Anthony’s auto shop has run into some mass merchandisers and is seeking an alternative costing system to lower costs which will hopefully increase their shrinking work volume and raise profits. Anthony’s has nine employees; there is a manger, four senior mechanics and two junior mechanics. Anthony has let his manager know that he is unwilling to part ways with any of the senior mechanics but will release junior mechanics if need be. Anthony’s current system is working under an 11% markup on both class A and Class B jobs. Class A jobs can only be performed by senior mechanics and Class B jobs can be performed by senior or junior mechanics. This was easily determined by subtracting the costs from the revenue and dividing that number by the costs (Exhibit 1).
Anthony’s manager is considering moving from a single charge rate system to one that applies charges rates depending on the job class. In order for his manager to determine the new hourly rates based on job class, he first needs to consider that 50% of jobs are class A and 50% are class B. taking the percentage into account he also needs to realize what the practical hours are for his mechanics. Given that the maximum hours a mechanic can work are 1750 a year (14000/year for 8 mechanics), the practical percentage of hours is 95% or 1662.5 hours a year (13300/year for 8 mechanics). Since the jobs are split 50/50 the hours should be halved between junior and senior mechanics leading to 6650 chargeable hours for each mechanic group. With class A jobs being more demanding on his resources it is determined that 60% of resources are taken up by class A jobs while the other 40% are class B jobs. Taking the total costs seen in exhibit 1 and multiplying it by .6 for class A and .4 for class B jobs, then0 dividing the resultant by the practical hours(6650) it is determined that the new rate would $55.20 for senior mechanics and $36.80 for junior mechanics. With these numbers in mind the standard 11% markup still needs to be added on for final hourly rates of $61.27 for senior and $40.85 for junior mechanics (Exhibit 2).
With two new jobs in the queue (job 101 and 102), Anthony’s manager can determine the net gain/loss from his proposed costing system. For this he also needs to calculate the gain/loss from his current system (Exhibit 3). The current system was easy because there is one rate; job 101 requires 6 hours times the current hourly rate. The resultant is the revenue for job 101 which will have the total expenses subtracted from it giving a profit of $30.36. Job 102 has 2 total hours and has a net profit of $10.12. With the current systems numbers calculated the focus could be turned to the new system. Keeping in mind that there a new rates dependant on job class, the two jobs needed to be broken down into class A hours and class B hours. Job 101 has 4.5 hours of class A work and 1.5 of class B work while job B has 2 hours of class B work only. The same method is followed from earlier only using the new hourly rates resulting in a profit of $33.40 for job 101 and $8.10 for job 102. With the new total gains calculated the accountant can see that his new system brings in a larger profit than the current system, and it is determined that the current system is overpricing class B jobs and under pricing class A jobs.
Before implementing his new system Anthony’s manager needs to consider if the new pricing is going to have an effect on the ratio of class A to class B work that is taken into the shop. Given the complexity of class A jobs it can be assumed that the majority of the work being taken by the mass merchandisers is class B level work. With the new system charging less for class B work which would be fine, as long as the class A customers are not leaving due to the higher charges. At first look it would appear that with lower class B costs and higher class A costs, the ratio of work would shift more to class B work. However, with more class B work leaving to the mass