Question

Answer both questions using chart

Lock-Tite Company

Jobs Report – Traditional OH allocation (Direct Labor Dollars)

Year Ending December 31

		JV28	BY92	ZF14
Sales Revenue		132,800	99,600	92,960	Calculated in 7e)
Job Costs:
Direct Material		26,560	19,920	13,280	From 7a)
Direct Labor		7,842	5,882	5,882	From 7b)
Overhead		4,313	3,235	3,235	From 7c)
Total Job Costs		38,715	29,037	22,397
Gross Margin		70.85	70.85	75.91
Gross Margin %		53%	71%	82%

1. Comparing the Gross Margin percentages of the jobs under traditional costing. Should Lock-Tite be concerned with the accuracy of the overhead applied to each job? Explain why in 30 to 50 words.

2. Businesses that typically use job costing, will generally quote their customers a price before the work begins. Recently, Lock-Tite’s customers have indicated that their prices are priced significantly different from competitive companies’ prices. Given the significant amount of under-applied overhead, do you think these gross margin percentages are realistic? Could they be charging their customers too much? Not enough? While answering these questions, explain how the application of overhead impacts the information the company uses. Use 30 to 50 words.

Answer 1

a) Yes Lock Tite should be worried about the accuracy of overhead allocation to jobs. The traditional cost driver allocates overheads based on one cost driver only. All the overheads may not have a single cost driver and hence the overheads allocated as per traditional method is unreliable. The higher gross margin is due to under-applied manufacturing overheads to each job. The products are under costed as per existing system of allocation of overheads

b) The gross margin percentage is unrealistic and under applied overheads is giving lot of profits on the job. The firm might be charging too much to the customers if the pricing is cost based pricing. The overheads are allocated as per single cost driver without actual cost driver being used in allocation. Thus the products are under costed since manufacturing overhead is under applied. When a rational cost driver is used the product costs are accurately reflected and gross margin reflection will be realistic.