Question One
The company is using direct labor cost method since a large proportion of the total cost of production is direct labor. Although the accounting system is suitable for this type of production, there are several disadvantages. For instance, there is no distinction between fixed and variable costs. The method is also not suitable for employees who are paid based on the pieces they work on. This is because the same rate will be applied on absorbing overhead expenses to all workers regardless of whether they are efficient or not. The main disadvantage of this system is the accuracy. Since the costs in support departments are not allocated to other support departments, the business will over-allocate production department’s costs and under-allocate support department’s costs.
Question Two
Since the company has three departments, cutting, finishing and assembly, a department cost allocation method is suitable. The company should have several cost pools for each department and allocate the overhead costs using a separate predetermined overhead cost for each department. Alternatively, the company can calculate overhead rate using machine hours instead of labor hours since the production process is more automated. In the current case, one can determine the cost of production using machine-hours instead of direct labor as follows: 4,040,000/59461 = 67.76. The overhead rate is $67.76 per machine hour.
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| Bid #74683 | Hours | Average Rate | Cost |
| Machine run time | 9.00 | ||
| Materials | |||
| All | $563.25 | ||
| Direct Labor | |||
| Labor | 2.50 | 18.00 | 45.00 |
| Equipment setup | 0.75 | 12.50 | 9.38 |
| Equipment tending | 2.50 | 12.50 | 31.25 |
| Overhead | 5.75 | 67.78 | 389.74 |
| Total Costs | 952.99 | ||
| Total Costs using labor hours | |||
| Bid #74687 | Hours | Average Rate | Cost |
| Machine run time | 34.00 | ||
| Materials | |||
| All | $4,904 | ||
| Direct Labor | |||
| Labor | 8.00 | 17.50 | 140.0 |
| Equipment setup | 0.75 | 12.50 | 9.39 |
| Equipment tending | 3.25 | 12.50 | 40.63 |
| Overhead | 12.00 | 67.78 | 813.36 |
| Total Costs | 5717.86 | ||
From the above calculations, the cost of production using department allocation costs pools decreases the cost of production. Therefore, the second method is better compared to plant overhead allocation, which is what the company is currently using. For instance, the plant overhead allocation costs the company $1507.12 in the production of the small order while the department allocation method costs the company $952.99, which saves $554.13.
Question Three
Plant-wide Allocation Approach using Direct Labor
The costs involved include direct labor, direct material and manufacturing overhead. The cost of production is calculated as follows:
| Bid #74683 | Bid #74687 | |
| Direct materials | 563.25 | 4,904.50 |
| Direct labor | 85.63 | 190.02 |
| Overhead | 220.29 | 508.35 |
| Total production cost | 869.17 | 5602.87 |
Plant-wide rate using machine hours
| Bid #74683 | Bid #74687 | |
| Direct materials | 563.25 | 4,904.50 |
| Direct labor | 85.63 | 190.02 |
| Overhead | 610.02 | 2304.52 |
| Total production cost | 1258.9 | 7399.04 |
Department allocation
The calculations indicate that a products passing through the cutting department are charged $56.27 in overhead costs for each hour of the machine. Products passing through the assembly department are charged $133.33 for each hour of direct labor.
| Cutting | Finishing | Assembly | |
| Overhead | $1,480,000 | $1,650,000 | $900,000 |
| Machine/direct labor hours | 26,300 (Machine Hrs) | 19,439 (Machine Hrs) | 6,750 (Direct labor Hrs) |
| Rate | 56.27 | 84.88 | 133.33 |
Recommendation
The results from each method are different since the costs are based on different cost drivers. In the case of Candor Medical Instrument Company, the best method to use is the department allocation approach. The method will allow the company to allocate costs in each department based on what drives the cost in that particular department. The method is accurate compared to a plant-wide rate, although it still relies on direct labor costs, machine hours and direct labor hours.
Question Four: Pros and Cons of Job Order Costing
The advantages of job costing are:
The costs can be ascertained at every stage of completion, which enable the management to take effective steps in controlling costs.
The firm can estimate the cost of an order based on past records.
The profit earned in each order can be calculated separately.
The overhead rates can be predetermined based on the budget.
After the order is completed, each element of cost, selling price and profit can be compared for the purposes of cost reduction and profit maximization.
The disadvantages are:
The method is paper intensive and more clerical work is required since one has to maintain detailed information.
Job costing is expensive.
There is no possibility of cost control since the steps to control costs are done after it has been incurred.
The price is fixed on the current market trends and not on the basis of past records.
Corrective action is not possible in the case where the actual profit is lower that the estimated profit.
