1. What is the engineer’s concern about the overhead rate going “up and up”?
In considering the engineer’s concerns regarding the rate of overhead, it is important to clarify their job order costing system. This method for the allocation of manufacturing costs to specific individual products is utilized predominantly when products being manufactured consistently differ substantially from job to job (Averkamp, 2015).
The engineer’s company, Fabricator Inc., utilizes this system in the manufacturing of specialized equipment due to this factor of differentiation. Thus, production and manufacturing costs are assigned to each job according to the estimated requirement for labor hours necessary for completion. In the use of the job order costing system, it is imperative to record and track costs of production, including labor, materials and overhead according to each job. As each job undertaken by Fabricator Inc. will have a substantial variation in each specialized equipment they manufacture, the job order costing system helps to determine a job cost record for every order and identify and report the specific materials and labor actually utilized in combination with manufacturing overhead assigned to each job. In light of this overhead assignment, the general cost and income generation comes into consideration.
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The engineer’s concern in the overhead rate going up and up essentially come around to confront the generalization of cost and income generation, which ultimately dictates their business generation and progress. Further, although direct labor makes up only 5% of their total product cost, it is the predetermining factor that drives the entirety of their combined costs. In addition, these rates also dictate the determination to outsource design by the design engineers to machine technology, which exacerbates the process for which the engineer’s concern is directed. This continual process is what precludes the overhead rate from remaining steady and supporting accurate estimates from job to job.
A foremost factor that is important in the overall cost as well, and should be taken into full consideration, is the engineer’s statement that “over the past years as we have had less and less direct labor.” Considering this fact that direct labor continues to decline, the substantiation for overhead cost allocated to it is not relevantly logical. This contribution may also have a significant influence in the engineer’s concerns.
2. What did the engineer mean about the large overhead rate being a disadvantage when placing bids and seeking new business?
In determining that the large overhead rate puts Fabricator Inc. at a disadvantage when placing bids and seeking new business, the engineer is referring back to the concerns detailed in the previous section where; direct labor makes up only 5% of Fabricator Inc.’s total product cost, it is the predetermining factor that drives the entirety of their combined costs and also dictates the determination to outsource design by the design engineers to machine technology, which exacerbates the process of the overhead rate continually increasing. Additionally, when factoring in the potential for a 30-minute error in Fabricator Inc.’s estimate of assembly time adding up to $1,500. which would be reflective in their bids to new business, these circumstances pervasively stand as determining factors for consideration by potential new business.
A persistently increasing overhead rate simply governs the price estimates provided in bidding to potential customers and new business. As the overhead is influenced by the cost associated with direct labor hour rates, they are an underlying factor in the interest each bid garners from new business prospects. If it is too high, Fabricator Inc. is obviously in a disadvantaged position over bids from competing companies.
The engineer’s statements here refer simply to the relatively uncomplicated concept that cost is usually king in the mind of the consumer/purchaser. With regard to the factors that have induced the engineer’s concerns, they dictate the cost presented to the consumer/purchaser.
3. What do you think is a possible solution?
The solution to this dilemma obviously lies in lowering and maintaining the overhead cost as it is associated with direct labor costs. It may be important to clearly identify factory labor and factory labor costs. “The cost of wages of employees who are directly involved in converting materials into the manufactured product is classified as direct labor cost,” (Thomson Learning, 2010). Fabricator Inc.’s allocation of these wages directly influences the set amount for direct labor costs per hour.
The costs aside from direct materials and direct labor through the manufacturing process are referred to as the factory overhead cost (Thomson Learning, 2010). These costs also factor into the overhead rate in one degree or another for Fabricator Inc. However, the determination for the allocated hourly direct labor cost is what is fluctuating, and is the factor that requires alteration in order to reach a possible solution.
Two possible solutions may come in the way of altering the pricing of $3,000 allocated to every hour of direct labor from Fabricator Inc. One, lowering the direct labor rate according to an estimated median for each job may prove to influence the consistency maintained in the general overhead cost without significant change as it only accounts for 5% of the product cost. Two, instead of a set hourly rate for every job, especially as direct labor has been evidently declining through the past few years, individual determinations for the price of direct labor hours may prove to enhance the attractiveness of certain bids toward new business. In other words, a single overhead rate may not be the most effective model for operation.
- Averkamp, Harold. (2004-2015). Accounting Coach.web. What is Job Order Costing. Retrieved January 18, 2015 from http://www.accountingcoach.com
- Thomson Learning. (2010). SW Learning.web. Manufacturing Cost Terms. Retrieved January 19, 2015 from http://www.swlearning.com/
