Chapter 9, Problem 1MC

1. a.

To determine

Compare the bid price for the job L and job E under simplified costing system.

Explanation of Solution

Budgeted overhead allocation rate: The budgeted overhead allocation rate is the rate at which the overhead is allocated. This is calculated by dividing the total fixed and variable overheads cost by the base of the allocation.

Compare the bid price for the job L and job E under simplified costing system.

	Job L	Job E
Professional labor cost:
70 hours at $65 (1)	$4,550
70 hours at $65		$4,550
Professional support:
70 hours at $70 (2)	4,900
70 hours at $70		4,900
Total cost	$9,450	$9,450
Markup on cost, 25%	2,363	2,363
Bid price	$11,813	$11,813

Working Note (1):

Compute the cost of professional labor per hour.

$\begin{array}{c}\text{Cost per hour=}\left[\frac{\left(\begin{array}{l}\text{Partner salary}\times \\ \text{Number of partners}\end{array}\right)+\left(\begin{array}{l}\text{Associate salary}\times \\ \text{Number of associates}\end{array}\right)}{\left(\begin{array}{l}\text{Number of hours}\times \\ \text{Number of partners and associates}\end{array}\right)}\right]\\ \text{=}\left[\frac{\left(\$250,000\times 5\right)\text{+}\left(\text{\$100,000}\times 20\right)}{\left(2,000\text{hours}\times 25\right)}\right]\\ \text{=\$65}\end{array}$

Working Note (2):

Computed the cost of professional support per hour.

$\begin{array}{c}\text{Cost per hour=}\left[\frac{\left(\begin{array}{l}\text{Partner salary+}\\ \text{Associate salary}\end{array}\right)}{\left(\begin{array}{l}\text{Number of hours}\times \\ \text{Number of partners and associates}\end{array}\right)}\right]\\ \text{=}\left[\frac{\left(\$2,500,000+\$100,000\right)}{\left(2,000\text{hours}\times 25\right)}\right]\\ \text{=\$70}\end{array}$

b.

To determine

Discuss whether the results seem reasonable.

Explanation of Solution

The administrative support costs are driven by the Job L, and also Job L had many more expensive partner hours. Yet the two jobs’ total costs are identical. Hence, no, the results do not seem reasonable.

2.

To determine

Compare the bid price for the job L and job E under activity-based costing system.

Explanation of Solution

Compare the bid price for the job L and job E under activity-based costing system.

	Job L	Job E
Partner labor cost:
50 hours at $125 (3)	$6,250
15 hours at $125		$1,875
Associate labor cost:
20 hours at $50 (4)	1,000
55 hours at $50		2,750
Legal support:
70 hours at $50 (5)	3,500
70 hours at $50		3,500
Administrative support:
50 hours at $100 (6)	5,000
15 hours at $100		1,500
Total cost	$15,750	$9,625
Markup on cost, 25%	3,938	2,406
Bid price	$19,688	$12,031

Working Note (3):

Compute the cost of partner labor per hour.

$\begin{array}{c}\text{Cost per hour=}\left[\frac{\text{Partners salary}}{\text{Number of hours}}\right]\\ \text{=}\left[\frac{\$250,000}{2,000\text{hours}}\right]\\ \text{=\$125}\end{array}$

Working Note (4):

Computed the cost of associate labor per hour.

$\begin{array}{c}\text{Cost per hour=}\left[\frac{\text{Associates salary}}{\text{Number of hours}}\right]\\ \text{=}\left[\frac{\$100,000}{2,000\text{hours}}\right]\\ \text{=\$50}\end{array}$

Working Note (5):

Computed the cost of legal support per professional hour.

$\begin{array}{c}\text{Cost per professional hour=}\left[\frac{\text{Cost of legal support}}{\left(\begin{array}{l}\text{Available billable hours}\\ \times \text{Number of partners and associates}\end{array}\right)}\right]\\ \text{=}\left[\frac{\$2,500,000}{\left(2,000\times 25\right)}\right]\\ \text{=\$50}\end{array}$

Working Note (6):

Computed the cost of staff support per partner hour.

$\begin{array}{c}\text{Cost per partner hour=}\left[\frac{\text{Cost of administrative support}}{\left(\begin{array}{l}\text{Number of partners}\\ \times \text{Number of hours}\end{array}\right)}\right]\\ \text{=}\left[\frac{\$1,000,000}{\left(5\times 2,000\right)}\right]\\ \text{=\$100}\end{array}$

3. a.

To determine

Compute the difference in bid price for each job between simplified costing system and activity-based costing system.

Explanation of Solution

Calculate the difference between the bid price under simplified costing system and activity-based costing system.

	Job L	Job E
Simplified costing	$11,813	$11,813
ABC costing	19,688	12,031
Difference	$(7,875)	$(218)

b.

To determine

Identify whether the jobs were undercosted or overcosted, and also identify the job that had the greater differential with the reason behind it.

Explanation of Solution

Using the simplified costing system, each of the two jobs was undercosted. Job E was undercosted by an insignificant amount of $218, whereas, the Job L was undercosted by a very significant amount of $7,875, as the litigation work was entailed by Job L, which had to be done primarily by partners. Without regard to whether associates’ hourly labor cost of $50 or partner hourly labor cost of $125 was being worked on a job, like peanut butter, the costs are equally spread by the simplified system over both jobs. Also, when compared to associates, more administrative support is more consumed by the partners.