Reference no: EM13336430

I. Retired Professor Housecleaning

Retired Professor Housecleaning provides housecleaning services to its clients. The company uses an activity-based costing system for its overhead costs. The company has provided the following data from its activity-based costing system.

	Activity Cost Pool	Total Cost	Total Activity
	Cleaning...............	$645,576	72,700	hours
	Job support..........	$129,546	5,400	jobs
	Client support.....	$ 20,900	760	clients
	Other.....................	$110,000
	Total......................	$906,022

The "Other" activity cost pool consists of the cost of idle capacity based on a normal capacity measure.

One particular client, the Anderson family, requested 31 jobs during the year that required a total of 62 hours of housecleaning. For this service, the client was charged $1,620

Required:

1) Compute the activity rates (i.e., cost per unit of activity) for all the activity cost pools.

2) Using the activity-based costing system, compute the customer margin for the Anderson family.

3) Assume the company decides instead to use a traditional costing system in which ALL costs are allocated to customers on the basis of cleaninghours. Compute the margin for the Anderson family.

4) The president of Retired Professor Housecleaning asks you to explain your decision about how you handled the cost of idle capacity in your calculations above. Explain your reasoning to the president.

5) The president also asks you about possible cost savings that could be realized by reducing the total number of jobs by 50. Since the activity level for jobs will decrease, the president says that the savings must be calculated by multiplying the decline in jobs times the activity rate for job support. What is your response to the president?

II. Sharpe Fabricators Corporation

Sharpe Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plant-wide predetermined overhead rate based on direct labor-hours. On December 10, 2013, the company's controller made a preliminary estimate of the predetermined overhead rate for 2014. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labor-hours for 2014:

$2,475,000 / 52,000 = $47.60 per direct labor hour

This new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2013. One of the subjects discussed at the meeting was a proposal by the production manager to purchase an automated milling machine center built by Central Robotics. The president of Sharpe Fabricators, Kevin Reynolds, agreed to meet with the regional sales representative from Central Robotics to discuss the proposal.

On the day following the meeting, Mr. Reynolds met with Jay Warner, Central Robotics' sales representative. The following discussion took place:

Reynolds:	Larry Winter, our production manager, asked me to meet with you since he is interested in installing an automated milling machine center. Frankly, I am skeptical. You're going to have to show me this isn't just another expensive toy for Larry's people to play with.
Warner:	That shouldn't be too difficult, Mr. Reynolds. The automated milling machine center has three major advantages. First, it is much faster than the manual methods you are using. It can process about twice as many parts per hour as your present milling machines. Second, it is much more flexible. There are some up-front programming costs, but once those have been incurred, almost no setup is required on the machines for standard operations. You just punch in the code of the standard operation, load the machine's hopper with raw material, and the machine does the rest.
Reynolds:	Yeah, but what about cost? Having twice the capacity in the milling machine area won't do us much good. That center is idle much of the time anyway.
Warner:	I was getting there. The third advantage of the automated milling machine center is lower cost. Larry Winters and I looked over your present operations, and we estimated that the automated equipment would eliminate the need for about 6,000 direct labor-hours a year. What is your direct labor cost per hour?
Reynolds:	The wage rate in the milling area averages about $21 per hour. Fringe benefits raise that figure to about $30 per hour.
Warner:	Don't forget your overhead.
Reynolds:	Next year the overhead rate will be about $48 per hour.
Warner:	So including fringe benefits and overhead, the cost per direct labor-hour is about $78.
Reynolds:	That's right.
Warner:	Since you can save 6,000 direct labor-hours per year, the cost savings would amount to about $468,000 a year.
Reynolds:	That's pretty impressive, but you aren't giving away this equipment are you?
Warner:	Several options are available, including leasing and outright purchase. Just for comparison purposes, our 60-month lease plan would require payments of only $300,000 per year.
Reynolds:	Sold! When can you install the equipment?

