Quiz 9: Absorption Cost System


In the problem, the customer engineer of Heath Metal Products, Chris Maynard is worried about the excess direct labor cost allocated to a particular job relating to one of his largest accounts. He is of the view that the direct labor hours in the welding and drilling departments which have been charged to this job are much higher than his estimates. He feels that if the costs charged to this job are too high then the vice president operations may charge a high price to the customer. If that happens then the customer may think of purchasing the product (radar housing) from some other supplier instead of Heath Metal Products. Since it is given that the company has announced bonuses to customers engineers if they are able to achieve their target sales forecast, hence if Maynard loses this customer then it may be difficult for him to achieve his target sales and so he wants to get the costing of the product rechecked.a. Problems at Heath Metal Products Heath Metal Products is a machine shop which has three factory departments - pressing, drilling and welding. It also has two service departments - maintenance and janitorial. The company is having a job order costing system for charging direct material and direct labor to individual jobs. It is using departmental rates for allocating overheads to the jobs. The overheads are allocated using direct labor hours as the base. It is given that there is huge variability in the work volume of Heath due to which its workers have to remain idle for six to nine months if the company loses a large contract. To save the labor cost during idle time the management of the company is adopting the policy of laying off employees when they have reduced work volume and rehiring employees when the volume increases. To achieve this they are employing non-union labor so that the employees are not able to protest or resist being laid off. It is also given that they are asking production employees to get trained in maintenance and cleaning tasks and maintenance employees are being asked to get trained in production tasks. This is one more tactic adopted by the management of the company so that they can reduce the idle time in the factory and increase productivity. However it is also given that the management's efforts in trying to cross-train the employees have met with limited success which points to the fact that the employees are resisting this practice of the management. The company does not have any formal incentive or bonus scheme for rewarding employees who perform their jobs well. Also the customer engineers do not receive any commission for sales made by them. All this again points to the fact that the company is not having any employee-friendly policies for keeping the employees motivated. Thus the only compensation which employees are getting from the company is in the form of salaries and annual increments. In view of the above factors it is quite possible that the employees are deliberately overstating the time spent by them on jobs in the time sheet so that they can increase their earnings. This can be assumed based on the data given regarding the Lingle Aerospace job where Maynard has found that the direct labor hours charged in the welding and drilling departments are more than the hours estimated by him. However in the case of this company it increases the cost manifold since the overheads are also charged on the basis of direct labor hours. Hence if the direct labor hours are overstated, both the direct labor and overhead costs charged to jobs will get overstated. b. Improvements suggested to be implemented Since Heath is a machine shop having various metal pressing, drilling and welding machines it is suggested that the management should use machine hours as allocation base for charging overheads to the jobs instead of direct labor hours. Machine hours can be verified for the machines in each of the three production departments and departmental rates should be used for allocating overheads as currently followed. If it is not possible to use machine hours in a particular department then there should be stricter controls on the recording of direct labor hours by the employees in the job time sheets. The department supervisor should personally verify the direct labor hours charged by each employee in his department to the jobs. He should maintain a list containing the normal time taken for completing various tasks and if he finds that the time recorded by a particular employee abnormally varies from the list he should demand an explanation from the concerned employee for the difference. To improve the morale of the employees and increase their motivation, employees should be rewarded for outstanding performance in the form of incentives or bonus. Customer engineers should be given commission if they are able to achieve the sales target given to them. If the employees know that they will get rewards for good performance then they will not resort to practices like overstating the labor hours for getting more salaries. The management of the company also has to look at reducing the idle time in the factory which appears to be very high. They should reduce the prices when demand is low so that at least the company gets some contract from customers and the employees and machines will not remain idle. Laying off employees is not a good idea since it has impact not only on the employee who is laid off but also on the other employees who may be fearing that their jobs are not secure and this may affect their job performance in future. In the long run the company may find it difficult to get new employees if it continues with this "hire and fire" policy.

