Question

1. Kootenay Welding company is not sure whether or not to use direct labour hours or machine hours to allocate manufacturing overhead. They expect total manufacturing overhead for the year to be $450,000. They expect to have 6,000 direct labour hours and 4,500 machine hours. Kootenay Welding Company is going to bid on a contract that is expected to take 450 direct labour hours and 375 machine hours. Direct Labour costs $45 an hour and materials would total $25,000.

1. Assuming a 25% markup, what would Kootenay Welding Company bid for the contract if they used direct labour hours as an allocation base?

2. Assuming a 25% markup, what would Kootenay Welding Company bid for the contract if they used machine hours as an allocation base?

3. If a competitor bids $100,000 amount, what does that mean for Kootenay Welding Company?

4. In a desire to decide whether or not use direct labour hours or machine hours as an allocation base for manufacturing overhead, Kootenay Welding Company does regression analysis. They find that direct labour hours vs manufacturing overhead has an r squared value of 0.856 and machine hours vs manufacturing overhead had an r squared of 0.962. Which would be a better allocation base? What does this mean for their bid (assuming the competitors bid of 100,000)?

Answer 1

Ans: 1 & 2

				Allocation Base
				Direct Labour	Machine Hour
Particular				Amount
Direct Material			20,250.00	20,250.00
Direct Labour		[450*45]	25,000.00	25,000.00
Total Prime Cost			45,250.00	45,250.00
Manufacturing Overheads
Direct Labour Base			33,750.00	-
Machine Hour Base			-	37,500.00
Total Cost			79,000.00	82,750.00
Add: Mark Up @25%		19,750.00	20,687.50
Bid Price for Contract		98,750.00	103,437.50

Ans.3) If a competitor bids $100,000 amount

In case of use of Labour Hour overhead allocation basis, Kootenay Welding company will bag the contract as its bidding price is $98750

and, In case of Machine Hour rate overhead allocation basis, Competitor with $100,000 bidding price will get the contact.

Ans.4) R-squared evaluates the scatter of the data points around the fitted regression line. It is also called the coefficient of determination, or the coefficient of multiple determination for multiple regression. For the same data set, higher R-squared values represent smaller differences between the observed data and the fitted values.

Therefore, machine hours vs manufacturing overhead had an r squared of 0.962 which is best fitted for allocation of overheads, but due to that Kootenay Welding company's bid qould quote $103,437.50 i.e above the bidded price of competitor resulting rejection of their bid.