Question

ProWorks is a website design and consulting firm based in Corvallis. The firm uses a job cost system in which each client is a different job. Proworks traces direct labor, software licensing costs, and travel costs directly to each job (client). It divides overhead into two cost pools, "Indirect Labor" and "Office Overhead." It allocates Indirect Labor (support staff salaries) to jobs based on software licensing costs. It allocates Office Overhead (all other overheads) to jobs based on direct labor hours. At the beginning of 2016, managing partner Mark Milici prepared the following estimates:

Direct labor hours $14,000 hours

Direct labor costs $1,400,000

Software licensing costs $50,000

Travel costs $80,000

Support staff salaries $200,000

Computer leases $50,000

Office supplies $30,000

Office rent $60,000

In January, 2016, ProWorks served three clients. Records for the clients appear here:

.Dining Corp .Hut Shuttle .Lucidyne

Direct Labor Hours: 600 hours 50 hours 300 hours

Software licensing costs: $5,000 $500 $2,000

Travel costs: $9,000 $2,000 $0

PLEASE HELP ANSWER THESE QUESTIONS:

1) Compute ProWorks overhead cost allocation rates and direct labor rate for 2016.

2) Construct a cost report for managers showing how all costs are allocated to each of the three jobs (clients) listed.

3) Write a business memo about cost allocation issues. In your analysis, explain the reasons why ProWork managers should assign all costs to jobs. Managers also want to know the factors they should consider when setting prices. If managers want to earn profits equal to 20% of sales revenue, what price should the company charge each client?   

Answer 1

1) Direct labour rate = total direct labour costs / total direct labour hours

= 1400000 / 14000

= $100

Overhead cost allocation based on software licence costs for support staff salaries and direct labour hours for all other overheads

Support staff salaries overhead rate = total support staff salaries / total software licence costs

= 200000 / 50000

= $4

All other overheads rate = Total other overheads cost / total direct labour hours

= 50000 (computer leases) + 30000(office supplies) + 60000 (office rent) / 14000

= 140000 / 14000

= $10

2) Total cost allocation to each of the three clients:

	Dining Corp	Hut Shuttle	Lucidyne
Direct costs
Direct labour	60000	5000	30000
Software license cost	$5,000	$500	$2,000
Travel costs	9000	2000	0
Total direct costs	$74,000	$7,500	$32,000
Support staff salaries:
Software license cost	$5,000	$500	$2,000
Support staff salaries rate	$4	$4	$4
Total support staff salaries	$20,000	$2,000	$8,000
All other overheads:
Overhead rate	$10	$10	$10
Direct labour hours	600	50	300
All other overheads	$6,000	$500	$3,000
Total overheads	$26,000	$2,500	$11,000
Total cost	$1,00,000	$10,000	$43,000

3) Memo

When setting prices, the management must account for all costs whether direct or indirect for a client to calculate the accurate prices. All the jobs or clients use the indirect costs and the depending on the usage of these indirect costs, these costs should be allocated to the jobs.The usage can be determined using the cost pools for the two category of indirect costs.

Price to be set to earn profits of 20% on sale is as follows:

	Dining Corp	Hut Shuttle	Lucidyne
Total cost	$1,00,000	$10,000	$43,000
Price	$1,25,000	$12,500	$53,750