Hokuriku-Seika Co., Ltd., of Yokohama, Japan, is a subcontractor to local manufacturing companies. The company specializes in precision metal cutting using focused high-pressure water jets and high-energy lasers. The company has a traditional job-order costing system in which direct labor and direct materials costs are assigned directly to jobs, but factory overhead is applied to jobs using a predetermined overhead rate based on direct labor-hours. Management uses this job cost data for valuing cost of goods sold and inventories for external reports. For internal decision making, management has largely ignored this cost data because direct labor costs are basically fixed and management believes overhead costs actually have little to do with direct labor-hours. Recently, management has become interested in activity-based costing (ABC) as a way of estimating job costs and other costs for decision-making purposes. Management assembled a cross-functional team to design a prototype ABC system. Electrical costs were among the first factory overhead costs investigated by the team. Electricity is used to provide light, to power equipment, and to heat the building in the winter and cool it in the summer. The ABC team proposed allocating electrical costs to jobs based on machine-hours because running the machines consumes significant amounts of electricity. Data assembled by the team concerning actual direct labor-hours, machine-hours, and electrical costs over a recent eight-week period appear below. (The Japanese currency is the yen, which is denoted by ?Y.)
To help assess the effect of the proposed change to machine-hours as the allocation base, the eight-week totals were converted to annual figures by multiplying them by six,
1. Assume that the estimated annual totals from the above table are used to compute the company’s predetermined overhead rate. What would be the predetermined overhead rate for electrical costs if the allocation base is direct labor-hours? Machine-hours?
2. Hokuriku-Seika Co. intends to bid on a job for a shipyard that would require 350 direct labor-hours and 270 machine-hours. How much electrical cost would be charged to this job using the predetermined overhead rate computed in (t) above if the allocation base is direct labor-hours? Machine-hours?
3. Prepare a scattergraph in which you plot direct labor-hours on the horizontal axis and electrical costs on the vertical axis. Prepare another scattergraph in which you plot machine-hours on the horizontal axis and electrical costs on the vertical axis. Do you agree with the ABC team that machine-hours is a better allocation base for electrical costs than direct labor-hours? Why?
4. Using machine-hours as the measure of activity, estimate the fixed and variable components of electrical costs using least-squares regression.
5. How much electrical cost do you think would actually be caused by the shipyard job in (2) above? Explain.
6. What factors, apart from direct labor-hours and machine-hours, are likely to affect consumption of electrical power in thecompany?