91Ó°ÊÓ

CMA, adapted) Best Test Laboratories evaluates the reaction of materials to extreme increases in temperature. Much of the company's early growth was attributable to government contracts, but recent growth has come from expansion into commercial markets. Two types of testing at Best Test are Heat Testing (HTT) and Arctic-condition Testing (ACT). Currently, all of the budgeted operating costs are collected in a single overhead pool. All of the estimated testing-hours are also collected in a single pool. One rate per test-hour is used for both types of testing. This hourly rate is marked up by \(45 \%\) to recover administrative costs and taxes, and to earn a profit. Rick Shaw, Best Test's controller, believes that there is enough variation in the test procedures and cost structure to establish separate costing rates and billing rates at a \(45 \%\) mark up. He also believes that the inflexible rate structure currently being used is inadequate in today's competitive environment. After analyzing the company data, he has divided operating costs into the following three cost pools: Rick Shaw budgets 106,000 total test-hours for the coming period. This is also the cost driver for labor and supervision. The budgeted quantity of cost driver for setup and facility costs is 800 setup hours. The budgeted quantity of cost driver for utilities is 10,000 machine-hours. Rick has estimated that HTT uses \(60 \%\) of the testing hours, \(25 \%\) of the setup hours, and half the machine-hours. 1\. Find the single rate for operating costs based on test-hours and the hourly billing rate for HTT and ACT. 2\. Find the three activity-based rates for operating costs. 3\. What will the billing rate for HTT and ACT be based on the activity-based costing structure? State the rates in terms of testing hours. Referring to both requirements 1 and 2 , which rates make more sense for Best Test? 4\. If Best Test's competition all charge \(\$ 20\) per hour for arctic testing, what can Best Test do to stay competitive?

Step by step solution

01

Calculate the Single Rate for Operating Costs

We begin by dividing the total cost into the total test-hours. Let the total operating costs be denoted by \(C_{total}\). Rick Shaw has provided that the projected total test-hours are 106,000. Thus, we assume for simplicity's sake that \(C_{total} = \text{some financial figure calculated by Best Test}\). Then, the single rate \(R_{single}\) per test hour becomes \[R_{single} = \frac{C_{total}}{106,000}\]This is the rate used to calculate the billing rate by multiplying it by 1.45 (the rate mark-up): \[R_{bill} = R_{single} \times 1.45\]This gives billing rates in terms of a standard test-hour for both HTT and ACT, as the same rate is applied to each test category.

02

Calculate Activity-Based Rates

Divide the total costs into three cost pools, each with their operating perspectives, and calculate their rates based on their cost drivers. Let's denote the costs for labor, supervision (\(L_{sup}\)), setup (\(S_{cost}\)), and utilities (\(U_{cost}\)) as follows:1. Labor and Supervision Rate: \[ R_{Lsup} = \frac{L_{sup}}{106,000} \] 2. Setup Costs Rate: \[ R_{setup} = \frac{S_{cost}}{800} \]3. Utilities Cost Rate:\[ R_{utl} = \frac{U_{cost}}{10,000} \]These three rates factor in distinct operating activities for both HTT and ACT.

03

Calculate the Billing Rate Using Activity-Based Costing

Now, compute separate billing for each type of test (HTT and ACT) leveraging their specific usage of resources:1. For HTT: - HTT utilizes \(60\%\) of testing hours. - HTT utilizes \(25\%\) of setup hours. - HTT uses \(50\%\) of machine hours. Compute: \[ \text{HTT Billing Rate} = (R_{Lsup} \times 0.60 + R_{setup} \times 0.25 + R_{utl} \times 0.50) \times 1.45 \]2. For ACT ensure all remaining resource usage assumptions are applied, and compute similarly for ACT.

04

Analysis on Costing Structures

Compare the billing rates from Step 1 (single rate times the markup) and Step 3 (activity-based billing rate). Check which of these two better aligns with Best Test's financial positioning and the competitive market: - A single rate is straightforward but might not reflect different cost structures. - Activity-based rates offer refined cost management indicating possibly better profit margin control. Determine which rates are more beneficial by looking at the strategic implication of both.

05

Competitive Strategy Decision

To stay competitive at a price point of $20 per hour for ACT, Best Test should determine if the calculated costs, profits, and customer perceived value justify the existing pricing or necessitate innovation in efficiencies, marketing, or additional value offerings to distinguish from competition. Consider reducing any unnecessary costs or enhance test value to maintain the premium pricing if activity-based rates prove uncompetitive in such context.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Activity-Based Costing

Activity-Based Costing (ABC) is an accounting methodology that helps companies assign costs to specific products, services, or processes based on the actual resources they consume. Instead of using traditional costing methods, which aggregate overhead costs into a single pool, ABC divides these costs into several cost pools linked to different activities. Each activity pool has its own cost driver which accounts for specific aspects like labor hours, machine hours, or setup times.

ABC is particularly useful in businesses with diverse operations or those offering a wide range of products and services. By identifying the specific costs associated with different activities, organizations are better equipped to determine the true cost of each offering, allowing for more informed pricing and strategic decisions. For instance, in Best Test Laboratories, applying ABC could help distinguish the differing resource usage between Heat Testing (HTT) and Arctic-condition Testing (ACT), leading to more accurate pricing that reflects the underlying costs.

Overhead Cost Allocation

Overhead Cost Allocation is the process of distributing indirect costs to various cost objects such as products, services, or departments based on specific criteria. Typically, these indirect costs include things like facilities maintenance, utilities, administrative salaries, and more.

In traditional cost accounting, overhead costs are pooled together and allocated using a common basis like total labor hours, machine hours, or even units produced. However, this can often lead to inaccurate cost analysis if different activities consume resources in varying proportions.

With methods like Activity-Based Costing, overhead allocation becomes more precise. In the context of Best Test Laboratories, overhead costs can be better allocated to HTT and ACT services through identified activities such as setup hours or machine hours. This precision ensures that each service is charged fairly, reflecting the true consumption of resources, ultimately allowing for more strategic pricing and improved cost management.

Billing Rate Calculation

Billing Rate Calculation is a crucial aspect where companies determine the amount they will charge their clients for services or products. This involves understanding both the total cost of providing the service and the desired profit margin.

To calculate a billing rate, you first need the total cost, which includes both direct costs (like materials and labor) and indirect overhead costs. In Best Test Laboratories' case, the billing rate can either be derived from a single overhead cost rate or through an activity-based costing approach.

Once the relevant costs are set, a markup percentage is applied. This markup covers additional costs like administrative functions and taxes, while also providing a profit. For example, Best Test applies a 45% markup to both single rate and activity-based rates to determine the final billing price for HTT and ACT. This ensures that billing rates not only cover costs but also align with strategic financial goals.

Test Hours Costing

Test Hours Costing is a method used to allocate and calculate the cost associated with utilizing testing resources such as time, equipment, and personnel during a test session. In scenarios like Best Test Laboratories, understanding test hours costing is vital as it's the basis for setting accurate and competitive pricing for testing services.

Allocating costs based on test hours takes into account the amount of time each test utilizes different resources, which can vary significantly between types of tests. For HTT versus ACT, test hours costing allows Best Test to account for the amount of hours each test consumes, thereby setting a more precise cost associated with each testing type.

It allows the company to understand exactly how much each hour of testing is costing them, enabling them to make more informed decisions about pricing, budgeting, and resource allocation. Proper management of test hours costing is key to maintaining profitability and competitiveness in the market.