Problem
Vanessa Noel, owner and manager of Noel Draperies and Window Treatments, has been receiving some complaints from her loyal clientele of interior decorators and home décor consultants. For example, one of her loyal customers, Phoebe, wanted to know why she was being charged a much higher price for an order that was almost identical to an order she placed last year. Phoebe felt that the price hike was simply not justified.
Although Vanessa, when responding to Phoebe's complaint, blamed the price hike on the rising price of materials, she herself was a bit perplexed and decided to look into the matter. Vanessa asked her accountant to write a report for her summarizing cost and pricing data for the last three years. The accountant presented this information in the following table:
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Year 1
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Year 2
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Year 3
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Budgeted results
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|
|
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Revenue
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$2,400,000
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$2,700,000
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$2,000,000
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|
Direct materials
|
360,000
|
405,000
|
320,000
|
|
Direct labor
|
720,000
|
810,000
|
650,000
|
|
Variable factory overhead
|
144,000
|
162,000
|
130,000
|
|
Fixed factory overhead
|
400,000
|
400,000
|
400,000
|
|
Variable SG&A expenses
|
240,000
|
300,000
|
220,000
|
|
Fixed SG&A expenses
|
200,000
|
180,000
|
200,000
|
|
|
|
|
|
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Actual results
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|
|
|
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Revenue
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$2,320,000
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$2,800,000
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|
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Direct materials
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380,000
|
430,000
|
|
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Direct labor
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725,000
|
900,000
|
|
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Variable factory overhead
|
140,000
|
160,000
|
|
|
Fixed factory overhead
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425,000
|
440,000
|
|
|
Variable SG&A expenses
|
260,000
|
300,000
|
|
|
Fixed SG&A expenses
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180,000
|
200,000
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|
Vanessa decides to examine how she prices jobs. When her company receives an order, Vanessa estimates the direct labor and material costs for the job, and then she applies an overhead amount to the job. At the beginning of each year, she computes a new budgeted overhead rate per direct labor dollar using the total budgeted overhead amount and budgeted labor cost for that year. She then uses this budgeted overhead rate to apply overhead to the orders she receives during the year. Vanessa then prepares the order quote by adding direct material costs, direct labor costs, applied overhead, and a 50% markup on the total cost.
Vanessa retrieves information corresponding to Phoebe's order in year 2, and compares it with the price quote the company prepared for Phoebe for her most recent order in year 3.
Required:
i. Compute the total budgeted overhead rates for years 1, 2, and 3.
ii. Compute the over-applied or under-applied overhead for year 1 and year 2.
iii. The following information pertains to Phoebe's order in year 2, and her current order for year 3, which is identical (in terms of the draperies and window treatments) to her year 2 order.
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year 2
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year 3
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Direct materials
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$15,000
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$15,500
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Direct labor
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$30,000
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$32,000
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Compute the price Vanessa charged Phoebe for her year 2 order and the price quoted for the year 3 order.
i. Do you agree with Phoebe that the price being quoted for her year 3 order is too high?
ii. Vanessa is not an accountant, but she is a good manager and can understand why Phoebe complained. Vanessa believes that the last few years have been fairly representative of business volume in general. Moreover, Vanessa believes the average of the direct labor cost for years 1 and 2 is a fair estimate of her "normal" volume of business, and this average volume should be used to calculate the total budgeted overhead rate for Year 3. She believes this will address Phoebe's complaint. Do you agree? (Calculate the price of Phoebe's order using this alternate overhead rate to answer this question). Show work in tables