Question

Gibson Fabricators Corporation Gibson Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plantwide predetermined overhead rate based on direct labour-hours. On the December 10, 2019, the company’s controller made a preliminary estimate of the predetermined overhead rate for 2020. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labourhours for 2020:

Predetermined overhead rate = $2,475,000/ 52,000 hours = $47.60 per direct labour-hour

This new predetermined overhead rate was communicated to top managers in a meeting on the December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2019. One of the subjects discussed at the meeting was a proposal by the production manager to purchase an automated milling machine centre built by Central Robotics. The president of Gibson Fabricators, Kevin Robinson, agreed to meet with the regional sales representative from Central Robotics to discuss the proposal. On the day following the meeting, Mr. Robinson met with Jay Warner, Central Robotics’ sales representative. The following discussion took place:

Robinson: Larry Winter, our production manager, asked me to meet with you since he is interested in installing an automated milling machine centre. Frankly, I am sceptical. You’re going to have to show me this isn’t just another expensive toy for Larry’s people to play with.

Warner: That shouldn’t be too difficult, Mr. Robinson. The automated milling machine centre has three major advantages. First, it is much faster than the manual methods you are using. It can process about twice as many parts per hour as your present milling machines. Second, it is much more flexible. There are some up-front programming costs, but once those have been incurred, almost no setup is required on the machines for standard operations. You just punch in the code of the standard operation, load the machine’s hopper with raw material, and the machine does the rest.

Robinson: Yeah, but what about cost? Having twice the capacity in the milling machine area won’t do us much good. That centre is idle much of the time anyway.

Warner: I was getting there. The third advantage of the automated milling machine centre is lower cost. Larry Winters and I looked over your present operations, and we estimated that the automated equipment would eliminate the need for about 6,000 direct labour-hours a year. What is your direct labour cost per hour?

Robinson: The wage rate in the milling area averages about $21 per hour. Fringe benefits raise that figure to about $30 per hour.

Warner: Don’t forget your overhead.

Robinson: Next year the overhead rate will be about $48 per hour.

Warner: So including fringe benefits and overhead, the cost per direct labour-hour is about $78.

Robinson: That’s right.

Warner: Since you can save 6,000 direct labour-hours per year, the cost savings would amount to about $468,000 a year.

Robinson: That’s pretty impressive, but you aren’t giving away this equipment are you?

Warner: Several options are available, including leasing and outright purchase. Just for comparison purposes, our 60-month lease plan would require payments of only $300,000 per year.

Robinson: Sold! When can you install the equipment?

Shortly after this meeting, Mr. Robinson informed the company’s controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realised that this decision would require recalculation of the predetermined overhead rate for the year 2020 since the decision would affect both the manufacturing overhead and the direct labourhours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labour-hours for the year from the levels that had initially been planned. When the revised predetermined overhead rate for the year 2020 was circulated among the company’s top managers, there was considerable dismay.

Required: Part A – Report Write a report addressing the following questions to be submitted to the president of Gibson Fabricators, Kevin Robinson. 1. Recalculate the predetermined rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for the year 2020.

2. The company has received a job order from Fairfield corporation. The estimated direct material costs for delivering the order is $45,800. The new machine will be used for this job. The expected labour cost will be $8,400 for 400 hours of direct labour. What will be the estimated total production cost of this job under the new predetermined rate?

Answer 1

Ans 1.: For Gibson Fabricators Corporation,

If the new machine is not purchased,than the Direct Labour Hours would be 52,000 Direct Labour Hours.Also New Wage rate would be $30 per hour and New Overhead rate would be $48 per hour.

Therefore,Total Cost would be as follows :

	Direct Labour Hour	Rate Per Hour ($)	Total Cost ($)
Wages	52,000	30	1,560,000
Overhead	52,000	48	2,496,000
Total		78	4,056,000

Now,if the new machine is purchased,there will be savings in 6,000 Direct Labour Hours. But,the Overhead would increase by $300,000 of lease and $45,000 payable for skilled technician/programmer.

Therefore,Total Cost would be as follows :

	Direct Labour Hour	Rate Per Hour ($)	($)	Total Cost ($)
Wages (A)	46,000	30		1,380,000
Overhead
Fixed	46,000	48	2,208,000
Lease	-	-	300,000
Skilled Technician	-	-	45,000
Total Overheads (B)	46,000	55.5		2,553,000

Total Cost (A+B)

3,933,000

Now From the above schedule, we can conclude that there is an increase in pre determined overhead rate by $7.5 ($55.5 - $48) but total overheads are increased by $ 57,000 ($2,553,000 - $2,496,000). This was due to increase in overhead cost by $345,000 due to lease & Skilled Technician and also there were savings of $288,000 due to reduction in 6,000 labour hours. Hence, there was net increase in total overheads by $57,000.

But, as there is decrease in 6,000 Labour Hours, Wages also reduced by $180,000 ($1,560,000 - $1,380,000).

And hence, there is a net savings in the total cost of $123,000.

Ans 2.: For the Job Order from Fairfield Corporation,

The Estimated Total Production Cost

Particulars	Amount ($)
Direct Materials	45,800
Direct Labours (for 400 hours)	8,400
Factory Overheads (400 hours x $55.5)	22,200
Total Production Cost	76,400