Chapter 5, Problem 27P

Firenza Company manufactures specialty tools to customer order. Budgeted overhead for the coming year is:

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:

The typical bid price includes a 40 percent markup over full manufacturing cost.

Required:

1. 1. Calculate a plantwide rate for Firenza Company based on machine hours. What is the bid price of each job using this rate?
2. 2. Calculate activity rates for the four overhead activities. What is the bid price of each job using these rates?
3. 3. Which bids are more accurate? Why?

To determine

Calculate the plant wide overhead rate for F Company based on machine hours and bid price for each job using plant wide overhead rate.

Explanation of Solution

Plant wide overhead rate: Plant wide overhead rate is the rate a company uses to allocate its manufacturing overhead costs to products and cost centers.

Calculate the overhead rate:

$\begin{array}{c}\text{Overhead rate}=\frac{\text{Budgeted overhead }\left(\text{refer working note}\left(\text{a}\right)\right)}{\text{Expected machine hours}}\\ =\frac{\$162,500}{50,000}\\ =\$3.25\text{ per machine hour}\end{array}$

Working note:

1. a) Calculate the budgeted overhead.

$\begin{array}{c}\text{Budgeted overhead}=\text{Purchasing}+\text{Setups}+\text{Engineering}+\text{Other}\\ =\$40,000+\$37,500+\$45,000+\$40,000\\ =\$162,500\end{array}$ 

Calculate the bid price for job 1 and job 2.

F company
Particulars	Job 1	Job 2
Direct materials	$4,500	$9,340
Direct labor	1,200	2,100
Overhead	$650 (b)	$650 (c)
Total manufacturing cost	$6,350	$12,090
Add: 40% markup	2,540 (d)	4,836 (e)
Bid price	$8,890	$16,926

Table (1)

Working notes:

1. b) Calculate the overhead for job 1.

$\begin{array}{c}\text{Overhead}=\text{Overhead rate}\times \text{Machine hours}\\ =\$3.25\times 200\\ =\$650\end{array}$

1. c) Calculate the overhead for job 2.

$\begin{array}{c}\text{Overhead}=\text{Overhead rate}\times \text{Machine hours}\\ =\$3.25\times 200\\ =\$650\end{array}$

1. d) Calculate the 40% markup for job 1.

$\begin{array}{c}\text{Markup}=\text{Total manufacturing cost}\times \text{Markup percentage}\\ =\$6,350\times 40\%\\ =\$2,540\end{array}$

1. e) Calculate the 40% markup for job 2.

$\begin{array}{c}\text{Markup}=\text{Total manufacturing cost}\times \text{Markup percentage}\\ =\$12,090\times 40\%\\ =\$4,836\end{array}$

To determine

Calculate the activity rate for all the overhead activities and bid price for both jobs using activity price.

Explanation of Solution

Calculate the purchasing rate per order.

$\begin{array}{c}\text{Purchasing rate}=\frac{\text{Budgeted purchasing cost}}{\text{Budgeted purchase order}}\\ =\frac{\$40,000}{5,000}\\ =\$8\text{ per purchasing order}\end{array}$

Calculate the setup cost rate per setup.

$\begin{array}{c}\text{Setup cost rate}=\frac{\text{Budgeted setup cost}}{\text{Budgeted setup}}\\ =\frac{\$37,500}{500}\\ =\$75\text{ per setup}\end{array}$

Calculate the engineering rate per engineering hour.

$\begin{array}{c}\text{Engineering rate}=\frac{\text{Budgeted engineering cost}}{\text{Budgeted engineering hours}}\\ =\frac{\$45,000}{2,500}\\ =\$18\text{ per engineering hour}\end{array}$

Calculate the other cost rate per machine hour.

$\begin{array}{c}\text{Other cost rate}=\frac{\text{Budgeted other cost}}{\text{Expected machine hours}}\\ =\frac{\$40,000}{50,000}\\ =\$0.80\text{ per machine hour}\end{array}$

Calculate the bid price for job 1 and job 2.

F company
Particulars	Job 1	Job 2
Direct materials	$4,500	$9,340
Direct labor	$1,200	$2,100
Overhead:
Purchasing	120 (f)	160 (g)
Setup	225 (h)	300 (i)
Engineering	810 (j)	180 (k)
Other	160 (l)	160 (m)
Total manufacturing cost	$7,015	$12,240
Add: 40% markup	2,806 (n)	4,896 (o)
Bid price	$9,281	$17,136

Table (2)

Working notes:

1. f) Calculate the purchasing overhead for job 1.

$\begin{array}{c}\text{Purchasing overhead}=\text{Cost per purchase order}\times \text{Number of purchase order}\\ =\$8\times 15\\ =\$120\end{array}$

1. g) Calculate the purchasing overhead for job 2.

$\begin{array}{c}\text{Purchasing overhead}=\text{Cost per purchase order}\times \text{Number of purchase order}\\ =\$8\times 20\\ =\$160\end{array}$

1. h) Calculate the setup overhead for job 1.

$\begin{array}{c}\text{Setup overhead}=\text{Cost per setup}\times \text{Number of setups}\\ =\$75\times 3\\ =\$225\end{array}$

1. i) Calculate the setup overhead for job 2.

$\begin{array}{c}\text{Setup overhead}=\text{Cost per setup}\times \text{Number of setups}\\ =\$75\times 4\\ =\$300\end{array}$

1. j) Calculate the engineering overhead for job 1.

$\begin{array}{c}\text{Engineering overhead}=\text{Cost per engineering hour}\times \text{Number of engineering hours}\\ =\$18\times 45\\ =\$810\end{array}$

1. k) Calculate the engineering overhead for job 2.

$\begin{array}{c}\text{Engineering overhead}=\text{Cost per engineering hour}\times \text{Number of engineering hours}\\ =\$18\times 10\\ =\$180\end{array}$

1. l) Calculate the other overhead for job 1.

$\begin{array}{c}\text{Other overhead}=\text{Cost per machine hour}\times \text{Number of machine hours}\\ =\$0.80\times 200\\ =\$160\end{array}$

1. m) Calculate the other overhead for job 2.

$\begin{array}{c}\text{Other overhead}=\text{Cost per machine hour}\times \text{Number of machine hours}\\ =\$0.80\times 200\\ =\$160\end{array}$

1. n) Calculate the 40% markup for job 1.

$\begin{array}{c}\text{Markup}=\text{Total manufacturing cost}\times \text{Markup percentage}\\ =\$7,015\times 40\%\\ =\$2,806\end{array}$

1. o) Calculate the 40% markup for job 2.

$\begin{array}{c}\text{Markup}=\text{Total manufacturing cost}\times \text{Markup percentage}\\ =\$12,240\times 40\%\\ =\$4,896\end{array}$

To determine

Identify the accurate bid price and explain the reason behind it.

Explanation of Solution

Assigning the overhead using activity based approach shows the accurate cost figure because most of the overheads are non-unit level and there is a variety of products.