ProWorks is a website design and consulting firm based in Mi

ProWorks is a website design and consulting firm based in Michigan. The firm uses a job cost system in which each client is a different job. Proworks traces direct labor, software licensing costs, and travel costs directly to each job (client). It divides overhead into two cost pools, \"Indirect Labor\" and \"Office Overhead.\" It allocates Indirect Labor (support staff salaries) to jobs based on software licensing costs. It allocates Office Overhead (all other overheads) to jobs based on direct labor hours. At the beginning of 2016, managing partner Mark Milici prepared the following estimates:

Direct labor hours $14,000 hours

Direct labor costs $1,400,000

Software licensing costs $50,000

Travel costs $80,000

Support staff salaries $200,000

Computer leases $50,000

Office supplies $30,000

Office rent $60,000

In January, 2016, ProWorks served three clients. Records for the clients appear here:

.Dining Corp .Hut Shuttle .Lucidyne

Direct Labor Hours: 600 hours 50 hours 300 hours

Software licensing costs: $5,000 $500 $2,000

Travel costs: $9,000 $2,000 $0

1) Write a business memo about cost allocation issues. In your analysis, explain the reasons why ProWork managers should assign all costs to jobs. Managers also want to know the factors they should consider when setting prices. If managers want to earn profits equal to 20% of sales revenue, what price should the company charge each client?

Solution

If the managers want to earn a profit of 20% on sales , the price to be charged from each client ca be calculated as follows:

Working notes:

Direct labour cost per hour = total direct labour cost / total number of hours

= 1400000 / 14000

= $100

Support staff salaries rate = total support staff salaries cost / software licencing cost

= 200000 / 50000

=$4

Other overheads rate = total other overheads cost / total direct labour hours

= 140000 / 14000

= $10

Memo

In order to charge the correct prices from the clients, it is important that accurate allocation of costs is done to the various clients/jobs. The direct costs can be directly be traced, however the complexity airses with the indirect costs like support staff salaries, office rent, office supplies and office lease. The basis of allocaiton of these costs is divided into two cost pools depending upon the usage of these indirect costs by the clients. Thus, the indirect costs are allocated basis the cost pools.This leads to an accurate allocation of the overheads which further leads to a more accurate pricing.

The issues with the allocation arises if the cost pools are not traced properly.