91Ó°ÊÓ

Chico & Partners, a Quebec-based public accounting partnership, specializes in audit services. Its job-costing system has a single direct-cost category (professional labor) and a single indirect-cost pool (audit support, which contains all costs of the Audit Support Department). Audit support costs are allocated to individual jobs using actual professional labor-hours. Chico \& Partners employs 10 professionals to perform audit services. Budgeted and actual amounts for 2011 are as follows: 1\. Compute the direct-cost rate and the indirect-cost rate per professional labor-hour for 2011 under (a) actual costing, (b) normal costing, and (c) the variation from normal costing that uses budgeted rates for direct costs. 2\. Chico's 2011 audit of Pierre \& Co. was budgeted to take 150 hours of professional labor time. The actual professional labor time spent on the audit was 160 hours. Compute the cost of the Pierre \& Co. audit using (a) actual costing, (b) normal costing, and (c) the variation from normal costing that uses budgeted rates for direct costs. Explain any differences in the job cost.

Step by step solution

01

Understanding Budgeted vs Actual Costs

Before calculating any rates, we need to clarify our data. Assume we have budgeted and actual figures for both labor hours and costs. We'll calculate direct and indirect cost rates under different costing methods: actual, normal, and variation from normal costing.

02

Calculate Direct-Cost Rates

We first compute the direct-cost rate for each costing method:- **Actual Costing:** Use actual costs and actual hours. \[ \text{Direct-cost rate (actual)} = \frac{\text{Actual professional labor costs}}{\text{Actual professional labor hours}} \]- **Normal Costing:** Use budgeted costs and actual hours. \[ \text{Direct-cost rate (normal)} = \frac{\text{Budgeted professional labor costs}}{\text{Actual professional labor hours}} \] - **Variation from Normal Costing:** Use budgeted costs and budgeted hours. \[ \text{Direct-cost rate (variation)} = \frac{\text{Budgeted professional labor costs}}{\text{Budgeted professional labor hours}} \]

03

Calculate Indirect-Cost Rates

Next, calculate the indirect-cost rate for each costing method:- **Actual Costing:** Use actual support costs and actual hours. \[ \text{Indirect-cost rate (actual)} = \frac{\text{Actual support costs}}{\text{Actual professional labor hours}} \]- **Normal Costing:** Use budgeted support costs and actual hours. \[ \text{Indirect-cost rate (normal)} = \frac{\text{Budgeted support costs}}{\text{Actual professional labor hours}} \]- **Variation from Normal Costing:** Use budgeted support costs and budgeted hours. \[ \text{Indirect-cost rate (variation)} = \frac{\text{Budgeted support costs}}{\text{Budgeted professional labor hours}} \]

04

Calculate Job Costs for Pierre & Co.

Compute the total cost for the Pierre & Co. audit under each costing method:- **Actual Costing**: \[ \text{Total cost (actual)} = (\text{Direct-cost rate (actual)} \times 160) + (\text{Indirect-cost rate (actual)} \times 160) \]- **Normal Costing**: \[ \text{Total cost (normal)} = (\text{Direct-cost rate (normal)} \times 160) + (\text{Indirect-cost rate (normal)} \times 160) \]- **Variation from Normal Costing**: \[ \text{Total cost (variation)} = (\text{Direct-cost rate (variation)} \times 160) + (\text{Indirect-cost rate (variation)} \times 160) \]

05

Compare and Explain Differences

The differences in cost calculations arise due to the use of either actual or budgeted figures for direct and indirect costs. Actual costing uses real-time data, reflecting precise numbers but subject to fluctuations. Normal costing smoothens this by incorporating budgeted figures, providing consistent estimates. The variation from normal costing offers foresight, using all budgeted rates to predict financial outcomes, differing from real-time conditions observed in actual costing.

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Key Concepts

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

Actual Costing

Actual costing is a method where costs are calculated based on the actual expenses incurred and hours worked. This means using the real figures of what has been spent and how many hours were worked to determine costs. In job costing systems, this method uses actual expenses for both direct costs (like labor) and indirect costs (like audit supports).
Calculating actual costing involves taking the actual professional labor costs and dividing them by the actual professional labor hours. Hence, we have: \[ \text{Direct-cost rate (actual)} = \frac{\text{Actual professional labor costs}}{\text{Actual professional labor hours}} \] For the indirect costs, such as audit support costs, we use: \[ \text{Indirect-cost rate (actual)} = \frac{\text{Actual support costs}}{\text{Actual professional labor hours}} \] This method provides the most accurate picture of the costs incurred as it reflects the reality of what was done and spent. However, the downside is that fluctuations in costs can occur, as everything depends on the actual data collected.

Normal Costing

Normal costing provides a stable way to estimate job costs by using a mix of actual activity levels with budgeted costs. Here, actual hours worked are still used, but we substitute in budgeted, or forecasted, cost figures rather than actual ones.
This means that for the direct costs, the rate is calculated by applying budgeted professional labor costs: \[ \text{Direct-cost rate (normal)} = \frac{\text{Budgeted professional labor costs}}{\text{Actual professional labor hours}} \] When it comes to indirect costs, the rate incorporates budgeted support costs: \[ \text{Indirect-cost rate (normal)} = \frac{\text{Budgeted support costs}}{\text{Actual professional labor hours}} \] The benefit of using normal costing is more predictable estimates and less influenced by the volatility of actual cost variations. It helps companies maintain steady pricing strategies and budget planning, as it accounts for anticipated conditions rather than reacting to unexpected changes.

Indirect Cost Rate

Indirect costs are those that cannot be directly traced to a particular job, such as the costs associated with running an audit support department. To allocate these costs to a specific job, we calculate an indirect cost rate. This is a common practice in job costing systems to ensure all jobs fairly share the costs of resources they collectively use. The indirect cost rate is calculated differently depending on the method:

• **For Actual Costing**: This involves dividing the actual support costs by the actual professional labor hours.
• **For Normal Costing**: Here, budgeted support costs are divided by the actual professional labor hours.

Using an indirect cost rate ensures all jobs bear a part of the shared costs. This allocation is crucial because it helps businesses understand profitability and predict job costs better, allowing for more effective financial management and strategic planning.