“Our costs are out of control, our accounting system is screwed up, or both!” screamed the sales manager. “We are simply non-competitive on a great many of the jobs we bid on. Just last week we lost a customer when a competitor underbid us by 25%! And I bid the job at cost because the customer has been with us for years but has been complaining about our prices.”

This problem, raised at the weekly management meeting, has been getting worse over the years. The Johnson Tool Company produces parts for specific customer orders. When the firm first became successful, it employed nearly 500 skilled machinists. Over the years the firm has become increasingly automated and now uses a number of different robotic machines. The firm currently employs only 75 production workers, but output has quadrupled.

The problems raised by the sales manager can be seen in the portions of two bid sheets brought to the meeting (as reproduced). The bids are from the cutting department, but the relative size of these three types of manufacturing costs is similar for other departments.

The cutting department charges overhead to products based on direct labor hours. For the current period, the department expects to use 4,000 direct labor hours. Departmental overhead, consisting mostly of depreciation on the robotic equipment, is expected to be $1,480,000.

An employee can typically set up any job on the appropriate equipment in about 15 minutes. Once machines are operating, an employee oversees five to eight machines simultaneously. All that is required is to load or unload materials and monitor calibrations. The department’s robotic machines will log a total of 25,000 hours of run time in the current period.

For bid 74683 the firm was substantially underbid by a competitor. The firm did get the job for bid 74687, but the larger jobs are harder to find. Small jobs arise frequently, but the firm is rarely successful in obtaining them.

CUTTING DEPARTMENT

Bid # 74683                                           Machine Run Time 3 Hours

Materials

Steel sheeting …………………………………………             $280.25

Direct labor

Equipment setup (0.25 hours @ $12.50) …..                  3.13

Equipment tending (1 hour @ $12.50) …….                  12.50

Overhead (1.25 hours @ $370) ………..…….                 462.50

Total costs ………………………………..............….             $758.38

CUTTING DEPARTMENT

Bid # 74687                                                      Machine Run Time 11 Hours

Materials

Steel sheeting ………………...…………...…………...………..            $2,440.50

Direct labor

Equipment setup (0.25 hours @ $12.50) ………...……                    3.13

Equipment tending (1.25 hours @ $12.50) …......…..                  15.63

Overhead (1.5 hours @ $370)             …………………...                555.00

Total costs ………………………………………....................…           $3,014.26

REQUIRED

A. Critique the cost allocation method used within the current cost accounting system.

B. Suggest a better approach for allocating overhead. Allocate costs using your approach and compare the costs of both jobs under the two systems.

C. Discuss the pros and cons of using job costs to determine the price for a job order.