Western Components

Sally Jones is a new marketing manager at Western Components. This company manufactures a variety of pinions, gears, and other component parts used by companies around the world. However, their major customer is a west coast aircraft manufacturer. Currently, Western has substantial excess capacity because of this customer’s production problems, which have temporarily reduced demand for Western’s components. This has had a significant effect on profit since Western’s workers are highly skilled, and the company does not want to reduce headcount during this temporary downturn. To increase demand, Sally has suggested to the vice president of marketing that Western lower bids, which in the past have averaged 25 percent above total production cost.

Sally’s boss has suggested that she do an analysis supporting her suggestion. Last week, Sally received an invitation to bid on a job for Husanti Industries, and she has decided to determine whether a “low” bid is warranted for this customer. From the production department, Sally received an estimate that the job will require 2000 labor hours, 8000 machine hours, and material cost of $178,000. Cost accounting has indicated that the average labor cost is $22 per hour. The cost accounting department indicated that the standard overhead rate is $34 per machine hour. This rate was determined at the start of the year based on an estimate of $23,800,000 of overhead and 700,000 machine hours.

Since her first day at Western, Sally has heard critical comments relating to the overhead rate. Her boss is critical of the rate because it is based on expected use of capacity (700,000 machine hours) rather than practical capacity (1,000,000 machine hours). Recently, he told Sally, “If the rate was based on practical capacity, our jobs could be bid for a lot less since our overhead rate would be lower.”