1. Critique the cost allocation method used within the current cost accounting system. 2. Suggest a better approach for allocating overhead. Allocate costs using your approach and compare the costs of both jobs under the two systems. 3. After presenting your results to the CEO, she suggests that if Candor needs to change the way it allocates overhead, a full investigation of overhead methods be conducted. Potentially you could also allocate overhead by departments (Cutting, Finishing and Assembly). As a result, the CEO would like a full comparison and analysis of the three alternatives suggested (plant-wide rate using direct labor hours, plant-wide rate using machine hours and allocation by departments). In addition, she wants you to recommend which method should be implemented. Include rationale for your recommendation and an explanation of why costs differ between methods. Departmental information is located in Exhibit 2. In addition, a description of the departments can be found in the next page. 4. Discuss the pros and cons of using job costs to determine the price for a job order.

Transcribed image text: Case #2 Candor Medical Instrument Company "Our costs are out of control, our accounting system is screwed up, or both!" screamed the sales manager. "We are simply not competitive on a great many of the jobs we bid on. Just last week we lost a customer when a competitor under-bid 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 Candor Medical Instrument Company produces custom medical instruments for specific customer orders. When the firm first became successful, it employed nearly 500 skilled machinists. Over the years the firm became 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 (Exhibit 1). These bids represent a typical small job (Bid # 74683) and a typical large job (Bid # 74687). Each job has direct material, direct labor and overhead, which is allocated to jobs using a plant-wide overhead rate based of direct labor hours. For the current period, Candor expects to use 27,000 direct labor hours. Overhead, consisting mostly of depreciation on the robotic equipment, is expected to be $4,030,000. 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 robotic machines will log a total of 59,461 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 having more difficulty in successfully obtaining them. Departmental Descriptions Cutting The cutting department takes raw materials and cuts or lathes the material into precise parts for medical instruments. The department is fully automated and the processes in this department utilize the robotic equipment almost exclusively. Materials are requisitioned from material stores and fed into the machines which require setups and monitoring. The setups entail selecting from an established set of programs. Occasionally, new programs need to be input but once the program is input it can be saved for future use. The overhead costs in this department are predominantly depreciation and maintenance of the robotic equipment. Finishing The finishing department takes the parts created in the cutting department and puts them through various chemical baths. This process is fully automated and, again, just requires machine setups and monitoring. Once the chemical processes are complete, a technical engineer examines each part under a microscope for quality, and removes any imperfections with a laser. The technical engineers require additional technical expertise and, as a result, they make more than the machine operators. In addition, the technical engineers spend more time on each job than the machine operators (see example below). The overhead costs in this department are related to depreciation and maintenance of the robotic equipment used in the chemical processes as well as costs related to the technical engineers functions. Because costs are related to both machines and technical engineers, you must choose the most predominant cost driver. Ultimately, you determine that direct labor cost is the best cost driver for the finishing department. Bid # 74683 Bid # 74687 Direct labor Hours Rate Total Hours Rate Total Laser finishing (Tech) 2.00 $20.00 $40.00 6.00 $20.00 $120.00 Equipment setup (Op) .25 $12.50 $ 3.13 .25 $12.50 $ 3.12 Equipment tending (Op) 1.00 $12.50 $12.50 1.25 $12.50 $ 15.63 Total 3.25 $55.63 7.50 $138.75 Assembly The assembly department assembles all of the parts from the finishing department and gets the final products ready for shipment. Part of the assembly process is automated but none of the packaging process is automated. Some of the overhead costs for this department are related to depreciation and maintenance of the assembly equipment, but the majority of the costs are related to indirect material and supplies used in the packing processes. The material is considered indirect because it is not economically feasible to track it by job (it costs more to measure than it is worth). The amount of indirect material use also impacts that amount of labor time it takes in the packing process. As a result, you determine that the predominant (measurable) cost driver is direct labor hours. Exhibit 1 - Bid Sheets for two typical jobs Total Total labor hours Total Overhead Overhead rate $ $ 27,000 4,030,000 149.26 Hours 9.00 Average Rate $ 563.25 Bid # 74683 Machine run time Materials All Direct labor Labor Equipment setup Equipment tending Overhead Total costs 2.50 0.75 2.50 5.75 18.00 12.50 12.50 149.26 45.00 9.38 31.25 858.24 1,507.12 $ Rate Cost Hours 34.00 $ 4,904.50 Bid # 74687 Machine run time Materials All Direct labor Labor Equipment setup Equipment tending Overhead Total costs 8.00 0.75 3.25 12.00 17.50 12.50 12.50 149.26 140.00 9.39 40.63 1,791.11 6,885.62 $ Exhibit 2 - Departmental Data Cutting Finishing Assembly Total Total direct labor hours 8,910 11,340 6,750 27,000 