A company manufactures jewelry settings and sells them to retain stores. In the
ID: 2435416 • Letter: A
Question
A company manufactures jewelry settings and sells them to retain stores. In the past, most settings were made by hand, and the overhead allocation rate in the prior year was $10 per labor hour ($2,000,000 overhead /200, labor hours). In the current year, overhead increased by $400,000 due to acquisition of equipment. Labor, however decreased by 50,000 hours because the equipment allows rapid creation of the settings. One of the company’s many customers is a local jewelry store, this store is relatively small and the time to make an order of jewelry pieces is typically less than 8 hours. On such jobs (less than 8 labor hours) the new equipment is not used and thus the jobs are relatively labor intensive.Required
Assume that in the current year, the company continues to allocate overhead based on labor hours. What would be the overhead cost of an 8-labor-hour job requested by the jewelry store. How does this compare to the overhead cost charged to such a job in the prior year? Assume that the price charged for small jobs does not change in the current year. Are small jobs less profitable that they were in the past?
Explanation / Answer
Old Overhead Rate $2,000,000/200,000 hours = $10
New Overhead Rate $2,400,000/150,000 hours = $16
Overhead Cost of an 8-labor-hour job = $16 x 8 labor hours
= $128
Prior year cost $10 x 8 labor hours = $80
Comparing these two costs we find that there is a 60% increase in overhead cost as compared to prior
year(s).
Yes with the introduction of new equipment, small job are less profitable than in past. The new equipment has decreased the labor hour 50,000 labor hours per year but there is considerable increase in overhead cost by $400,000 (20%).
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