Fluent Essays

Sharpton Fabricators Corporation manufactures a variety of parts for theautomotive industry. The company uses a job-order costing system with aplantwide predetermined overhead rate based on direct labour-hours. OnDecember 10, 2015, the companys controller made a preliminary estimateof the predetermined overhead rate for 2016. The new rate was based onthe estimated total manufacturing overhead cost of $3,402,000 and theestimated 63,000 total direct labour-hours for 2016:$54 per direct labour hourThis new predetermined overhead rate was communicated to top managersin a meeting on December 11. The rate did not cause any comment becauseit was within a few cents of the overhead rate that had been used during2015. One of the subjects discussed at the meeting was a proposal by theproduction manager to purchase an automated milling machine centre builtby Central Robotics. The president of Sharpton Fabricators, Kevin Reynolds,agreed to meet with the regional sales representative from Central Roboticsto discuss the proposal.On the day following the meeting, Reynolds met with Jay Warner, CentralRobotics sales representative. The following discussion took place:Reynolds: Lisa Winter, our production manager, asked me to meet with yousince shes interested in installing an automated milling machine centre.Frankly, Im skeptical. Youre going to have to show me this isnt justanother expensive toy for Lisas people to play with.Warner: That shouldnt be too difficult, Kevin. The automated millingmachine centre has three major advantages. First, its much faster than themanual methods youre using. It can process about twice as many parts perhour as your current milling machines. Second, its much more flexible.There are some up-front programming costs, but once those have beenincurred, almost no setup is required on the machines for standardoperations. You just punch in the code of the standard operation, load themachines hopper with raw material, and the machine does the rest.Reynolds: Yeah, but what about cost? Having twice the capacity in themilling machine area wont do us much good. That centre is idle much of thetime, anyway.Warner: I was getting there. The third advantage of the automated millingmachine centre is lower cost. Winters and I looked over your presentoperations, and we estimated that the automated equipment wouldeliminate the need for about 6,000 direct labour-hours a year. What is yourdirect labour cost per hour?Reynolds: The wage rate in the milling area averages about $32 per hour.Fringe benefits raise that figure to about $41 per hour.Warner: Dont forget your overhead.Reynolds: Next year the overhead rate will be about $54 per direct labourhour.Warner: So including fringe benefits and overhead, the cost per directlabour-hour is about $95.Reynolds: Thats right.Warner: Since you can save 6,000 direct labour-hours per year, the costsavings would amount to about $570,000 a year, and our 60-month leaseplan would require payments of only $348,000 per year.Reynolds: Sold! When can you install the equipment?Shortly after this meeting, Reynolds informed the companys controller ofthe decision to lease the new equipment, which would be installed over theChristmas vacation period. The controller realized that this decision wouldrequire a recomputation of the predetermined overhead rate for 2016, sincethe decision would affect both the manufacturing overhead and the directlabour-hours for the year. After talking with both the production managerand the sales representative from Central Robotics, the controller discoveredthat in addition to the annual lease cost of $348,000, the new machinewould also require a skilled technician/programmer who would have to behired at a cost of $50,000 per year to maintain and program the equipment.Both of these costs would be included in factory overhead. There would beno other changes in total manufacturing overhead cost, which is almostentirely fixed. The controller assumed that the new machine would result ina reduction of 6,000 direct labour-hours for the year from the levels that hadinitially been planned.When the revised predetermined overhead rate for 2016 was circulatedamong the companys top managers, there was considerable dismay.Required:1. Recompute the predetermined rate assuming that the new machinewill be installed. Explain why the new predetermined overhead rate ishigher (or lower) than the rate that was originally estimated for 2016.2. What effect (if any) would this new rate have on the cost of jobs thatdo not use the new automated milling machine?3. Why would managers be concerned about the new overhead rate?4. After seeing the new predetermined overhead rate, the productionmanager admitted that he probably wouldnt be able to eliminate all ofthe 6,000 direct labour-hours. He had been hoping to accomplish thereduction by not replacing workers who retire or quit, but that wouldnot be possible. As a result, the real labour savings would only beabout 2,000 hours—one worker. In the light of this additionalinformation, evaluate the original decision to acquire the automatedmilling machine from Central Robotics.