Total Machine hours 26,300 19,439 13,722 59,461 Total Direct labor costs $ 57,159 $ 285,839 $ 70,032 413,030 Total Overhead Costs $ 1,480,000 $1,650,000 $900,000 4,030,000 Bid #74683 Direct labor hours Machine hours Direct labor costs Direct material cost 1.25 3.25 1.25 5.75 4.00 3.00 2.00 9.00 15.63 55.63 14.37 85.63 280.25 $ 183.00 $ 100.00 $ 563.25 $ $ Bid # 74687 Direct labor hours Machine hours Direct labor costs Direct material cost 1.50 7.50 3.00 12.00 15.00 11.00 8.00 34.00 18.76 138.75 32.50 190.01 $ 2,440.50 $ 1,594.00 $ 870.00 $4,904.50 Transcribed image text: Case #2 Candor Medical Instrument Company "Our costs are out of control, our accounting system is screwed up, or both!" screamed the sales manager. "We are simply not competitive on a great many of the jobs we bid on. Just last week we lost a customer when a competitor under-bid 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 Candor Medical Instrument Company produces custom medical instruments for specific customer orders. When the firm first became successful, it employed nearly 500 skilled machinists. Over the years the firm became 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 (Exhibit 1). These bids represent a typical small job (Bid # 74683) and a typical large job (Bid # 74687). Each job has direct material, direct labor and overhead, which is allocated to jobs using a plant-wide overhead rate based of direct labor hours. For the current period, Candor expects to use 27,000 direct labor hours. Overhead, consisting mostly of depreciation on the robotic equipment, is expected to be $4,030,000. 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 robotic machines will log a total of 59,461 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 having more difficulty in successfully obtaining them. Departmental Descriptions Cutting The cutting department takes raw materials and cuts or lathes the material into precise parts for medical instruments. The department is fully automated and the processes in this department utilize the robotic equipment almost exclusively. Materials are requisitioned from material stores and fed into the machines which require setups and monitoring. The setups entail selecting from an established set of programs. Occasionally, new programs need to be input but once the program is input it can be saved for future use. The overhead costs in this department are predominantly depreciation and maintenance of the robotic equipment. Finishing The finishing department takes the parts created in the cutting department and puts them through various chemical baths. This process is fully automated and, again, just requires machine setups and monitoring. Once the chemical processes are complete, a technical engineer examines each part under a microscope for quality, and removes any imperfections with a laser. The technical engineers require additional technical expertise and, as a result, they make more than the machine operators. In addition, the technical engineers spend more time on each job than the machine operators (see example below). The overhead costs in this department are related to depreciation and maintenance of the robotic equipment used in the chemical processes as well as costs related to the technical engineers functions. Because costs are related to both machines and technical engineers, you must choose the most predominant cost driver. Ultimately, you determine that direct labor cost is the best cost driver for the finishing department. Bid # 74683 Bid # 74687 Direct labor Hours Rate Total Hours Rate Total Laser finishing (Tech) 2.00 $20.00 $40.00 6.00 $20.00 $120.00 Equipment setup (Op) .25 $12.50 $ 3.13 .25 $12.50 $ 3.12 Equipment tending (Op) 1.00 $12.50 $12.50 1.25 $12.50 $ 15.63 Total 3.25 $55.63 7.50 $138.75 Assembly The assembly department assembles all of the parts from the finishing department and gets the final products ready for shipment. Part of the assembly process is automated but none of the packaging process is automated. Some of the overhead costs for this department are related to depreciation and maintenance of the assembly equipment, but the majority of the costs are related to indirect material and supplies used in the packing processes. The material is considered indirect because it is not economically feasible to track it by job (it costs more to measure than it is worth). The amount of indirect material use also impacts that amount of labor time it takes in the packing process. As a result, you determine that the predominant (measurable) cost driver is direct labor hours. Exhibit 1 - Bid Sheets for two typical jobs Total Total labor hours Total Overhead Overhead rate $ $ 27,000 4,030,000 149.26 Hours 9.00 Average Rate $ 563.25 Bid # 74683 Machine run time Materials All Direct labor Labor Equipment setup Equipment tending Overhead Total costs 2.50 0.75 2.50 5.75 18.00 12.50 12.50 149.26 45.00 9.38 31.25 858.24 1,507.12 $ Rate Cost Hours 34.00 $ 4,904.50 Bid # 74687 Machine run time Materials All Direct labor Labor Equipment setup Equipment tending Overhead Total costs 8.00 0.75 3.25 12.00 17.50 12.50 12.50 149.26 140.00 9.39 40.63 1,791.11 6,885.62 $ Exhibit 2 - Departmental Data Cutting Finishing Assembly Total Total direct labor hours 8,910 11,340 6,750 27,000 Total Machine hours 26,300 19,439 13,722 59,461 Total Direct labor costs $ 57,159 $ 285,839 $ 70,032 413,030 Total Overhead Costs $ 1,480,000 $1,650,000 $900,000 4,030,000 Bid #74683 Direct labor hours Machine hours Direct labor costs Direct material cost 1.25 3.25 1.25 5.75 4.00 3.00 2.00 9.00 15.63 55.63 14.37 85.63 280.25 $ 183.00 $ 100.00 $ 563.25 $ $ Bid # 74687 Direct labor hours Machine hours Direct labor costs Direct material cost 1.50 7.50 3.00 12.00 15.00 11.00 8.00 34.00 18.76 138.75 32.50 190.01 $ 2,440.50 $ 1,594.00 $ 870.00 $4,904.50