Chapter 3, Problem 3CE

Darnell Poston, owner of Poston Manufacturing, Inc., wants to determine the cost behavior of labor and overhead. Darnell pays his workers a salary; during busy times, everyone works to get the orders out. Temps (temporary workers hired through an agency) may be hired to pack and prepare completed orders for shipment. During slower times, Darnell catches up on bookkeeping and administrative tasks while the salaried workers do preventive maintenance, clean the lines and building, etc. Temps are not hired during slow times. Darnell found that workers’ salaries, temp agency payments, rentals, utilities, and plant and equipment depreciation are the largest dollar accounts. He believes that workers’ salaries and plant and equipment depreciation are fixed, temp agency payments are associated with the number of orders (since temp workers are used to pack and prepare completed orders for shipment), and electricity is associated with the number of machine hours. When the number of different parts stored by Poston exceeds the space in the materials storeroom, Darnell rents nearby warehouse space. He can rent as much or as little space as he wants on a month-to-month basis. Therefore, he believes warehouse rental payments are variable with the number of parts purchased and stored. The account balances for the past six months as well as the six-month total are as follows:

Information on number of machine hours, orders, and parts for the six-month period follows:

Required:

1. 1. Calculate the monthly average account balance for each account. Calculate the average monthly amount for each of the three drivers.
2. 2. Calculate fixed monthly cost and the variable rates for temp agency payments, warehouse rent, and electricity. Express the results in the form of an equation for total cost.
3. 3. In July, Darnell predicts there will be 420 orders, 250 parts, and 5,900 machine hours. What is the total labor and overhead cost for July?
4. 4. What if Darnell buys a new machine in July for $24,000? The machine is expected to last 10 years and will have no salvage value at the end of that time. What part of the cost equation will be affected? How? What is the new expected cost in July?

To determine

Calculate the monthly average account balance for each account. Calculate the average monthly amount for each of the three drivers.

Explanation of Solution

Cost estimation: Cost estimation is the process of ascertaining the behavior of particular cost.

Calculate monthly average account balance for each account.

Account	Workings	Amount
Average workers' salaries	($43,200 ÷ 6)	$7,200
Average temp agency payment	($6,240 ÷ 6)	$1,040
Average warehouse rental	($1,700 ÷ 6)	$283
Average electricity	($3,410 ÷ 6)	$568
Average depreciation	($13,200 ÷ 6)	$2,200

Table (1)

Calculate the average monthly amount for each of the three drivers.

Account	Workings	Amount
Average machine hours	($29,600 ÷ 6)	$4,933
Average number of orders	($1,720÷ 6)	$287
Average number of parts	($2,800 ÷ 6)	$467

Table (2)

To determine

Calculate fixed monthly cost and the variable rates for temp agency payments, warehouse rent, and electricity. Express the results in the form of an equation for total cost.

Explanation of Solution

Calculate monthly fixed cost.

$\begin{array}{c}\text{Monthly fixed cost =}\text{Warehouse salaries + plant}\text{\& Equipment}\text{depreciation}\\ \text{=}\text{\$7,200}\text{+\$2,200}\\ \text{=}\text{\$9,400}\end{array}$

Calculate variable rate for temp agency.

$\begin{array}{c}\text{Variable rate =}\frac{\text{Temp agency cost}}{\text{Units}}\\ =\frac{\$1,040}{287}\\ =\$3.62\text{per order}\end{array}$

Calculate variable rate for warehouse rental.

$\begin{array}{c}\text{Variable rate =}\frac{\text{Warehouse rental cost}}{\text{Units}}\\ =\frac{\$283}{467}\\ =\$0.61\text{per part}\end{array}$

Calculate variable rate for electricity.

$\begin{array}{c}\text{Variable rate =}\frac{\text{Electricity cost}}{\text{Units}}\\ =\frac{\$568}{4,933}\\ =\$0.12\text{per}\text{machine hour}\end{array}$

Monthly cost equation is $\$9,400+\$3.62(\text{per orders) +\$0}\text{.61}\left(\text{parts}\right)+\$0.12\left(\text{machine hour}\right)$

To determine

Calculate the total labor and overhead cost for July.

Explanation of Solution

Calculate the total labor and overhead cost for July.

$\begin{array}{c}\text{Total cost =}\text{Fixed cost + Variable cost}\\ \text{=}\text{\$9,400 +}\left(\$3.62\times 420\text{orders}\right)+\left(\$0.61\times 250\text{parts}\right)+\left(\$0.12\times 5,900\text{machine hours}\right)\\ =\$9,400+\$1,520+\$153+\$708\\ =\$11,781\end{array}$

To determine

State whether, Person D buys a new machine in July for $24,000, if the machine is expected to last 10 years and will have no salvage value at the end of that time. And identify the part of the cost equation will be affected, and identify the new expected cost in July.

Explanation of Solution

Calculate new machine depreciation per month.

$\begin{array}{c}\text{New machine =}\frac{\text{total cost}-\text{Salvage value}}{\text{Estimated life}}\\ =\frac{\left(\$24,000-\$0\right)}{\left(10\text{years}\times \text{12}\right)}\\ =\frac{\$24,000}{120\text{months}}\\ =\$200\end{array}$

Calculate new total cost for July month.

$\begin{array}{c}\text{Total cost =}\text{Fixed cost + Variable cost}\\ \text{=}\text{\$9,600 +}\left(\$3.62\times 420\text{orders}\right)+\left(\$0.61\times 250\text{parts}\right)+\left(\$0.12\times 5,900\text{machine hours}\right)\\ =\$9,600+\$1,520+\$153+\$708\\ =\$11,981\end{array}$