LIFO It stands for last in first out and it is a method of recording the inventory by the company that the newest inventory is to sell first by the company FIFO FIFO is a First-in and First-out method of valuation of Inventory. Under this method, it is assumed that the goods which are purchased first are sold first and the goods purchased later are sold later. The answer for this issue requires a comprehension of the connection between the start and closure WIP accounts and the stream of units through the creation procedure. Specifically, the accompanying chart shows these relations: The equation of the same is shown below. img Calculate the equivalent units as shown below. img The result of the above MS-Excel sheet has been shown below: img Thus, the equivalent units used comes out to be img and cost used comes out to be img .

The company Portable Phones Inc. has five manufacturing departments (phone assembly departments) and one service department. The service department (board department) is commonly used by all the departments and is a scarce resource since it can only assemble boards for one type of phone at a time. Due to this each assembly department has to wait for its turn before it can get its circuit boards assembled by the board department. So it is possible that the manufacturing departments have to stay idle for some time during a day or for an entire day waiting for its turn at the board department. It is given in the case that there is also a peak load problem since all the assembly departments want their boards assembled at the same time during the month. So this further points to the fact that there is a possibility of clash among the five assembly departments as to who will get priority service from the board department. The board department is having 80 percent fixed costs and 20 percent variable costs. Direct labor is the only variable cost component of the board department. All other costs like equipment depreciation, maintenance, supervision and engineering support are fixed costs. It is also given that due to increased competition and outsourcing of some models, the board department is operating at 70 percent capacity only. The overheads of the board department are being charged to the assembly departments on the basis of hourly rate calculated as total monthly costs divided by total number of hours of capacity in the month. a. Suitable time for seeking board department's services It is given that the board department has only a single assembly line so it can only cater to one assembly department at a time. If all the departments seek the services of the board department at the same time then there will be a peak load problem for the board department and it has to work overtime to complete the work as given in the problem. This leads to overtime costs being charged to the assembly departments and also leads to the board department remaining idle during non-peak times. From the point of view of employees also it may lead to clashes among the managers of the five assembly departments and also the board department for priority services to their department. Hence it is very important that the time of the board department be used judiciously by the assembly departments. Hence it will be beneficial for all the department managers to sit together and decide on the exact date each month when each department will get its boards assembled by the board department. Once decided this schedule has to be strictly followed by all the departments every month so that there is optimum utilization of the board department's time. b. Various dysfunctional behaviors likely to occur among the departments As pointed out above, if all the assembly departments go to the board department simultaneously to get their boards assembled, then there will be dispute among the departments as to who should be serviced first, who will get second preference and so on. If the board department is not able to complete the work on time then again the employees of the department who could not get its boards assembled on time will fight with the board department employees. It is also given that the board department is charging the assembly departments for the time when the last job was finished till the time the next job is finished. So even if the board department employees are idle between two jobs the idle time is being charged to the assembly departments. This practice may also lead to disputes between the employees of assembly departments and the board department since no department will want to bear the idle time costs of another department. c. Changes suggested In view of the fact that the company is having only assembly line to cater to the services of the five manufacturing departments it is suggested that additional assembly line or lines be installed by the management so that the peak time load on the board department is reduced. If that is not feasible then the management should allow the manufacturing departments to seek the services of competitive outside firms for assembling their boards in times when the board department is having heavy workload.It is given that the board department has to work overtime in peak periods and has to remain idle in non-peak periods. This can be avoided if there is proper co-ordination among the departments and the assembly schedule for the month is planned correctly. It is given that the board department is charging the assembly departments based on the number of working days in a month and number of hours worked in a day and for two shifts. However since majority of the costs (80 percent) of the board department are fixed costs hence they will have to be incurred whether the department is working or not working. Hence the total number of days in the month has to be considered and not only the working days. Also it is given that the department remains idle during non-peak times and hence it may be working lesser number of hours on non-peak days. Hence the number of hours worked on peak days and non-peak days has to be observed and then the average number of hours worked during the month has to be taken.