model (June 2007), Anderson can compute the $187,726 cost figure using normal costing. Anderson can use this information to manage the costs of the Laguna Model job as well as to bid on similar jobs later in the year. In contrast, Anderson has to wait until the December 2007 year-end to 3.) compute the $180,526 cost of the Laguna Model using actual costing.

Per DL Hr

Per DL Hr

4-19 Page 126 Budgeted manufacturing overhead costs Budgeted machine-hours Actual manufacturing overhead costs Actual machine-hours $4,000,000 200,000 $3,860,000 195,000

1.) Budgeted manufacturing overhead rate =

Budgeted manufacturing overhead Budgeted machine hours $4,000,000 200,000

$20.00

2.) Manufacturing overhead allocated =

Actual Machine hours x Budgeted mfg OH rate 195,000 $20.00 $3,900,000 $3,900,000 $3,860,000 $40,000

3.) Manufacturing overhead allocated Actual manufacturing overhead costs Over(Under) allocated mfg overhead

Since manufacturing overhead allocated is greater than the actual manufacturing overhead costs, Waheed overallocated manufacturing overhead

5-19 Page 165 1.) Variable Manufacturing Overhead in 2009 $ 39,000 $ 29,600 $ 240,000 $308,600 Usage of Cost Drivers by Customer Contract Holden Motors 200 60 2,800 Leland Vehicle 80 240 1,080

Department Design Engineering Production Total

Cost Driver CAD-design hours Engineering hours Machine hours

United Motors 110 70 120

Percentage of machine overhead allocated to each Variable manufacturing hours used by each customer customer with machine-hours as allocation base

3% $9,258

70% $216,020

27% $83,322

2.) Department Design Engineering Production Cost Driver CAD-design hours Engineering hours Machine hours

Variable Manufacturing Overhead in 2007 $ 39,000 29,600 240,000

Usage of Cost Drivers by Customer Contract Holden Leland United Motors Motors Vehicle 110 70 120 $11,000 $5,600 $7,200 $23,800 200 60 2,800 $20,000 $4,800 $168,000 $192,800 80 240 1,080 $8,000 $19,200 $64,800 $92,000

Design-related overhead, allocated on CAD-design hours Production-related overhead, allocated on engineering hours Engineering-related overhead, allocated on machine hours Total

3.) Department rates (Requirement 2) Machine Hour Rate (Requirement 1) Difference Ratio

United Motors $23,800 $9,258 $14,542 2.57

Holden Motors $192,800 $216,020 $(23,220) 0.89

Leland Vehicle $92,000 $83,322 $8,678 1.10

The variable manufacturing overhead allocated to United Motors increases by 157% under the department rates, the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by abou 10%. The three contracts differ sizably in the way they use the resources of the three departments. The percentage of total driver units in each department used by the companies is:
Percentage of CAD-design hours used by each customer 28% 51% 21%

Percentage of engineering hours used by each customer Percentage of machine hours used by each customer

19% 3%

16% 70%

65% 27%

The United Motors contract uses only 3% of total machines hours in 2004, yet uses 28% of CAD design-hours and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will greatly underestimate the cost of resources used on the United Motors contract. This explains the 157% increase in indirect costs assigned to the United Motors contract when department rates are used. In contrast, the Holden Motors contract uses less of design (51%) and engineering (16%) than of machine-hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate. Holden Motors was probably complaining under the use of the simple system because its contract was being overcosted relative to its consumption of MOH resources. United, on the other hand was having its contract undercosted and underpriced by the simple system. Assuming that AP is an efficient and competitive supplier, if the new department-based rates are used to price contracts, United will be unhappy. AP should explain to United how the calculation was done, and point out United’s high use of design and engineering resources relative to production machine hours. Discuss ways of reducing the consumption of those resources, if possible, and show willingness to partner with them to do so. If the price rise is going to be steep, perhaps offer to phase in the new prices.
4.)

Other than for pricing, AP can also use the information from the department-based system to examine and streamline its own operations so that there is maximum value-added from all indirect resources. It might set targets over time to reduce both the consumption of each indirect resource and the unit costs of the resources. The department-based system gives AP more opportunities for targeted cost management.

5.) ÷

It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation among contracts in the consumption of activities within a department. If, for example, most activities within the design department were, in fact, driven by CAD-design hours, then the more refined system would be more costly and no more accurate than the department-based cost system. Even if there was sufficient variation, considering the relative sizes of the 3 department cost pools, it may only be cost-effective to further analyze the engineering cost pool, which consumes 78% ($240,000$308,600) of the manufacturing overhead.

Customer Contract

Total 390 370 4,000

100% $308,600

Customer Contract Total 390 370 4,000 $39,000 29,600 240,000 $308,600 Rate $100 $80 $60

$308,600 $308,600 $-

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