Case 4.64 Choice of Cost

Case # 4.64

Huge Company Ð'- Tooling Business Unit (TBU) Ð'- Choice of Cost System

Huge Company's tooling business unit manufactures metal and carbon fiber parts for the company's major products. They currently use the Functional-Based Costing system or FBC. In this costing system they compute a combined labor and overhead cost per labor hour and charges each job based on the number of labor hours used. This labor-based charge is added to the materials cost to calculate the total job cost. TBU works for internal customers only and not allowed to seek outside work. Management is concerned that the current costing system is causing other business units to send it work that does not use TBU's strengths to the company's overall advantage.

We will investigate the current Functional-Based Costing System (FBC) to determine if management's concerns are justified. We accomplish this by the following process:

Ð'* Explain the steps to compute job costing under the current standard costing system (Functional-Based Costing system - FBC)

Ð'* Provide a recommendation for another cost accounting system that recognizes additional differences among jobs (Activity Based Costing Ð'- ABC)

Ð'* Compute and explain the steps for job costing under the newly recommended costing system (Activity Based Costing Ð'- ABC)

Ð'* Explain differences in decision making at TBU

Ð'* Identify TBY's internal customers that might be influenced by use of the alternative cost system.

Ð'* Discuss under what scenarios each system might lead to better decision making at Huge Company

Explain the steps and compute the job costing under the current standard costing system (functional-based costing system - FBC)

Step 1 Ð'- Divide total overhead of 300,000,000 by total labor hours of 2,000,000 (2,000 hours x 1000 employees) = $150.00 labor cost per hour

Step 2 Ð'- Multiply $150.00 by the total labor hours

Step 3 Ð'- Add total labor charge to material costs for the final answer.

Job 1. $150.00 x 22.50 = 3,375.00 (total labor charge)

$3,375.00 + $30,000.00 = $33,375.00 (Cost of job 1)

Job 2. $150.00 x 160 = 24,000.00 (total labor charge)

$24,000.00 + $100,000.00 = $124,000.00 (Cost of job 2)

Job 3. $150.00 x 21 = 3,150.00 (total labor charge)

$3,150.00 + $28,000.00 = $31,150.00 (Cost of job 3)

Job 4. $150.00 x 120 = 18,000.00 (total labor charge)

$18,000.00 + $40,000.00 = $58,000.00 (Cost of job 4)

Job5. $150.00 x 60 = 9,000.00 (total labor charge)

$9,000.00 + $20,000.00 = $29,000.00 (Cost of job 5)

Shown on a chart, the costing under FBC is as follows:

Job Labor charge per job Materials charge per job Total cost per job

1 $ 3,375 $ 30,000 $ 33,375

2 $ 24,000 $ 100,000 $ 124,000

3 $ 3,150 $ 28,000 $ 31,150

4 $ 18,000 $ 40,000 $ 58,000

5 $ 9,000 $ 20,000 $ 29,000

Provide a recommendation for another cost accounting system that recognizes additional differences among jobs (Activity Based Costing Ð'- ABC)

Under the current FBC system, materials consumed during the course of a job are applied to that job according to their use, however, allocation of labor and machine time are allocated as if they we all of equal cost per unit of time. This produces an unrealistic and inaccurate costing of items produced. We recommend using an Activity Based Costing System Ð'- (ABC) with machine hours as a base. Machine hours on M machines are three times more expensive than machine hours on S Machines and Machine time is ten to twenty times more expensive than employee Labor costs. (The McGraw−Hill, 2003).

To show the under and over costing that is currently being employed with the FBC system, we will recalculate the five jobs, as shown above, using the ABC system.

Compute and explain the steps for job costing under the newly recommended costing system (Activity Based Costing Ð'- ABC)

Calculations for using machine hours as a cost driver are calculated as follows:

Total Overhead $ 300,000,000

Calculating the activity base cost (overhead to assign to each machine type)

S Machines M Machines Comment

# of Machines 13 6 Given

Cost Multiplier 1 3 Given

Hours avail. per 6,000 6,000 Given

Total Hours avail. 78,000 36,000 # Machines x hrs

Hours x cost mult. 78,000 108,000 Hrs x cost mult.

Cost Driver % 42% 58% % of overhead

Activity Cost $ 125,806,452 $ 174,193,548 % x overhead

Calculating the cost driver per hour of machine usage

Resource Cost driver base Activity cost Activity volume Predetermined cost driver (per hr)

S Machine Hours used $ 125,806,452 78,000 $ 1,613

M Machine Hours used $ 174,193,548 36,000 $ 4,839

Calculating