Integrative Case 7-78 (Algo) Predetermined Rates, Job Costing, Service Firms, Product-Line Profitability (LO 7-3)

A&R Quality Advisors is a small consulting firm offering quality audits and advising services to small and mid-sized manufacturing firms. Quality audits entail reviewing, checking, and documenting quality practices within a firm. Quality advising entails making recommendations for new or revised quality practices. Other firms in the area offer one or both of these services, although the competition for quality audit jobs is stronger than for quality advising.

In addition to senior executives, A&R employees are either staff or managers. Staff employees are usually younger with less experience. Managers, who oversee the staff on jobs, are more experienced. The average hourly wage is $90 for staff and $225 for managers. (Both staff and managers are paid an annual salary; these hourly costs are based on 2,000 average annual hours worked.) Staff are expected to spend at least 90 percent of their time on billable work. Because of administrative work associated with supervising the staff and the expectation that managers will spend a portion of their time seeking new business, managers are expected to spend about 50 percent of their time on billable work. A&R employs 10 staff and two managers.

In addition to staff and manager costs, A&R has overhead and administrative costs of $5,088,000, of which about $1,696,000 is variable with respect to billable hours. Overhead and administrative costs include the nonbillable cost of the staff and managers.

Selected information on billable hours expected for the next year follows:

	Billable Audit Hours	Billable Advising Hours	Total Billable Hours
Staff	Manager	Staff	Manager	Staff	Manager
Client 01	156	18	206	16	362	34
Client 02	112	16	0	0	112	16
Client 03	226	36	86	21	312	57
Client 49	46	8	0	0	46	8
Client 50	306	26	206	21	512	47
Total	8,800	1,500	9,800	1,100	18,600	2,600

Although not all clients use A&R for both services, about 70 percent do.

A&R bills audit services based on billable hours and advising services at a fixed fee. The cost for audit services is determined by multiplying the billable hours by the quoted employee rates. Staff rates for the following year are $230 per hour, and manager rates are $575 per hour. The rates are set to meet the competition in the area.

To determine the cost (not the price) of the job, A&R uses a job costing system. To the employee costs (not the billing rates) is added an amount for overhead based on the predetermined rate and the billable hours in the job. The predetermined rate is based on expected billable hours.

Total revenue at A&R next year is expected to be $9 million.

The two founding partners of A&R are looking at these forecasts for next year and trying to decide whether to drop one of these services. We should probably become more focused, as we sometimes remind our clients.

Required:

What is the predetermined overhead rate for costing jobs in the following year?

How much will Client 02 be billed for audit services next year?

How much will the job costing system report as the cost of Client 02 audit services next year?

What will be the total revenues from audit services next year based on the expected hours and the billing rates?

Based on the job costing system, what will the reported cost of audit services be next year?

Based on the job costing system, what will be the cost of advisory services?

What is the expected profit of audit services next year?

What is the expected profit of advisory services next year?