Newcastle Machining produces parts for the steel industry. It has 3 categories of overhead costs: machine operating costs, engineering and inspecting costs. The costs expected for these categories for the coming year are as follows:

Machining $440,000
Engineering 220,000
Inspecting 180,000
Total 840,000

The plant currently uses machine hours to apply overhead. Expected capacity is 100,000 machine hours. Tom, the plant manager, has been asked to submit a bid on a potential job. He provides you with the following data for this job:

 

Direct materials $8,000
Direct labour $12,000
Overhead $?
Number of inspections 1
Number of machine hours 2,000
Engineering hours 10

 

Tom has been told that other firms will be competing for this job as well. Most of his competitors are using the ABC overhead allocation method. He wants to compare his bid using his existing and ABC approaches. He estimates that there will be 6,000 inspections, and 10,000 engineering hours consumed in the plant next year.

 

  1. Compute the total cost of the potential job using machine hours to assign overhead. Assume that the bid price is based on full manufacturing cost plus 25% mark up. What is Tom’s bid price?
  2. Compute the total cost of the job using the number of inspections to assign inspection costs, engineering hours to assign engineering costs, and machine hours to assign machining costs. Assume the same bid pricing approach as in (1): what is Tom’s bid price?
  3. The production manager suggested that inspection hours rather number of inspections would provide a better cost assignment for jobs. The plant can carry out 12,000 inspection hours per year. The job in question should consume 60 inspection hours. Calculate the effect of this change on the job’s bid price. Explain why inspection hours is a better or worse driver than number of inspections.

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