Diamonds, Etc. manufactures jewelry settings and sells them to retail stores. In

Question

Diamonds, Etc. manufactures jewelry settings and sells them to retail stores. In the past, most settings were made by hand, and the overhead allocation rate in the prior year was $12 per labor hour ($2,400,000 overhead divided by 200,000 labor hours). In the current year, overhead increased by $800,000 due to acquisition of equipment. Labor, however, decreased by 40,000 hours because the equipment allows rapid creation of the settings. One of the company’s many customers is a local jewelry store, Jasmine’s Fine Jewelry. The store is relatively small, and the time make an order of jewelry pieces is typically less than 10 labor hours. On such jobs (less than 10 hours), the new equipment is not used, and thus the jobs are relatively labor intensive.
Required:
a. Assume that in the current year, the company continues to allocate overhead based on Labor hours. What would be the overhead cost of a 10-labor-hour job in prior year?
b. Assuming that the price charged for small jobs does not change in the current year. Are small jobs less profitable than they were in the past?

Explanation / Answer

Overhead cost per hour in prior year = $12 Overhead cost of a 10 labor hour job in prior year = 12 * 10 = $120 New overhead cost = 2,400,000 + 800,000 = $3,200,000 New labour hours = 200,000 - 40,000 = 160,000 Overhead cost per hour in current year = 3200000 / 160000 = $20 Though the new equipment is not used in making small jobs, the overhead cost will still be allocated uniformly among all jobs. Since the overhead cost per hour has increased from $12 in prior year to $20 in current year, small jobs are now less profitable.

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