Shortly after this meeting, Mr. Reynolds informed the company's controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realized that this decision would require a re-computation of the predetermined overhead rate for the year 2014 since the decision would affect both the manufacturing overhead and the direct labor-hours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned.

When the revised predetermined overhead rate for the year 2014 was circulated among the company's top managers, there was considerable dismay.

Required:

1)Re-compute the predetermined rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for the year 2014.

2) What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine? Why?

3) Why would managers be concerned about the new overhead rate?

4) After seeing the new predetermined overhead rate, the production manager admitted that she probably wouldn't be able to eliminate all of the 6,000 direct labor-hours. She had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would be only about 2,000 hours-one worker. In the light of this additional information, evaluate the original decision to acquire the automated milling machine from Central Robotics.

III. Joe's Tabletops

Joe's Tabletops produces fine tabletops. The company's income statements for two months during the last year are given below:

		April	July
	Units sold	5,000	7,000
	Sales	$8,000,000	$11,200,000
	Cost of goods sold	5,500,000	7,100,000
	Gross margin	2,500,000	4,100,000
	Selling & administrative expense	1,500,000	1,900,000
	Net operating income	$1,000,000	$ 2,200,000

The company has no beginning or ending inventories.

Required:

1) Estimate the company's total variable cost per unit and its total fixed costs per year.

2) Compute the company's contribution margin for July.

 IV. Sportway, Inc.

Sportway, Inc., is a wholesale distributor supplying a wide range of moderately priced sporting equipment to large chain stores. About 60 percent of Sportway's products are purchased from other companies, while the remaining products are manufactured by Sportway. The company's Plastics Department is currently manufacturing molded fishing tackle boxes. Sportway is able to manufacture and sell 8,000 tackle boxes annually, making full use of its direct labor capacity at available workstations. Following are the selling price and costs associated with Sportway's tackle boxes.

Selling price per box			$86.00
Costs per box:
Molded plastic	$8.00
Hinges, latches, handle	9.00
Direct labor ($15/hour)	18.75
Manufacturing overhead	12.50
Selling and administrative expenses	17.00		65.25
Profit per box			$20.75

Because Sportway believes it could sell 12,000 tackle boxes if it had sufficient manufacturing capacity, the company has looked into the possibility of purchasing the tackle boxes for distribution. Maple Products, a steady supplier of quality products, would be able to provide up to 9,000 tackle boxes per year at a price of $68 per box delivered to Sportway's facility.

Bart Johnson, Sportway's product manager, has suggested that the company could make better use of its Plastics Department by manufacturing skateboards. To support his position, Bart has a market study that indicates an expanding market for skateboards and a need for additional suppliers. He believes that Sportway could expect to sell 17,500 skateboards annually at a price of $45 per skateboard. Bart's estimate of the costs to manufacture the skateboards follows:

Selling price per skateboard			$45.00
Costs per skateboard:
Molded plastic	$5.50
Wheels, hardware	7.00
Direct labor ($15/hour)	7.50
Manufacturing overhead	5.00
Selling and administrative expenses	9.00		34.00
Profit per skateboard			$11.00

In the Plastic Department, Sportway uses direct labor hours as the application base for manufacturing overhead. Included in the manufacturing overhead for the current year is $50,000 of factory-wide, fixed manufacturing overhead that has been allocated to the Plastics Department. For each unit of product that Sportway sells, regardless of whether the product has been purchased or is manufactured by Sportway, an allocated $6 fixed overhead cost per unit for distribution is included in the selling and administrative expenses for all products. Total selling and administrative expenses for the purchased tackle boxes would be $10 per unit.

Required:

1) Prepare an analysis based on the data presented that will show which product or products Sportway, Inc., should manufacture and/or purchase in order to maximize the company's profitability. It should also show the associated financial impact. Support your answer with appropriate calculations.

2) Discuss some qualitative factors that might affect Sportway's decision.