George Fayne Mining Co. received a $760,000 low bid from a reputable manufacturer for the construction of

Question:

George Fayne Mining Co. received a $760,000 low bid from a reputable manufacturer for the construction of special production equipment needed by Fayne in an expansion program. Because the company’s own plant was not operating at capacity, Fayne decided to construct the equipment and recorded the following production costs related to the construction.

Services of consulting engineer ....... $ 40,000

Work subcontracted ............. 31,000

Materials ................ 300,000

Plant labor normally assigned to production ... 114,000

Plant labor normally assigned to maintenance . 160,000

Total ................. $645,000

Management prefers to record the cost of the equipment under the incremental cost method. Approximately 40% of the company’s production is devoted to government supply contracts which are all based in some way on cost.

The contracts require that any self-constructed equipment be allocated its full share of all costs related to the construction.

The following information is also available.

1. The production labor was for partial fabrication of the equipment in the plant. Skilled personnel were required and were assigned from other projects. The maintenance labor would have been idle time of nonproduction plant employees who would have been retained on the payroll whether or not their services were utilized.

2. Payroll taxes and employee fringe benefits are approximately 35% of labor cost and are included in manufacturing overhead cost. Total manufacturing overhead for the year was $6,084,000, including the $160,000 maintenance labor used to construct the equipment.

3. Manufacturing overhead is approximately 60% variable and is applied on the basis of production labor cost.

Production labor cost for the year for the corporation’s normal products totaled $8,286,000.

4. General and administrative expenses include $27,000 of allocated executive salary cost and $13,750 of postage, telephone, supplies, and miscellaneous expenses identifiable with this equipment construction.

Instructions

(a) Prepare a schedule computing the amount that should be reported as the full cost of the constructed equipment to meet the requirements of the government contracts. Any supporting computations should be in good form.

(b) Prepare a schedule computing the incremental cost of the constructed equipment.