Question

You employ Cheska, the owner of a sole trader gate replacement business, to do the job that you need for a new gate on your old home. Although Cheska’s quote was the lowest you received, you picked her because she was highly recommended by your family. You were sure the low quote did not suggest a low-quality job. As it turned out, you were right.

Cheska works alone so you chatted with her during lunch breaks to keep her company. During one of these chats, you were surprised to hear that her business was struggling financially, even though Cheska had jobs booked 5 days a week for a year ahead, except for 4 weeks in summer when she wants to take a well-earned break. You thought about that low quote. Was she charging enough to cover all his costs?

The answer became clear when you received Cheska’s invoice. It included the correct list of materials, all charged at appropriate, going-rate-in-the-market prices (total $10,000). No obvious problems there. It was the other item on the invoice – labour – that suggested a problem. Cheska had charged the correct amount of hours (total 80 hours = 8 hours per day, 5 days per week for 2 weeks) but at only $30 per hour! Clearly such a low rate could only be the direct labour rate. It seemed that no overheads had been incorporated into that rate, as would normally be the case for ‘tradies’. You guess Cheska’s overheads would be around $50,000 per year.

You pay the invoice but then decide you want to help Cheska out by explaining how he could apply a job costing approach in the future.

In your explanation to Cheska, you will need to include the following:

a) A brief description of job costing and its purpose.

b) A definition of overheads along with 4 examples of overheads applicable to jobs for William’s business.

c) A numerical example applied to your roofing job that derives the full cost of your job. The example should correctly use the information above, provide any necessary formulas and justify any choices. The example should be well presented in a logical order that will be easy for William to follow and understand.

Your answer should not exceed 500 words.

Answer 1

(a): Job costing is an accounting method in which costs and revenues are tracked on an each “job” basis. Here the costing is done for individual jobs that are being provided by an individual or an entity. The main purpose of job costing is that it enables standardized reporting with regards to profitability by job to job basis. It allows business to track costs by individual jobs being done by it.

(b): In plain and simple words overheads can be defined as those ongoing business expenses that are not directly attributable to producing a product or a service or is not incurred when doing a job. In other words they are business costs that are related to the day-to-day running of the business. It should be noted that overheads are not the same as operating expenses. While operating expenses can be traced back to a specific business activity or a specific cost unit overheads cannot be traced back to a business activity. Thus we can say that overheads provide support to the overall activities of a business that generates revenue.

4 examples of overheads that can be applicable here are –

(i): Rent – Cheska must be renting a place for the gate replacement business. The place must be serving as the office as well as the place in which all tools and equipment are stored. The rental expenses are an overhead cost for this gate replacement business.

(ii): Depreciation of assets – Cheska must be using some tools and equipment for the purpose of replacing gates and the depreciation amount on these assets will be an overhead expense.

(iii): Cost of office supplies – This will include all cost of office supplies that is being consumed by Cheska and will include stationary items and other items of office supplies.

(iv): Advertising and marketing costs – This will include all costs being incurred by Cheska to market the gate replacement business and attract new clients.

(c ): Here total no. of weeks that Cheska works = 52 weeks in a year – 4 weeks of break = 48 weeks. Thus total no. of hours worked by Cheska in a year = 8 hours per day * 5 days per week * 48 weeks in a year = 1,920 hours per year.

Amount of overheads = $50,000 (as provided in the question).

Thus indirect labor rate = $50,000/1920 hours = $26.04 per hour. Thus Cheska should start charging a total of $30+$26.04 = $56.04 per hour as labor charges.

Thus in the example rate Cheska should ideally charge an amount that is equal to material cost + total labor cost = $10,000 + (80 hours * $56.04 per hour)

= $14,483.33

(444 words)