2. Compute the following question Canadian Adventure recently required Deep Alaska Air. Deep Alaska has been in business for many years and provide charter flight for remote finishing and camping ethusiaasts. When the campany originally started in to business, aircraft, insurance and fuel were relatively inexpensive. Pilot salaries was by far the most significant cost factor and has continued to be used as the basis for allocating overhead. Heretofore, the company has company has classified all costs, other than pilot salaries as overhead. The company prices trips to customers at 150% of “cost” Canadian was concerned about the appropratness of the costing/pricing technique and has engaged you to study this issue. With goal of improving Deep Alaska overhead operations.
Aggrigated data for the most receint year are:
Pilot salaries……………………………………..$350,000
Aircraft depreciation (6,000 engine hours)………935,000
Insurance (fixed annual cost)…………………….400,000
Fuel ($11 per gallon)……………………………..900,000
Other costs………………………………………..125,000
Includes amount paid for “wait time” that varies considerably by trip
Sample data from three specific recent flights is as follws:
Flight A Flight B Flight C
Pilot salaries $350 $615 $400
Engine hours on flight 3 1 9
Fuel used 60 gals 20 gals 180 gals
a) Using the existing scheme determine the overhead application rate and price for flight A, B and C
b) Is “Job” costing approperate for non manufacturing business like Deep Alaska
c) Evaluate the merits of the overhead allocation scheme in use by the company
d) Using the engine hours to allocate overhead and classify pilot salaries as a direct labour and fuel as direct material cost prepare a revised pricing schedule for the three flights (continue to assume that flights are priced at 150% of cost)
e) If pricing is revised as described in part (d), what is likely results on profits?
a) To determine the overhead application rate, we need to calculate the total overhead cost and the total pilot salaries.
Total overhead cost = Aircraft depreciation + Insurance + Other costs
Total overhead cost = $935,000 + $400,000 + $125,000 = $1,460,000
Total pilot salaries = $350 + $615 + $400 = $1,365
Overhead application rate = Total overhead cost / Total pilot salaries
Overhead application rate = $1,460,000 / $1,365 = $1,069.96 per pilot salary
To calculate the price for each flight:
Price = Cost + (Overhead application rate * Pilot salary)
For Flight A:
Cost = Pilot salary + Fuel cost
Cost = $350 + (60 * $11) = $970
Price = $970 + ($1,069.96 * $350)
Price = $970 + $374,986
Price for Flight A = $375,956
For Flight B:
Cost = Pilot salary + Fuel cost
Cost = $615 + (20 * $11) = $835
Price = $835 + ($1,069.96 * $615)
Price = $835 + $663,015
Price for Flight B = $663,850
For Flight C:
Cost = Pilot salary + Fuel cost
Cost = $400 + (180 * $11) = $2,180
Price = $2,180 + ($1,069.96 * $400)
Price = $2,180 + $427,984
Price for Flight C = $430,164
b) "Job" costing can be appropriate for a non-manufacturing business like Deep Alaska if they have unique and identifiable jobs or projects, such as different flights in this case, which require separate cost allocation. It helps in determining the actual cost of each job or project.
c) The merits of the overhead allocation scheme in use by the company can be evaluated based on factors such as accuracy, fairness, and alignment with the company's pricing goals. The current scheme uses pilot salaries as the basis for allocating overhead, but it may not accurately reflect the actual cost drivers of the business. Additionally, classifying all costs other than pilot salaries as overhead may not provide a precise representation of the costs associated with each flight.
d) To prepare a revised pricing schedule using engine hours to allocate overhead, we need to calculate the total overhead cost and determine the overhead application rate.
Total overhead cost = Aircraft depreciation
Total overhead cost = $935,000
Total engine hours = 3 + 1 + 9 = 13
Overhead application rate = Total overhead cost / Total engine hours
Overhead application rate = $935,000 / 13 = $71,923.08 per engine hour
Revised pricing schedule:
For Flight A:
Overhead cost = Engine hours * Overhead application rate
Overhead cost = 3 * $71,923.08 = $215,769.24
Direct labor cost (pilot salaries) = $350
Direct material cost (fuel) = 60 * $11 = $660
Total cost = Direct labor cost + Direct material cost + Overhead cost
Total cost = $350 + $660 + $215,769.24 = $216,779.24
Revised price = Total cost * 150%
Revised price for Flight A = $216,779.24 * 1.5 = $325,168.86
Similarly, calculate the revised prices for Flight B and Flight C using the same calculations.
e) The likely result on profits would depend on various factors such as customer demand, competition, and cost control measures. If the revised pricing takes into account the direct labor and material costs more accurately, it may result in a better understanding of the profitability of each flight. It could potentially lead to improved pricing strategies and better cost management, which may positively impact profits.