a. Compute the overhead application rate based on (1) direct labor hours and (2ik) number of repair jobs — Olde Bump Grind Inc automobile body fender shop work done hand with
General StudiesGeneralWorked Solution
Ye Olde Bump & Grind, Inc., is an automobile body and fender repair shop. Repair work is done by hand and with the use of small tools. Customers are billed based on time (direct labor hours) and materials used in each repair job.
The shop’s overhead costs consist primarily of indirect materials (welding materials, metal putty, and sandpaper), rent, indirect labor, and utilities. Rent is equal to a percentage of the shop’s gross revenue for each month. The indirect labor relates primarily to ordering parts and processing insurance claims. The amount of indirect labor, therefore, tends to vary with the size of each job.
Henry Lee, manager of the business, is considering using either direct labor hours or number of repair jobs as the basis for allocating overhead costs. He has estimated the following amounts for the coming year:
Estimated number of repair jobs . . . . . . . . . . . . . . . . . … 300
Instructions
a. Compute the overhead application rate based on (1) direct labor hours and (2ik) number of repair jobs.
b. Shown below is information for two repair jobs:
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Job 1 Repair a dented fender. Direct material used, $25; direct labor hours, 5; direct labor cost, $75.
Job 2 Repair an automobile involved in a serious collision. Direct materials used, $3,800; direct labor hours, 200; direct labor cost, $3,000.
Determine the total cost of each repair job, assuming that overhead costs are applied to each job based on:
1. Direct labor hours.
2. Number of repair jobs.
c. Discuss the results obtained in part b. Which overhead application method appears to provide the more realistic results? Explain the reasoning behind your answer, addressing the issue of what “drives” overhead costs in this business.
SOLUTION
a.
(1)
Overhead application rate based on direct labor hours:
Overhead application rate based on direct labor hours:
Overhead application rate based on direct labor hours:
Overhead application rate based on direct labor hours:
Estimated total overhead
Estimated total overhead
Estimated total overhead
$ 123,000
Estimated direct labor hours
Estimated direct labor hours
Estimated direct labor hours
10,000
Overhead application rate per direct labor hour ($123,000 ÷ 10,000 hours)
Overhead application rate per direct labor hour ($123,000 ÷ 10,000 hours)
Overhead application rate per direct labor hour ($123,000 ÷ 10,000 hours)
$ 12.30
(2)
Overhead application rate based upon number of repair jobs:
Overhead application rate based upon number of repair jobs:
Overhead application rate based upon number of repair jobs:
Overhead application rate based upon number of repair jobs:
Estimated total overhead
Estimated total overhead
Estimated total overhead
$ 123,000
Estimated number of repair jobs
Estimated number of repair jobs
Estimated number of repair jobs
300
Overhead application rate per repair job ($123,000 ÷ 300 jobs)
Overhead application rate per repair job ($123,000 ÷ 300 jobs)
Overhead application rate per repair job ($123,000 ÷ 300 jobs)
$ 410
b.
(1)
Overhead applied using direct labor hours:
Overhead applied using direct labor hours:
Overhead applied using direct labor hours:
Overhead applied using direct labor hours:
Job 1:
Job 1:
Job 1:
Direct materials used
Direct materials used
$ 25.00
Direct labor costs
Direct labor costs
75.00
Overhead applied (5 hr × $12.30 per hr)
Overhead applied (5 hr × $12.30 per hr)
61.50
Total cost of Job 1
$ 161.50
Job 2:
Job 2:
Job 2:
Direct materials used
Direct materials used
$3,800
Direct labor costs
Direct labor costs
3,000
Overhead applied (200 hr × $12.30 per hr)
Overhead applied (200 hr × $12.30 per hr)
2,460
Total cost of Job 2
$ 9,260
(2)
Overhead applied on a per-job basis:
Overhead applied on a per-job basis:
Overhead applied on a per-job basis:
Overhead applied on a per-job basis:
Job 1:
Job 1:
Job 1:
Direct materials used
Direct materials used
$ 25
Direct labor costs
Direct labor costs
75
Overhead applied ($410 per job)
Overhead applied ($410 per job)
410
Total cost of Job 1
$ 510
Job 2:
Job 2:
Job 2:
Direct materials used
Direct materials used
$ 3,800
Direct labor
Direct labor
3,000
Overhead applied ($410 per job)
Overhead applied ($410 per job)
410
Total cost of Job 2
$ 7,210
c.
Comments on the alternative overhead applications:
Allocating overhead based upon the number of jobs assumes that each repair job should be charged with an equal amount ($410) of overhead. This allocation method ignores the fact that a large job, such as Job 2, generates more overhead costs than does a small job, such as Job 1. Relative to Job 1, Job 2 probably requires more indirect materials, more indirect labor, and more usage of utilities, and causes higher rental payments. Therefore, Job 2 clearly should be charged with more overhead costs than Job 1.
In this business, direct labor hours appear to be the major causal factor in the incurrence of overhead costs. The use of indirect materials (sandpaper, welding materials, and metal putty) is likely to be greater on jobs requiring more direct labor hours. As rent is a percentage of gross revenue, large jobs cause the business to incur higher rent costs than do small jobs. Larger jobs also require more indirect labor, such as ordering more parts and paperwork in filing insurance claims. Even such costs as property taxes and depreciation are “driven” by the direct labor hours needed to complete a job. Jobs that require many hours to complete “tie up” the physical facilities of the business longer than do the short jobs.
In conclusion, allocating overhead costs in proportion to direct labor hours provides much more realistic results than does allocating an equal dollar amount of overhead costs to each repair job.