Q:
Over the past 15 years, Anthony's Auto Shop has prepared a reputation for reliable repairs and has grown from a one-person operation to a nine-person operation, adding one manager and eight skilled auto mechanics. In current years, however, competition from mass merchandisers has eroded business profits and volume, Anthony Axle, leading the owner, to ask his manager to take a closer look at the cost structure of the auto shop.
The manager evaluated that direct materials (parts and components) are identified with individual jobs and charged straight to the customer. Direct labor (mechanics) is also recognized with individual jobs and charged at a pre-specified rate to the customers. The benefits and salary for a senior mechanic are $65,000 per year, and they are $45,000 per year for a junior mechanic. Each mechanic will work up to 1,750 hours in a year on customer jobs, but if there are not sufficient jobs to keep each of them busy, the cost of their compensation still may have to be incurred. The manager's benefits and salary amount to $75,000 per year. In addition, the subsequent fixed costs are also incurred each year:
Rent............................... $40,000
Insurance.............................7,000
Utilities............................... 7,000
Supplies.............................10,000
Machine maintenance..............9,000
Machine depreciation ............23,800
Total costs........................ $96,800
Because material costs are recovered straightforwardly from the customers, the profitability of the operation depends on the hourly rate charged for labor and the volume of business. At present, Anthony's Auto Shop charges $51.06 per hour for all jobs. Anthony said he would not think firing any of the four senior mechanics because he believes it is hard to get workers with their skills and loyalty to the firm, but he is willing to consider releasing one or two of the junior mechanics.
The current job costing system uses a single conversion rate for all jobs. The cost driver rate is presently determined by dividing estimated total overhead and labor costs by expected hours charged to customers. The eight mechanics are expected to be busy on customer jobs for 95% of the total available time. The price of $51.06 per hour is evaluated by adding a markup of x% to the cost driver rate, that is $51.06 = [1 + x/100] × cost driver rate. Note that all personnel costs are added in conversion costs at present.
The manager is taking switching to the use of two rates, one for class A repairs and another for class B repairs. Internal carburetor repairs or electronic ignition system repairs are examples of class A repairs. Class A repairs require careful adjustments and measurements with equipment such as an oscilloscope or infrared gas analyzer. Class B repairs are easy repairs, such as shock absorber replacements or exhaust part replacements. Class A repairs will be done only by senior mechanics; class B repairs are done mostly by junior mechanics. Half of the hours charged to customers are predictable to be for class A repairs, and the other half for class B repairs. Because class A repairs are predictable to account for all of the senior mechanics' time and most of the machine usage, 60 percent of the total costs (adding personnel costs) are attributable to class A repairs and the remaining 40 percent to class B repairs.
Required
(a) Evaluate the markup of x% currently used.
(b) Evaluate the two new rates, one for class A repairs and another for class B repairs, using the similar markup of x% that you determined in part a.
(c) The subsequent are expected labor hours anticipated for two customer jobs:
Job #101 Class A Repairs 4.5 hours Class B Repairs 1.5 hours
Job #102 Class A Repairs 0 hours Class B Repairs 2.0 hours
Evaluate the price (in addition to materials) to be charged for each of the two jobs under the current accounting system and under the proposed accounting system.
(d) What change in service mix is probable to result from the proposed price change?
(e) Give reasons why Anthony might retain the present costing system or change to the proposed costing system.