Reference no: EM131196665

Factory overhead rate

Salvo Inc., a specialized equipment manufacturer, uses a job order costing system. The overhead is allocated to jobs on the basis of direct labor hours. The overhead rate is now $1,500 per direct labor hour. The design engineer thinks that this is illogical. The design engineer has stated the following:

Our accounting system doesn't make any sense to me. It tells me that every labor hour carries an additional burden of $1,500. This means that direct labor makes up only 6% of our total product cost, yet it drives all our costs.

In addition, these rates give my design engineers incentives to"design out" direct labor by using machine technology. Yet, over the past years as we have had less and less direct labor, the overhead rate keeps going up and up. I won't be surprised if next year the rate is $2,000 per direct labor hour. I'm also concerned because small errors in our estimates of the direct labor content can have a large impact on our estimated costs. Just a 30-minute error in our

estimate of assembly time is worth $750. Small mistakes in our direct labor time estimates really swing our bids around. I think this puts us at a disadvantage when we are going after business.
1. What is the engineer's concern about the overhead rate going "up and up"?

2. What did the engineer mean about the large overhead rate being a disadvan­ tage when placing bids and seeking new business?

3. What do you think is a possible solution?

Recording manufacturing costs

Todd Lay just began working as a cost accountant for Enteron Industries Inc., which manufactures gift items. Todd is preparing to record summary journal entries for the month. Todd begins by recording the factory wages as follows:
Wages Expense 60,000
Wages Payable 60,000

Then the factory depreciation:
Depreciation Expense-Factory Machinery 20,000 Accumulated Depreciation-Factory Machinery 20,000 Todd's supervisor, Jeff Fastow, walks by and notices the entries. The following con­ versation takes place:

Jeff: That's a very unusual way to record our factory wages and depreciation for the month.

Todd: What do you mean? This is exactly the way we were taught to record wages and depreciation in school. You know, debit an expense and credit Cash or payables, or in the case of depreciation, credit Accumulated Depreciation.

Jeff: Well, it's not the credits I'm concerned about. It's the debits-I don't think you've recorded the debits correctly. I wouldn't mind if you were recording the administrative wages or office equipment depreciation this way, but I've got real questions about recording factory wages and factory machinery depreciation this way.

Todd: Now I'm really confused. You mean this is correct for administrative costs, but not for factory costs? Well, what am I supposed to do-and why?

1. Play the role of Jeff and answer Todd's questions.

2. Why would Jeff accept the journal entries if they were for administrative costs?