Mission, Inc., is a technology consulting firm focused on Web site development and integration of Internet business applications President Susan Nelson's ear is ringing after an unpleasant call form client Jerry Webb. Webb said irate after opening his bill for Mission's redesign of his company's Web site. Webb said that Mission's manor competitor, Delta Applications, charged much lower fees to another company for which Webb serves on the board of directors.
Nelson is puzzled for two reasons. First, she is confident that her firm knows Web site design and support as well as any of Mission's competitors. Nelson cannot understand how Delta Applications can undercut Mission's rates and still make a profit. But Delta Applications is reputed to be very profitable. Second, just yesterday Nelson received a call from client Keith Greg. Greg was happy with excellent service and reasonable fees Nelson charged him for adding a database-driven job-posting feature to his company's Web site. Nelson was surprised by Greg's compliments because this was an unusual job for Mission that required development of complex database management and control applications, and she had felt a little uneasy accepting it.
Like most consulting firms, Mission traces direct labor to individual engagements (jobs). Missions allocate indirect costs to engagements using a budgeted rate based on direct labor hours. Nelson is happy with this system, which she has used since she established Mission in 1995.
Nelson expects to incur $706,000 of indirect costs this year, and she expects her firm to work 5,000 direct labor hours. Nelson and the other system consultants earn $350 per hour. Clients are billed at 150% of direct labor cost, Last month; Mission's consultants spent 100 hours on Webb's engagement. They also spent 100 hours on Greg's engagement.
a) S4-11 Compute and use traditional allocation rate (Learning Objective 1)
Refer to Mission Data Set.
1) Compute Mission's indirect cost allocation rate
2) Compute the total costs assigned to the Web and Greg engagements.
3) Compute the operating income from the Web and Greg engagements.
b) S4-12 Identify clues that old system is broken (Learning Objective 3)
Refer to the Mission Data Set. List all of the signals or clues indicating that Mission's cost system may be "broken".
c) S4-13 Compute activity cost allocation rates (Learning Objective 2)
Refer to the Mission Data Set. Nelson suspects that her allocation of indirect costs could be giving misleading results, so she decides to develop an ABC system, She identifies three activities: documentation preparation, information technology support, and training. Nelson figures that documentation costs are driven by the number of pages, information technology support costs are driven by the number of software applications used, and training costs are most closely associated with the number of direct labor hours worked. Estimates of the costs and quantities of the allocation bases follow:
|
Activity
|
Estimated Cost
|
Allocation Base
|
Estimated Quantity of Cost Driver
|
|
Documentation preparation
|
$100,000
|
Pages
|
3,125 Pages
|
|
Information technology support
|
156,000
|
Application used
|
780 applications
|
|
Training
|
450,000
|
Direct labor hours
|
5,000 hours
|
Compute the cost allocation rate for each activity