Question

Case 4-27.

Sharpton fabricators corporation manufactures a variety of parts for the automative industry. th company uses a jo order costing system with a plantwide predetermined overhead rate based on direct hours. On December 10, 2015, the company's controller made a preliminary estimates of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labor - hours for 2016. Pretermined overhead rate = $2,475,000/ $2,000 hours = $47.60 per direct labor hour. The new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2015. One of the subject discussed at the meeting was a proposal by the manager to purchase an automated milling machine built by central robotics the president of sharpton fabricators, kevin reynolds, agreed to meet with the regional sales representative from central robotics to discuss proposal. one of the following meeting, Mr raynolds met with jay warner central robotics sales represntatives. the following took place

Reynolds: Larry winter, our production manager asked me to meet with you because he is interested in installing an automated milling machine, frankly, I am skeptical, you going to have to show me this isnt just another expenisve toy for larry's people to play with.

Warner: That should not be difficult Mr Reynolds. The automated mailiing machine has three major advantage. First, it is much faster than the manual method you are using.It can produce as fast as twice as many parts as per hour as your present milling machine. Second, it is much more flexible. there are some up front programming cost but once those have been incurred, almost no setup on the machine for standard operation. You just punch the code of the standard operation, load the machines hopper with raw material and the machine does the rest.

Reynolds : Yeah, but what about cost? having twice the capacity in the mailing machine area wont do us much good. That center is idle much of the time anyway.

Warner: I was getting there, the third advantage of the autoimated milling machine is lower cost. larry winters and i look over your present operations and we estimated that the automated equipment will eliminate the need for about 6,000 direct labor hours a year. What is your direct labor cost per hour.

Reynolds : The wage rate in the milling area avarage about $21 per hour. Fringe benefits raise that figure to about $30 per hour.

Warner : Dont forget the overhead

Reynolds : next year the overhead rate will be about $48 per hour

Warner : so including fringe benefit and overhead, the cost per direct labor hour is about $78

Reynolds: thats righ.

warner : Since you save 6,000 direct labor hours per year, the cost savings would amount to about $468,000 a year.

Reynlds: that's pretty impressive, but you arent giving away the equipment are you?

Warner : Several options are available, including leasing and outright purchase just for comprison purposes, our 60 - month lease plan would requoire payment of only $30,000 per year

Reynolds: sold! When can install the equipment?

Shortly after this meeting, Mr Raynolds informed the comapny controller of the decision to lease the new equipment, which would be installed over the christmas vacation period.The conroller realise that this decision would require a recomputation of the predetermined overhead rate for the year 2016 since the decision would affect both the manufacturing overhead and the direct labor hours for the year. after taking with both the production manager and the sales represntative from the centra robotic, .the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/ programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned. When the revised predetermined overhead rate for the year 2016 was circulated among the company's top managers, there was considerable dismay.

Required:

1. Recompute the predetermined overhead rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher or lower than the rate that was originally estimated for the year 2016.

2. What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine

3 Why would managers be concerned about the new overhead rate?

4 After seeing the new predertermined overhead rate, the production manager admitted that he probably wouldn't be able to eliminate all of the 6,000 direct labor hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would be only about 2,000 hours - one worker. Given this additional information, evaluate the original decision to acquire the automated milling machine from central robotics.

Answer 1

1	Original Overhead	2475000
	Add: Lease Cost	300000
	Add: Technician Cost	45000
	Total New Overhead	2820000
	Original Labor Hour	52000
	Less: Reduction in Hour	-6000
	Total New Labor Hour	46000
	Net Predetermined Overhead Rate (New OVH/New Hour)	2820000/46000
		61.30
	New Rate is higher than original rate of 47.6 since increase in cost is 345000, however reduction is of just 6000 Hours
2	For Jobs that do not uses Machine, cost will be increased for those jobs
3	Manager is concerned because it will raise their cost for few early years
4	If Actual reduction in labor hours is just 2000, it will increase predetermined overhead rate to (2820000/(52000-2000)=56.4
	Which is not beneficial for company as it will increase overhead and reduce net income