1.4 Gateway Construction Company
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Feb 20, 2024
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1.4 Gateway Construction Company
Gateway Construction Company, run by Jack Gateway, employs 25 to 30 people as subcontractors for laying gas, water, and sewage pipelines. Most of Gateway's work comes from contracts with city and state agencies in Nebraska. The company's sales volume averages $3 million, and profits vary between 0 and 10% of sales.
Sales and profits have been somewhat below average for the past 3 years due to a recession and intense competition. Because of this competition, Jack constantly reviews the prices that other companies bid for jobs. When a bid is lost, he analyzes the reasons for the differences between his bid and that of his competitors and uses this information to increase the competitiveness of future bids.
Jack believes that Gateway's current accounting system is deficient. Currently, all expenses are simply deducted from revenues to arrive at operating income. No effort is made to distinguish among the costs of laying pipe, obtaining contracts, and administering the company. Yet all bids are based on the costs of laying pipe.
With these thoughts in mind, Jack looked more carefully at the income statement for the previous year (see below). First, he noted that jobs were priced on the basis of equipment hours, with an average price of $165 per equipment hour. However, when it came to classifying and assigning costs, he needed some help. One thing that really puzzled him was how to classify
his own $114,000 salary. About half of his time was spent in bidding and securing contracts, and
the other half was spent in general administrative matters.
Gateway Construction Company
Income Statement
For the Year Ended December 31, 2017
Sales (18,200 equipment hours @ $165 per hour) $3,003,000
Less expenses:
Utilities $24,000
Machine operators 218,000
Rent, office building 24,000
CPA fees 20,000
Other direct labor 265,700
Administrative salaries 114,000
Supervisory salaries 70,000
Pipe 1,401,340
Tires and fuel 418,600
Depreciation, equipment 198,000
Salaries of mechanics 50,000
Advertising 15,000
Total expenses
2,818,640
Operating income § 184,360
1.4 Gateway Construction Company
Read Case 2-62: Cost Classification, Income Statement at the very end of Chapter 2. Answer the following questions:
Classify the costs in the income statement as production costs (cost of laying pipe), selling costs (costs of securing contracts), or general administration costs.
For production costs, identify whether the costs are direct materials, direct labor, or overhead costs. Keep in mind that the company never has significant work in process
(most jobs are started and completed within a day).
Assume that a significant driver of cost is equipment hours. Identify the expenses that would likely be traced to jobs using this driver. Explain why you feel these costs are traceable using equipment hours.
Calculate the cost per equipment hour for these traceable costs.
1. Classification of Costs:
Production Costs (cost of laying pipe):
o
Utilities: $24,000
o
Machine operators: $218,000
o
Other direct labor: $265,700
o
Pipe: $1,401,340
o
Tires and fuel: $418,600
o
Depreciation, equipment: $198,000
o
Salaries of mechanics: $50,000
Selling Costs (costs of securing contracts):
o
Advertising: $15,000
o
Half of administrative salaries (Jack's time on bidding): $57,000 (50% of $114,000)
General Administration Costs:
o
Rent, office building: $24,000.
o
CPA fees: $20,000
o
Supervisory salaries: $70,000
o
Half of administrative salaries (Jack's time on general admin): $57,000 (50% of $114,000)
2. Production Cost Classification:
Direct Materials:
o
Pipe: $1,401,340
Direct Labor:
o
Machine operators: $218,000
o
Other direct labor: $265,700
Overhead Costs:
o
Utilities: $24,000
o
Tires and fuel: $418,600
1.4 Gateway Construction Company
o
Depreciation, equipment: $198,000
o
Salaries of mechanics: $50,000
3. Expenses Traceable to Equipment Hours:
Traceable Costs:
o
Machine operators: Since they operate the equipment.
o
Tires and fuel: Directly associated with the equipment usage.
o
Depreciation, equipment: As equipment gets used, it depreciates.
o
Salaries of mechanics: Their primary job is likely maintaining and fixing equipment, so the more the equipment is used, the more likely they'll need to intervene.
These costs are traceable to equipment hours because they are directly or indirectly impacted by how much the equipment is used. For instance, the more hours the equipment runs, the more wear and tear (hence, depreciation), fuel consumption, and potentially more work for mechanics and operators.
4. Cost Per Equipment Hour Calculation for Traceable Costs:
Traceable costs total: = Machine operators ($218,000) + Tires and fuel ($418,600) + Depreciation, equipment ($198,000) + Salaries of mechanics ($50,000) = $884,600
Total equipment hours = 18,200 hours
Cost per equipment hour:
= $884,600 ÷ 18,200 hours
= $48.60 per equipment hour
.
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