Management of FWC is concerned about overhead cost allocations

The management of FWC is concerned about overhead cost allocations. The Company has been using the plant-wide rate based on direct labor costs since it began operations. The CEO, J. B. Gogo, has decided to hire you as a consultant to evaluate overall overhead allocation system and prepare recommendations. He tells you that a number of problems have arisen in the past few months. The pressure on prices for the black widget has been growing and marketing is indicating that the Company may lose some large retailers if the price is not reduced. However, since the company has just turned its earnings around, a drop in selling price would have a serious impact on the bottom line. The specialty widget line does seem to allow for some increase in selling price, however, the CEO is concerned that an aggressive increase in price might jeopardize the growing market. But the lack of any competition in this area also indicates that there might be something wrong with the current pricing strategy. Since prime costs are fairly standard and stable for the industry, he is beginning to suspect that the overhead costs are not being allocated in the proper manner and/or may be out of line with the competition, particular since that competition can undercut FWC's selling price by $1 and no competitor seems willing to enter the specialty widget market.

The next part of your analysis concerns the use of activity based costing to assign the overhead to the jobs. As the consultant, you've broken down the estimated overhead for 2012 into the following five cost pools.

Assumptions for cost pools:

Setups average one setup each month for the black widget and one setup for each separate run. The material moves are required twice a month for the black widgets and once for each run of the specialty widgets. Inspection hours vary based on the detail needed and/or problem found in the different production runs.

Maintenance is based on the number of units produced for the black widgets with regular maintenance scheduled every after approximately 200,000 units are produced. Because of the modifications made when a specialty widget is produced, maintenance is required after every run. Other costs of production are gathered into the final pool and are allocated based on machine hours.

1. Prepare a schedule showing total cost per pool and the pool rates.

2. Prepare another schedule showing the total costs attached to each of the completed jobs using the pool rates above to apply the overhead and the prime costs found in part 1. Break the information down into unit cost for material, labor and overhead as well as total unit cost for each job. (See schedule below for the activities for each job.)

3. Prepare the income statement for January using ABC and compare this to the income statement using the plant-wide rate.

4. Prepare a final schedule comparing the total cost, unit costs and selling price for each of the completed jobs using the plant-wide rates and ABC rates. Include the total sales by job and the gross profit margin on each job using the two different techniques.

5. Prepare a chart comparing the unit costs (material, labor and overhead) and a separate chart showing only the total overhead costs assigned to each job under the two methods evaluated

6. Assume that the company wants to maintain a minimum gross profit of 30% on each job. Compute the estimated selling price need per unit on each of the jobs analyzed. In general, discuss what the company needs to do to maintain the desired gross profit margin. Can the company reduce the selling price of the black widget to meet competitor's selling price? Explain.

7. Discuss, in a report form, the impact on the costs and bids using the plant-wide rate and activity based costing. Include the recommendation for one of these methods. Be sure to include proper rationale. The report should include schedules and charts (graphs) as needed to illustrate your points.