Huge Company's tooling business unit (TBU) manufactures metal and
carbon-fiber parts for the company's major products.  TBU's principal
focus in recent years has been to schedule its resources properly, but
its manager is concerned that the current method of costing the unit's
work is causing other business units to send it work that does not use
TBU's strenghts to the company's overall advantage.  TBU computes a
combine labor and overhead cost per labor hour and charges each job
based on the number of labor hours used.  This labor-based charge is
added to materials cost to calculate the total job cost.
     TBU works for internal cusomers exclusively, and there is no
consideration to allow it to seek outside work.  Other business units
are allowed to use external suppliers, however, and are encouraged but
not required to use TBU, which has 19 work centers, each of which uses
computer-controlled machines and processess.
     TBU uses two basis types of machines: (1)6 multi-axis
(M)machines, which allow complex parts to be rotated in multiple
directions while directions while being completed without removing the
part and (2)13 single-axis (S) machines, which are used for parts that
do not hae to be rotaed more than once to be completed.  The M
machines were just purchased to replace 6 (S)machines.  They are three
times as expensive to operate as (S) machines.  Each machine is
considered a work center and is available 6,000 hours (three shifts)
per year.
     TBU's employees are highly skilled and are among Huge Company's
highest paid hourly workers.  They are qualified to work on either
type of machine and any type of job.  As a practical matter, employees
tend to work on machines and jobs that interest them most, but TBU
management encouages workers to diversify their efforts.  TBU
employees are available 2,000 hours per year.
     Stainless steel(SS) and aluminum(A) parts are machined from metal
stock.  Carbon fiber(CF) parts are made by laminating carbon fiber and
plastic resins.  Carbon-fiber materials are much more expensive and
require more labor.
     Last year's labor cost and overhead (which includes the costs of
management and equipment but excludes materials costs) follow:
     Labor (1,000 employees)          $ 90,000,000
     Overhead
          Equipment (19 work center)  $190,000,000*  
          Management and engineering  $ 20,000,000
     Total                            $300,000,000

     *Based on 19(S) machines

The following are the data for and characteristics of five representative jobs:

Job    Equipment    Machine    Material    Weight    Materials    Labor
                    Hours      Type        (kg)      Cost         Hours
1      M            7.5        SS          300       $30,000      $22.50
2      S            10.00      CF          200       100,000      160.00
3      M            8.75       A           350        28,000       21.00
4      S            12.50      A           500        40,000      120.00
5      S             5.00      SS          200        20,000       60.00

QUESTION:
a.     Compute the costs of each job using the current cost system
b.     Recommend an altenatie cost system that recognize additional
differences among jobs
c.     Recompute the job costs using your alternative cost system
d.     Explain differences in decision making at TBU
e.     Identify TBU's internal customers that might be influence by
the use of the alternative cost system.

Dear ginger8,



a.  Compute the costs of each job using the current cost system.


We must first compute the combined labor and overhead cost per labor
hour. Given that there are 1,000 employees in TBU who each work 2,000
hours a year, the total number of labor hours a year is

  1,000 * 2,000  =  2,000,000.

Knowing that the total cost of annual labor and overhead is $300,000,000,
we determine that the combined labor and overhead cost per labor hour is

  $300,000,000 / 2,000,000  =  $150.

To find the total cost of each job under the current costing system,
we multiply this figure by the number of labor hours, finally adding
the materials cost. Let us do so for each job in order.


1.

The 22.50 labor hours incur a cost of

  22.50 * $150  =  $3,375

which we add to the materials cost of $30,000 to determine that the
total job cost is

  $30,000 + $3,375  =  $33,375.


2.  The 160.00 labor hours account for

  160.00 * $150  =  $24,000

leading to a total job cost of

  $100,000 + $24,000  =  $124,000.


3.  The 21.00 labor hours account for

  21.00 * $150  =  $3,150

leading to a total job cost of

  $28,000 + $3,150  =  $31,150.


4.  The 120.00 labor hours account for

  120.00 * $150  =  $18,000

leading to a total job cost of

  $40,000 + $18,000  =  $58,000.


5. The 60.00 labor hours account for

  60.00 * $150  =  $9,000

leading to a total job cost of

  $20,000 + $9,000  =  $29,000.



b.  Recommend an alternative cost system that recognizes additional
differences among jobs.


The flaw in the current costing system is that it does not take into
account the difference in operating cost between the multi-axis machines
and single-axis machines. Although labor hours can be considered as
uniform due to the diversification of worker effort, and the materials
cost is fixed for each job, the computed cost of operating the machine
for a given job should reflect the type of the machine and the number
of hours spent on that machine.

We recommend an alternative costing system in which the cost of a labor
hour excludes the overhead equipment costs. Instead, these costs are
distributed among the machines according to their type, taking into
account that multi-axis machines take three times as much to operate as
single-axis machines. Then, after computing the labor cost and materials
cost of a given job, we multiply the cost of a machine hour by the number
of hours spent on the machine of the appropriate type. The sum of these
three costs makes up the total job cost.



c.  Recompute the job costs using your alternative cost system.


