Question

Overhead Application, Activity-Based Costing, Bid Prices Firenza Company manufactures specialty tools to customer order. Budgeted overhead for the coming year is:
Purchasing $40,000
Setups 37,500
Engineering 50,000
Other 40,000
Previously, Sanjay Bhatt, Firenza Company's controller, had applied overhead on the basis of machine hours. Expected machine hours for the coming year are 50,000. Sanjay has been reading about activity-based costing, and he wonders whether or not it might offer some advantages to his company. He decided that appropriate drivers for overhead activities are purchase orders for purchasing, number of setups for setup cost, engineering hours for engineering cost, and machine hours for other. Budgeted amounts for these drivers are 5,000 purchase orders, 500 setups, and 2,500 engineering hours. Sanjay has been asked to prepare bids for two jobs with the following information:
Job 1 Job 2
Direct materials $4,600 $9,340
Direct labor $1,200 $2,200
Number of purchase orders 15 20
Number of setups 3 4
Number of engineering hours 45 10
Number of machine hours 200 200
The typical bid price includes a 40 percent markup over full manufacturing cost.
Required:
1. Calculate a plantwide rate for Firenza Company based on machine hours.
2. Calculate activity rates for the four overhead activities. What is the bid price of each job using these rates?
3. Which bids are more accurate?

Answer 1

Answer:

Firenza Company

1. Plantwide overhead rate based on machine hours = $3.35

2. Overhead Rates:

Purchasing          $8 per purchase order

Setups                 $75 per setup

Engineering        $20 per engineering hour

Other                  $8 per machine hour

                       Plantwide rate     ABC rates

Bid prices

Job 1                      $6,470            $12,103

Job 2                    $12,210           $19,320

                 

3. The bids based on ABC rates are more accurate.

Explanation:

a) Data and Calculations:

Budgeted overhead for the coming year is:

Purchasing          $40,000

Setups                   37,500

Engineering          50,000

Other                    40,000

Total overhead $167,500

Expected machine hours = 50,000

Plantwide overhead rate based on machine hours = $3.35 ($167,500/50,000)

                           Overhead  Usage / Cost Driver           Overhead Rates

Purchasing          $40,000    5,000 purchase orders    $8/purchase order

Setups                   37,500        500 setups                    $75/ setup

Engineering          50,000    2,500 engineering hours $20/eng. hour

Other                    40,000     5,000 machine hours       $8 /machine hour  

Job Costing based on Plantwide rate:

                                                       Job 1                      Job 2

Direct materials                           $4,600                   $9,340

Direct labor                                     1,200                     2,200

Overhead costs:                               670                        670

Total production costs               $6,470                   $12,210

Job Costing based on ABC rates:

                                                       Job 1                      Job 2

Direct materials                           $4,600                   $9,340

Direct labor                                  $1,200                   $2,200

Overhead costs:                         $2,845                   $2,260

Total costs of production           $8,645                  $13,800

Markup (40%)                             $3,458                   $5,520

Selling price                               $12,103                  $19,320

   

Number of purchase orders         $120 (15*$8)           $160 (20*$8)

Number of setups                          225 (3*$75)            300 (4*$75)

Number of engineering hours      900 (45*$20)          200 (10*$20)

Number of machine hours          1,600 (200*$8)       1,600 (200*$8)

Overhead costs:                       $2,845                    $2,260