Sharpe Fabricators Corporation manufactures

Sharpe Fabricators Corporation
Sharpe Fabricators Corporation manufactures a variety of parts for the automotive industry.
The company uses a job-order costing system with a plant-wide predetermined overhead rate
based on direct labor-hours. On December 10, 2013, the company’s controller made a
preliminary estimate of the predetermined overhead rate for 2014. The new rate was based
on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000
total direct labor-hours for 2014: $2,475,000 / 52,000 = $47.60 per direct labor hour
This new predetermined overhead rate was communicated to top managers in a meeting on
December 11. The rate did not cause any comment because it was within a few pennies of the
overhead rate that had been used during 2013. One of the subjects discussed at the meeting was a
proposal by the production manager to purchase an automated milling machine center built by
Central Robotics. The president of Sharpe Fabricators, Kevin Reynolds, agreed to meet with the
regional sales representative from Central Robotics to discuss the proposal.
On the day following the meeting, Mr. Reynolds met with Jay Warner, Central Robotics’ sales
representative. The following discussion took place:
Reynolds Larry Winter, our production manager, asked me to meet with you since he is
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interested in installing an automated milling machine center. Frankly, I am
skeptical. You’re going to have to show me this isn’t just another expensive toy for
Larry’s people to play with.
Warner: That shouldn’t be too difficult, Mr. Reynolds. The automated milling machine
center has three major advantages. First, it is much faster than the manual methods
you are using. It can process about twice as many parts per hour as your present
milling machines. Second, it is much more flexible. There are some up-front
programming costs, but once those have been incurred, almost no setup is required
on the machines for standard operations. You just punch in the code of the
standard operation, load the machine’s hopper with raw material, and the machine
does the rest. Reynolds Yeah, but what about cost? Having twice the capacity in the milling machine area
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won’t do us much good. That center is idle much of the time anyway.
Warner: I was getting there. The third advantage of the automated milling machine center is
lower cost. Larry Winters and I looked over your present operations, and we
estimated that the automated equipment would eliminate the need for about 6,000
direct labor-hours a year. What is your direct labor cost per hour? Reynolds The wage rate in the milling area averages about $21 per hour. Fringe benefits : raise that figure to about $30 per hour. Warner: Don’t forget your overhead. Reynolds Next year the overhead rate will be about $48 per hour.
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Warner: So including fringe benefits and overhead, the cost per direct labor-hour is about
$78. Reynolds That’s right.
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Warner: Since you can save 6,000 direct labor-hours per year, the cost savings would
amount to about $468,000 a year. Reynolds That’s pretty impressive, but you aren’t giving away this equipment are you?
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Warner: Several options are available, including leasing and outright purchase. Just for
comparison purposes, our 60-month lease plan would require payments of only
$300,000 per year. Reynolds Sold! When can you install the equipment?
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Shortly after this meeting, Mr. Reynolds informed the company’s controller of the decision to
lease the new equipment, which would be installed over the Christmas vacation period. The
controller realized that this decision would require a re-computation of the predetermined
overhead rate for the year 2014 since the decision would affect both the manufacturing overhead
and the direct labor-hours for the year. After talking with both the production manager and the
sales representative from Central Robotics, the controller discovered that in addition to the
annual lease cost of $300,000, the new machine would also require a skilled
technician/programmer who would have to be hired at a cost of $45,000 per year to maintain and
program the equipment. Both of these costs would be included in factory overhead. There would
be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The
controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours
for the year from the levels that had initially been planned.
When the revised predetermined overhead rate for the year 2014 was circulated among the
company’s top managers, there was considerable dismay.
Required:
1) Re-compute the predetermined rate assuming that the new machine will be installed. Explain
why the new predetermined overhead rate is higher (or lower) than the rate that was originally
estimated for the year 2014.
2) What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine? Why?
3) Why would managers be concerned about the new overhead rate?
4) After seeing the new predetermined overhead rate, the production manager admitted that she
probably wouldn’t be able to eliminate all of the 6,000 direct labor-hours. She had been hoping
to accomplish the reduction by not replacing workers who retire or quit, but that would not be
possible. As a result, the real labor savings would be only about 2,000 hours—one worker. In the
light of this additional information, evaluate the original decision to acquire the automated
milling machine from Central Robotics.