Question

Case Study: Williams Ltd

Williams Ltd manufactures iron gates to individual customers’ specifications. The company use the tender process to obtain work, where the company responds to an invitation to submit a competitive bid. Over the last few months, Williams Ltd. has been very quiet, and the managing director, Jack Jones, is concerned that the business will fail if it does not improve its success rate with tenders. The company has two production departments, Bending and Welding, and the production requirements for individual jobs can differ significantly. Some jobs require extensive bending with little welding; others require little bending with a lot of welding.

The following table describes the results of the five bids that the company submitted last month. The numbers in brackets after losses indicate where the company ranked in the bid process:

Job no.	Direct labour hours in Bending	Direct labour hours in Welding	Estimated direct labour hours	Overhead cost of bid	Won/lost
1	1,200	300	1,500	$4,125	Lost (5th)
2	300	1,200	1,500	$4,125	Won
3	1,400	100	1,500	$4,125	Lost (3rd)
4	100	1,400	1,500	$4,125	Won
5	750	750	1,500	$4,125	Lost (2nd)

The pattern of resource usage implied in the above table has persisted for several months. The company uses a pre-determined plant-wide overhead rate based on practical capacity, which is measured in direct labour hours. The budgeted overhead for the year for the Bending Department is $54,000 (including $18,000 fixed and $36,000 variable), and for the Welding Department it is $144,000 (including $36,000 fixed and $108,000 variable). Each department has a monthly practical capacity of 3 000 direct labour hours.

Required:

• How the overhead cost of $4,125 is determined for each job?
• A statement of the agreed analysis of the problem(s) resulting from the use of current overhead allocation approach.

• Required: Refer to Part A – Williams Ltd Case Study and answer the following:

• Discuss an alternative bidding scheme that overcomes the current overhead allocation situation facing the firm, by proposing an alternative method of allocating manufacturing overheads. Support your analysis with calculations by showing the overheads cost bid for each job applying your alternative method. Your discussion part has a word limit of 150 words (excluding the calculations).                                                           (10 marks)
• Explain how this alternative bidding scheme may improve its success rate with tenders. Your explanation should take into account the qualitative factors. Your discussion has a word limit of 300 words.
•                                                                                    

Answer 1

a) Determination of overhead cost of $4,125 for each job

As mentioned in question, company uses a pre-determined plant-wide overhead rate based on practical capacity, i.e., Overhead Rate = (Total Overhead cost(including Fixed as well as Variable) / (Total Number of hours)

Total Overhead Cost = Blending Department's Overhead cost + Welding Department's Overhead cost = $54,000 + $1,44,000 = $1,98,000

Total Number of Hours = 3,000 * 12 * 2 (Monthly capacity of each department * No. of months in year * No. of Departments) = 72,000 hrs

Plant wide Overhead Rate = 1,98,000/72,000 = $2.75/hr

Company consumes 1,500 labour hours in each case, hence Overhead cost for bidding based on plant wide overhead rate = 1,500 hrs * $2.75/hr = $4,125

b) Problem(s) resulting from the use of current overhead allocation approach.

Plant-wide overhead rate has various limitations, which are as follows:-

> Overhead costs may not bear any relationship with direct labor hours.

> All products may not use overhead costs in the same proportion

> It can distort product costs as it assumes that products are similar in volume, complexity, batch size (which is normally not the case).

> It also allocates Fixed Cost, which is generally irrelevant for decision making, thereby leading to incorrect decisions.

Though it has some advantages as well like its readily availability & ease to implement, but these advantages could never compensate for its limitations. Hence, practically Plant wide overhead rate is redundant whole around the world.

c) Alternative bidding scheme that overcomes the current overhead allocation

Departmental Overhead Rate can overcome the situation created by Plant wide overhead rate. Departmental Overhead rate is calculated separately for each department based on the departmental cost & depatment's capacity.  

Departmental Overhead Rate = (Total Departmental Overhead cost(including Fixed as well as Variable) / (Total Practical hours of Department)

Departmental Overhead rate for both the departments is calculated as below :-

* Bending Department = $54,000/36,000 hrs = $1.50/hr

* Welding Department = $1,44,000/36,000 hrs = $4.00/hr

Overheads cost bid for each job using Departmental Overhead Rate (Table A):-

Job no.	Direct labour hours in Bending	Direct labour hours in Welding	Estimated direct labour hours	Overhead Cost of Blending @ $1.50/hr	Overhead Cost of Welding @ $4.00/hr	TOTAL Overhead Cost
1	1200	300	1500	1800	1200	3000
2	300	1200	1500	450	4800	5250
3	1400	100	1500	2100	400	2500
4	100	1400	1500	150	5600	5750
5	750	750	1500	1125	3000	4125

As evident from above table, Overhead cost of each department is systematically allocated to jobs as per labour hours used of that particular department, which was contrarily used as same for Plant-wide overhead rate. Welding Department's overhead rate is $4/hr which is around 267% of Bending Department's rate of $1.50/hr. However, in Plant-wide overhead rate both were considered as same. Hence, Departmental Overhead Overhead overcomes limitations of Plant-wide Overhead rate.

d) Alternative bidding scheme impact on improvement of Success rate with Tenders

Alternative bidding scheme proposed, i.e., Departmental Overhead Rate has numerous advantages over Plant-wide Overhead rate & it eliminates all the major limitations in Plant wide overhead rate.

Same is explained with comparison of Overhead Costs in below table (Table B):-  

Job No.	Overhead Cost as per Plant-wide Overhead Rate ($)	Overhead Cost as per Departmenal Overhead rate ($)	Diff b/w Overhead cost as per Plantwide rate vs Departmental Rate ($)	Bid Won/Loss	Remarks
1	4,125	3,000	1,125	Lost (5th)	As per Note 1
2	4,125	5,250	(1,125)	Won	As per Note 2
3	4,125	2,500	1,625	Lost (3rd)	As per Note 3
4	4,125	5,750	(1,625)	Won	As per Note 4
5	4,125	4,125	-	Lost (2nd)	As per Note 5

Note 1: Williams Ltd has quoted rate $ 4,125 as per Plant-wide Overhead Rate as against $ 3,000 and has ended up losing bid at 5th position. Had it quoted 3,000 it might have been lowest bidder as rate is considerably decreased, leading to improvement of success rate in bid.

Note 2: Williams Ltd has quoted rate $ 4,125 as per Plant-wide Overhead Rate as against $ 5,250 and has ended up winning bid. But here 2 scenarios need to be critically examined that it might have received order but it may end up on losing in financial terms as it has quoted way below its more practical cost. Hence, it may increase its profit & still win tender by quoting $5,000.

Note 3 : Same as Note 1.

Note 4 : Same as Note 2.

Note 5 : Overhead Amount as per both rates are equal and still bidder has ended up 2nd. Here, bidder needs to review competitiveness of tender & can quote on basis of Variable cost only, as Fixed cost is just for purpose of allocation.

We can derive following points from above analysis :-

1. Departmental Overhead Rate helps in quoting more accurate rate.
2. Departmental Overhead Rate increases success rates of tender, i.e., makes it more competitive.
3. Departmental Overhead Rate at times can also lead to incremental profit as illustrated at Note 2.