CASE – 4   STAR ENGINEERING COMPANY

IIBMS – STAR ENGINEERING COMPANY 

Star Engineering Company (SEC) produces electrical accessories like meters, transformers, switchgears, and automobile accessories like taximeters and speedometers.

SEC buys the electrical components, but manufactures all mechanical parts within its factory which is divided into four production departments Machining, Fabrication, Assembly, and Painting—and three service departments—Stores, Maintenance, and Works Office.

Though the company prepared annual budgets and monthly financial statements, it had no formal cost accounting system. Prices were fixed on the basis of what the market can bear. Inventory of finished stocks was valued at 90 per cent of the market price assuming a profit margin of 10 per cent.

In March, the company received a trial order from a government department for a sample transformer on a cost-plus-fixed-fee basis. They took up the job (numbered by the company as Job No 879) in early April and completed all manufacturing operations before the end of the month.

            Since Job No 879 was very different from the type of transformers they had manufactured in the past, the company did not have a comparable market price for the product. The purchasing officer of the government department asked SEC to submit a detailed cost sheet for the job giving as much details as possible regarding material, labour and overhead costs.

SEC, as part of its routine financial accounting system, had collected the actual expenses for the month of April, by 5th of May. Some of the relevant data are given in Exhibit A.

The company tried to assign directly, as many expenses as possible to the production departments. However, It was not possible in all cases. In many cases, an overhead cost, which was common to all departments had to be allocated to the various departments using some rational basis. Some of the possible bases were collected by SEC’s accountant. These are presented in Exhibit B.

He also designed a format to allocate the overhead to all the production and service departments. It was realized that the expenses of the service departments on some rational basis. The accountant thought of distributing the service departments’ costs on the following basis:

1. Works office costs on the basis of direct labour hours.
2. Maintenance costs on the basis of book value of plant and machinery.
3. Stores department costs on the basis of direct and indirect materials used.

The accountant, who had to visit the company’s banker, passed on the papers to you for the required analysis and cost computations.

 

REQUIRED

 

Based on the data given in Exhibits A and B, you are required to:

 

1. Complete the attached “overhead cost distribution sheet” (Exhibit C).
   Note: Wherever possible, identify the overhead costs chared directly to the production and service departments. If such direct identification is not possible, distribute the costs on some “rational basis.
2. Calculate the overhead cost (per direct labour hour) for each of the four producing departments. This should include share of the service departments’ costs.
3. Do you agree with:
   a.   The procedure adopted by the company for the distribution of overhead costs?
   b.   The choice of the base for overhead absorption, i.e. labour-hour rate?

 

Exhibit A

 

STAR ENGINEERING COMPANY Actual Expenses(Manufacturing Overheads) for April
	RS	RS
Indirect Labour and Supervisions: Machining Fabrication Assembly Painting Stores Maintenance Indirect Materials and Supplies Machining Fabrication Assembly Painting Maintenance Others  Factory Rent Depreciation of Plant and Machinery Building Rates and Taxes Welfare Expenses (At 2 per cent of direct labour wages and Indirect labour and supervision) Power  (Maintenance—Rs 366; Works Office Rs 2,200, Balance to Producing Departments) Works Office Salaries and Expenses Miscellaneous Stores Department Expenses	33,00022,000 11,000  7,000 44,000 32,700 2,200 1,100 3,300 3,400 2,800 1,68,000    44,000      2,400    19,400   68,586 1,30,260      1,190	1,49,700 12,800 4,33,930 5,96,930

 

Exhibit B

STAR ENGINEERING COMPANY Projected Operation Data for the Year
Department	Area  (sq.m)	Original Book of Plant & Machinery Rs	Direct Materials Budget Rs	Horse  Power Rating	Direct Labour  Hours	Direct Labour  Budget Rs
Machining Fabrication Assembly Painting Stores Maintenance Works Office Total	13,000 11,000  8,800  6,400  4,400  2,200  2,200 48,000	26,40,000 13,20,000   6,60,000   2,64,000   1,32,000   1,98,000     68,000 52,80,000	62,40,000 21,60,000 10,80,000 94,80,000	20,000 10,000   1,000   2,000 33,000	14,40,000   5,28,000   7,20,000   3,30,000 30,18,000	52,80,000 25,40,000 13,20,000   6,60,000 99,00,000

 

Note 

The estimates given in this exhibit are for the budgeted year January to December where as the actuals in Exhibit A are just one month—April of the budgeted year.

 

Exhibit C STAR ENGINEERING COMPANY Actual Overhead Distribution Sheet for April
Departments Overhead Costs	Production Departments	Service Departments	Total Amount Actuals for April (Rs)	Basis for Distribution
A. Allocation of Overhead to all departments A.1 Indirect Labour and Supervision								1,49,700
A.2 Indirect materials and supplies								12,800
A.3 Factory Rent								1,68,000
A.4 Depreciation of Plant and Machinery								44,000
A.5 Building Rates and Taxes								2,400
A.6 Welfare Expenses								19,494
A.7 Power								68,586
A.8 Works Office Salaries and Expenses								1,30,260
A.9 Miscellaneous Stores Expenses								1,190
A. Total (A.1 to A.9)								5,96,430
B. Reallocation of Service Departments Costs to Production Departments
B.1 Distribution of Works Office Costs
B.2 Distribution of Maintenance Department’s Costs
B.3 Distribution of Stores Department’s Costs
Total Charged to Producing C. Departments (A+B)								5,96,430
D. Labour Hours Actuals for April	1,20,000	44,000	60,000	27,500
E. Overhead Rate/Per Hour (D)

 

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