Question

Marine Components produces parts for airplanes and ships. The parts are produced to specification by their customers, who pay either a fixed price (the price does not depend directly on the cost of the job) or price equal to recorded cost plus a fixed fee (cost plus). For the upcoming year (year 2), Marine expects only two clients (client 1 and client 2). The work done for client 1 will all be done under fixed-price contracts while the work done for client 2 will all be done under cost-plus contracts.

The controller at Marine Components chose direct labor cost as the allocation base in year 2, based on what she considered reflected the relation between overhead and direct labor cost. Year 3 is approaching and again the company only expects two clients: client 1 and client 3. Work for client 1 will continue to be billed using fixed-price contracts, and client 3 will be billed based on cost-plus contracts.

Manufacturing overhead for year 3 is estimated to be $17 million. Other budgeted data for year 3 include:

	Client 1			Client 3
Machine-hours (thousands)		2,550			14,450
Direct labor cost ($000)	$	5,000		$	5,000

Required:

a. Compute the predetermined rate assuming that Marine Components uses machine-hours to apply overhead.

b. Compute the predetermined rate assuming that Marine Components uses direct labor cost to apply overhead.

Answer 1

a.

Predeterminened overhead rate = Estimated Manufacturing overhead / Estimated Machine-hours

Client 1 :

==> Predeterminened overhead rate = $17,000,000 / 2,550,000 = $6.67 per MH

Client 3:

==> Predeterminened overhead rate = $17,000,000 / 14,450,000 = $1.17 per MH

b.

Predeterminened overhead rate = Estimated Manufacturing overhead / Estimated Direct labor cost

Client 1 :

==> Predeterminened overhead rate = ($17,000,000 / $5,000,000) x 100 = 340% of direct labor cost

Client 3 :

==> Predeterminened overhead rate = ($17,000,000 / $5,000,000) x 100 = 340% of direct labor cost