We begin by recomputing the cost per labor hour and computing the cost
per machine hour.

After excluding the cost of equipment overhead, the cost of a labor hour
consists of the labor cost along with management and engineering overhead.

  $90,000,000 + $20,000,000  =  $110,000,000

As before, dividing this sum by the number of labor hours gives us the
cost per labor hour.

  $110,000,000 / 2,000,000  =  $55

The total equipment overhead was $190,000,000 for 19 S machines, implying
an overhead per S machine of

  $190,000,000 / 19  =  $10,000,000.

We are told that multi-axis machines cost three times as much to operate,
implying an overhead per M machine of

  3 * $10,000,000  =  $30,000,000.

Since each machine is available for 6,000 hours a year, we compute an
S machine hour cost of

  $10,000,000 / 6,000  =  $1,666.67

and an M machine hour cost of

  $30,000,000 / 6,000  =  $5,000

Now let use our alternative costing system to compute the total job cost
for each job in order.


1.

Under our alternative system, the 22.50 labor hours account for

  22.50 * $55  =  $1,237.50

in labor costs. Since the job is done on an M machine, we multiply the
M machine hour cost by 7.50 machine hours to determine that the machine
cost is

  7.50 * $5,000  =  $37,500.

Finally, we add the materials cost to obtain the following total job cost.

  $30,000 + $1,237.50 + $37,500  =  $68,737.50


2.

The 160.00 labor hours account for a labor cost of

  160.00 * $55  =  $8,800.

Since this job uses an S machine, we use the S machine hour cost to
calculate a machine cost of

  10.00 * $1,666.67  =  $16,666.70.

Finally, we add the materials cost to obtain the following total job cost.

  $100,000 + $8,800 + $16,666.70  =  $125,466.70


3.

The 21.00 labor hours account for

  21.00 * $55  =  $1,155
  
and the 8.75 hours for an M machine cost of

  8.75 * $5,000  =  $43,750

leading to the following total job cost.

  $28,000 + $1,155 + $43,750  =  $72,905.


4.

The 120.00 labor hours account for

  120.00 * $55  =  $6,600
  
and the 12.50 machine hours for an S machine cost of

  12.50 * $1,666.67  =  $20,833.38

leading to the following total job cost.

  $40,000 + $6,600 + $20,833.38  =  $67,433.38

  
5.

The 60.00 labor hours account for

  60.00 * $55  =  $3,300

and the 5.00 machine hours for an S machine cost of

  5.00 * $1,666.67  =  $8,333.35

leading to the following total job cost.

  $20,000 + $3,300 + $8,333.35  =  $31,633.35



d.  Explain differences in decision making at TBU.

Under its current costing system, TBU makes no distinction between
machine hours spent on an S machine and those on an M machine. This
is a relic of the prior era, when only S machines were available,
and might not have been an unreasonable system at that time. However,
such a system distorts the true cost of doing jobs that require the use
of the considerably more expensive M machines. Furthermore, the current
system does not take into account the number of machine hours devoted
to each job, causing further distortion.

Under the alternative costing system we propose, the computed cost of
each job reflects the type of machine and the number of machine hours
devoted to it. This will make a difference in TBU decision-making by
discouraging jobs that use a great deal of machine time without yielding
a proportional profit to the company. Furthermore, it will promote the
use of M machines to take advantage of their expense. Once purchased,
the M machines must not be allowed to remain idle, or else they would
merely be depreciating the company's capital without contributing to its
productivity. To this end, it might even be necessary to change company
policy so as to allow TBU to perform work for outside customers.


e.  Identify TBU's internal customers that might be influenced by the
use of the alternative cost system.

Those internal customers who currently have jobs to be done requiring
the use of an M machine will be encouraged ever more strongly, or even
required, to keep their work in-house so as to maximize the productivity
of the M machines. Thus, internal customers requiring jobs 1 and 3 will
be prompted to favor TBU instead of external suppliers.

Another possibility is that internal customers who need labor-intensive
work done, such as jobs 2 and 4, will give greater consideration to
outsourcing their work to offshore companies. This is because the cost
of labor can be dramatically reduced by offshore production, whereas the
purchase prices of specialized manufacturing machines are not appreciably
affected by a change of locale.

All in all, considering that machine hours are much costlier than
labor hours, internal customers ought to give greater consideration
to maximizing the usage of TBU's machines. A job that requires many
more labor hours than machine hours will occupy TBU's labor to a
disproportionately greater extent than its machines, making it a less
attractive proposition from the perspective of capital utilization.



It has been a pleasure to address this question on your behalf. If you
find fault with my answer, please let me know through a Clarification
Request so that I may fully meet your needs before you assign a rating.


Regards,

leapinglizard