Problem 2: Vanessas predicament

Vanessa Noel, owner and manager of Noel Draperies and Window Treatments, has been receiving some complaints from her loyal clientele of interior decorators and home dcor consultants. For example, one of her loyal customers, Phoebe, wanted to know why she was being charged a much higher price for an order that was almost identical to an order she placed last year. Phoebe felt that the price hike was simply not justified.

Although Vanessa, when responding to Phoebes complaint, blamed the price hike on the rising price of materials, she herself was a bit perplexed and decided to look into the matter. Vanessa asked her accountant to prepare a report for her summarizing cost and pricing data for the last three years. The accountant presented this information in the following table:

	Year 1	Year 2	Year 3
Budgeted results
Revenue	$2,400,000	$2,700,000	$2,000,000
Direct materials	360,000	405,000	320,000
Direct labor	720,000	810,000	650,000
Variable factory overhead	144,000	162,000	130,000
Fixed factory overhead	400,000	400,000	400,000
Variable SG&A expenses	240,000	300,000	220,000
Fixed SG&A expenses	200,000	180,000	200,000
Actual results
Revenue	$2,320,000	$2,800,000
Direct materials	380,000	430,000
Direct labor	725,000	900,000
Variable factory overhead	140,000	160,000
Fixed factory overhead	425,000	440,000
Variable SG&A expenses	260,000	300,000
Fixed SG&A expenses	180,000	200,000

Vanessa believes that the last few years have been fairly representative of business volume in general. Moreover, Vanessa believes the average of the direct labor cost for years 1 and 2 is a fair estimate of her normal volume of business.

Vanessa next turns her attention to how she prices jobs. When her company receives an order, Vanessa estimates the direct labor and material costs for the job, and then she applies an overhead amount to the job. Each year, she computes a new budgeted overhead rate per direct labor dollar. Vanessa then prepares the order quote by adding direct material costs, direct labor costs, applied overhead, and a 50% markup on the total cost.

Vanessa retrieves information corresponding to Phoebes order in year 2, and compares it with the price quote the company prepared for Phoebe for her most recent order in year 3. Vanessa is not an accountant, but she is a good manager and can understand why Phoebe complained.

Required:

1. Compute the total overhead application rates for years 1, 2, and 3.
2. Compute the over-applied or under-applied overhead for year 1 and year 2.

3. The following information pertains to Phoebes order in year 2, and her current order for year 3, which is identical (in terms of the draperies and window treatments) to her year 2 order.

	year 2	year 3
Direct materials	$15,000	$15,500
Direct labor	$30,000	$32,000

Compute the price Vanessa charged Phoebe for her year 2 order and the price quoted for the year 3 order.

4. Do you agree with Phoebe that the price being quoted for her year 3 order is too high?
5. What should Vanessa do? Can you suggest an alternative way for Vanessa to develop her price quotes? Explain.