Monroe Clock Company: Recomputing Overhead Rates

Jim Monroe, president of the Monroe Clock Company, has just finished saying he did not think they knew what the new household timer was going to cost. His controller, Tom, had provided figures showing a full cost of $11.60, and Frank Tyler, his sales manager, ha worked out a cost of $6.30. Frank said that was the timer's cost using only incremental costs. These computations are shown in the Monroe Clock Company A case.
Alright, said Frank, if you don't like our figures do you want to anoint?

The Company

Monroe Clock Company was started by Jim Monroe the company's president in 1985. In 1998, Monroe had sold out to Piedmont Appliance Corp but he remained with the company as Monroe clock's president. Originally, Monroe clock made decorative clocks, but by 1992, Jim had decided he was much better at making the works than decorations. So the company shifted to making accurate, durable, but inexpensive electric timing mechanisms. The company now made only three basic models, differing in size and strength. Slight modifications were made only to fit each customer's needs. Sales had grown to over $50 million and the timing mechanisms were made entirely for producers of timed electrical appliances. About half of Monroe's output went to Piedmont Appliance and about half to other companies.

The new household timing device

After his house was burgled over the 2000 Labor Day weekend, Jim Monroe bought two timers that could be set to turn on house lights in the evening. Then, he had the idea to make better timing mechanism for household use, one that had two features that he thought made his timer superior to those currently on the market. The Monroe timer has two options: 48 hours cycle or two different 24 hour cycles so that one timer could operate two lights, each on a different 24 hour cycle. The design of these features was quite simple. There were 2 different 24 hour cycles and for the 48 hour option, the timer switched back and forth.

Jim's sales manager, Frank Tyler, was not sure how important or valuable these options would be to the potential customer. Furthermore, this complete product would have to be sold through wholesalers and manufacturers' representatives, which were new for Monroe Clock. The company's sales force usually sold to a relatively small number of industrial customers. Frank thought price` would be an important factor since other timers were on the market .But before Jim could set a price on the new timer, he needed to know how much it was going to cost.

The issue of overhead cost

Well, said Jim, after saying he did not think they knew what the new household timer was going to cost. It seems to me this household timer is different from the timers we usually make. There is a lot more wiring and assembly work involved. Our main products are timing mechanisms, and they all require about the same sequence of product steps. The heavy duty one is a bit different from the others in that it has more machined parts instead of stamped parts, and actually I've wondered for some time whether our plant-wide overhead rate was OK. If one type of work uses a lot more overhead than another, the products that require a lot of high overhead work may be getting a free ride. In the case of the new timers, since wiring and assembly work likely is low overhead activity, the situation probably is reversed.

'That's true' said Tom, "but the only way to find out if there's much of a difference in overhead is to distribute overhead to the different functions. A lot of that overhead like occupancy cost and plant administration, can only be distributed in a fairly arbitrary way"

Jim noted that parts of the overhead like machine depreciation and probably machine maintenance could be fairly accurately distributed. After some discussion, Tom said he'd make some approximations, and they could then decide if a detailed allocation would be worth.

Tom set up 3 cost centers, each to have its own overhead rate. These were fabrication, machining and assembly. If further subdivision into more cost centers was needed he could do that later.

He then computed direct labor for last year by cost center. This was easy to do because workers were classified to show if they were direct labor and did not shift among 3 cost centers. Thus, payroll information quickly told him the direct labor by cost center.

Then, he began allocating last year's functional overhead costs to 3 cost centers. He did this mostly by guesswork, but when in doubt he looked at the detailed cost records and talked with the people involved. The result, which he was able to put together next day is shown in Exhibit 1

As expected, the machining overhead rate was the highest, however, Tom was surprised that the fabrication rate was not higher in relation to assembly. He decided to check his figures but did not expect to find any large changes.
Using the new overhead rates, Tom planned to recomputed the timer's cost on a fully allocated basis to see what selling price that would suggest. Then he thought he would use $85,000 as a target contribution (from which advertising would be taken) and see how many timers would have to be sold at $8.00, $10.00 and $15.00 to achieve that contribution to fixed costs and profit.

Overhead Components as a percent of direct labor by cost center (Exhibit 1)

Overhead Components Fabrication Machining Assembly

Supplemental compensation
For direct labor 35% 35% 35%
Supervision 10 20 20
Indirect labor 20 38 42
Machine maintenance 40 150 17
Machine depreciation 30 100 17
Manufacturing engineering 30 75 17
Plant administration 36 40 47
Electricity 10 18 5
Occupancy 35 50 42

Total 246% 526% 242%

Approximate ratio of
Direct labor dollars 50% 20% 30%

1- Using the new overhead rates recomputed the new household timer's cost on a fully allocated basis.
2- Using $85,000 as a target contribution (from which advertising would be taken), determine how many of the new timers would have to be sold at $8.00, $10.00 and $15.00 to achieve that contribution to fixed costs and profit.