Spectra Inc. produces color monitors for personal computers. The firm makes 19-inch moni...

Spectra Inc. produces color monitors for personal computers. The firm makes 19-inch monitors with the following cost structure:

Because of the rapidly changing market for computer monitors, standard costs, overhead rates, and prices are revised quarterly. While the direct labor component of standard cost has been relatively constant over time, direct materials costs, especially the cost of the circuit boards, fluctuate widely. Therefore, for pricing purposes, management reviews costs each quarter and forecasts next quarter’s costs using the current quarter’s cost structure. It also uses this method for revising overhead costs each quarter. Overhead is absorbed to products using direct labor cost. Fixed overhead is incurred fairly uniformly over the year. The overhead rate next quarter is the actual overhead costs incurred this quarter divided by this quarter’s direct labor cost. Data for the last six quarters are shown.

The president of the company, responding to the auditor’s suggestion that Spectra set standard costs on an annual basis, replied, “Annual budgeting is fine for more static companies like automobiles. But the computer industry, especially peripherals, changes day by day. We have to be ahead of our competitors in terms of changing our product price in response to cost changes. If we waited eight months to react to cost changes, we’d be out of business.”

Required:

Do you agree with the president or the auditor? Critically evaluate Spectra’s costing system. What changes would you suggest, and how would you justify them to the president?