Question

A&R Quality Advisors is a small consulting firm offering quality audits and advising services to small and mid-sized manufacturing firms. Quality audits entail reviewing, checking, and documenting quality practices within a firm. Quality advising entails making recommendations for new or revised quality practices. Other firms in the area offer one or both of these services, although the competition for quality audit jobs is stronger than for quality advising.

In addition to senior executives, A&R employees are either staff or managers. Staff employees are usually younger with less experience. Managers, who oversee the staff on jobs, are more experienced. The average hourly wage is $60 for staff and $150 for managers. (Both staff and managers are paid an annual salary; these hourly costs are based on 2,000 average annual hours worked.) Staff are expected to spend at least 90 percent of their time on billable work. Because of administrative work associated with supervising the staff and the expectation that managers will spend a portion of their time seeking new business, managers are expected to spend about 50 percent of their time on billable work. A&R employs ten staff and two managers.

In addition to staff and manager costs, A&R has overhead and administrative costs of $4,500,000, of which about $1,500,000 is variable with respect to billable hours. Overhead and administrative costs include the non-billable cost of the staff and managers.

Selected information on billable hours expected for the next year follow.

	Billable Audit Hours				Billable Advising Hours				Total Billable Hours
	Staff		Manager		Staff		Manager		Staff		Manager
Client 01	150		12		200		10		350		22
Client 02	70		10		0		0		70		10
Client 03	220		30		80		15		300		45
⋮	⋮		⋮		⋮		⋮		⋮		⋮
Client 49	40		2		0		0		40		2
Client 50	300		20		200		15		500		35
Total	8,500		1,200		9,500		800		18,000		2000

Although not all clients use A&R for both services, about 70 percent do.

A&R bills audit services based on billable hours and advising services at a fixed fee. The cost for audit services is determined by multiplying the billable hours by the quoted employee rates. Staff rates for the following year are $200 per hour and manager rates are $500 per hour. The rates are set to meet the competition in the area.

To determine the cost (not the price) of the job, A&R uses a job costing system. To the employee costs (not the billing rates) is added an amount for overhead based on the predetermined rate and the billable hours in the job. The predetermined rate is based on expected billable hours.

Total revenue at A&R next year is expected to be $8 million.

The two founding partners of A&R are looking at these forecasts for next year and trying to decide whether to drop one of these services. “We should probably become more focused, as we sometimes remind our clients.”

Required:

a. What is the predetermined overhead rate for costing jobs in the following year?

b. How much will Client 02 be billed for audit services next year?

c. How much will the job costing system report as the cost of Client 02 audit services next year?

d. What will be the total revenues from audit services next year based on the expected hours and the billing rates?

e. Based on the job costing system, what will the reported cost of audit services be next year?

f. Based on the job costing system, what will be the cost of advisory services?

g. What is the expected profit of audit services next year?

h. What is the expected profit of advisory services next year?

Answer 1

Answer to question a:

$75 i.e. Variable overhead cost of $15,00,000/20000 total billable hours since variable cost can be only apportioned

Answer to question b:

	Billable audit hours	Rate per hour	total billing
	Staff	Manager	Staff	Manager	Staff	Manager	Total
Client 2	$                             70.00	$   10.00	$                        200.00	$       500.00	$      14,000.00	$        5,000.00	$    19,000.00

Answer to question c:

	Billable audit hours	Costing per hour	Total cost
	Staff	Manager	Staff	Manager	Overheads	Staff	Manager	Overheads	Total
Client 2	$70.00	$ 10.00	$                60.00	$150.00	$      75.00	$4,200.00	$1,500.00	$6,000.00	$11,700.00

Answer to question d:

	Billable audit hours	Rate per hour	total billing
	Staff	Manager	Staff	Manager	Staff	Manager	Total
For all clients	$8500	$1200	$200	$500	$1700000	$600000	$2300000

Answer to question e:

	Billable audit hours	Costing per hour	Total cost
	Staff	Manager	Staff	Manager	Overheads	Staff	Manager	Overheads	Total
For all clients	$8,500.00	$1,200.00	$   60.00	$ 150.00	$   75.00	$5,10,000.00	$1,80,000.00	$7,27,500.00	$ 14,17,500.00

Answer to question f:

	Billable Advising Hours	Costing per hour	Total cost
	Staff	Manager	Staff	Manager	Overheads	Staff	Manager	Overheads	Total
Total	$                       9,500.00	$ 800.00	$                           60.00	$       150.00	$              75.00	$   5,70,000.00	$ 1,20,000.00	$7,72,500.00	$ 14,62,500.00

Answer to question g:

	Billable audit hours	Billing rate per hour	Cost per hour	Total billing	Total cost
	Staff	Manager	Staff	Manager	Staff	Manager	Overheads	Staff	Manager	Total	Staff	Manager	Overheads	Total	Profit
Total	$                       8,500.00	$1,200.00	$                         200.00	$       500.00	$              60.00	$            150.00	$            75.00	$ 17,00,000.00	$   6,00,000.00	$ 23,00,000.00	$5,10,000.00	$1,80,000.00	$7,27,500.00	$ 14,17,500.00	$8,82,500.00

Answer to question h:

	Billable Advising Hours	Billing rate per hour	Cost per hour	Total billing	Total cost
	Staff	Manager	Staff	Manager	Staff	Manager	Overheads	Staff	Manager	Total	Staff	Manager	Overheads	Total	Profit
Total	$                       9,500.00	$    800.00	$                         200.00	$       500.00	$              60.00	$            150.00	$            75.00	$ 19,00,000.00	$   4,00,000.00	$ 23,00,000.00	$5,70,000.00	$1,20,000.00	$7,72,500.00	$ 14,62,500.00	$8,37,500.00