Greenscape Pty Ltd provides commercial landscaping services. Linda Drake, the firms owner, wants to develop cost estimates that sh. can use to prepare bids on jobs. After analysing the firm’s costs. Drake has developed the following preliminary cost estimates for each 1000 square metres of landscaping:
Direct labour (5 direct bbour hours $19 per hour)……………95
Overhead (e 818 per direct labour hour)………………………90
Total cost per 1000 square metres…………………………$585
Drake is quite certain about the estimates for direct materials and direct labour, but she LS not as comfortable with the overhead estimate. As indirect costs, overhead costs cannot be traced directly to landscaping. Instead, Drake has used a common method of estimating an overhead rate per direct labour hour. However the estimate for overhead is based on the overhead costs that were incurred during the past 12 months, as presented in the following schedule. The estimate of $18 per direct labour hour was determined by dividing the total overhead costs for the 12-month period ($648,000) by the total direct labour hours (36,000).
Drake believes that overhead is affected by total monthly direct labour hours. She decided to perform a regression analysis of overhead (OH) on total direct labour hours (DIM). The following regression formula was obtained:
OH = $26,201 + $9.27DLH
1. The overhead rate developed from the regression analysis is different from Linda Drakes preliminary estimate of $18 per direct Labour hour. Explain the difference in the two overhead rates.
2. Using the overhead formula that was derived from the regression analysis, determine a total variable cost estimate (or each 1000 square metres of landscaping.
3. Linda Drake has been asked to submit a bid on a landscaping project for Melbourne City Council consisting of 50,000 square metres. Drake estimates that 30 per cent of the direct labour hours required for the project will be on overtime, Calculate the variable costs per 1000 metres of landscaping that should b. included in any bid that Drake would submit on lhs project. Use the overhead formula derived from the regression analysis.
4. Should Greenscape rely on the overhead formula derived from the regression analysis as the basis for the variable overhead component of its cost estimate? Explain your answer.
5. After attending a seminar on activity-based costing. Drake decided on a further analysis of Greenscapes activities and costs. She discovered that a more accurate portrayal of the Firm’s cost behaviour could be achieved by dividing overhead into three separate cost pools-administration, seeding and individual planting-each with its own cost driver. After discussions with some of the landicapers who work within the firm, Drake came to the conclusion that possible cost drivers for each of these cost pools were-direct labour hours (DLH), the number of square metres of turf seeded (STS), and the number of individual trees and shrubs planted (TSP), respectively. A separate regression equation was estimated for each overhead cost pool, with the following results
Administration OH1= $10,000 + $4.10DLU
where DLH denotes direct labour hours
Seeding OH2 = $9100 + $13.50STS
where STS denotes the number of square metres of turf seeded (in thousands)
Planting OH3 = $8000 + $6.60TSP
where PL denotes the number of individual plantings (such as trees and shrubs)
Assume that 5 direct labour hours are needed to landscape each 1000 square metres, regardless of the specific planting material that is used.
(a) Suppose the landscaping project for the city will involve seeding all 000 square metres of turf and planting 70 trees and shrubs. Calculate the variable overhead cost that Drake should include in the bid.
(b) Recalculate the variable overhead cost For the city’s landscaping protect, assuming that half of the 50000 square metre landscaping area will be seeded and there will be 230 individual plantings.
(c) Explain why the costs differ in requirements (a) and (b).