Brenda McCoy, the managing partner of McCoy, Brennan, and Cable, a public accounting firm, is considering the desirability of tracing more costs to jobs than just direct labor. In this way, the firm will be able to justify billings to clients.

Last year’s costs were as follows:

Direct-professional labor … $ 5,000,000

Overhead …………………. 10,000,000

Total costs ………………. $15,000,000

The following costs were included in overhead:

Computer time …………………………………………. $  750,000

Secretarial cost ……………………………………………. 700,000

Photocopying ………………………………………………. 250,000

Fringe benefits to direct labor ……………………………… 800,000

Phone call time with clients (estimated but not tabulated) … 500,000

Total ……………………………………………………… $3,000,000

The firm’s data processing techniques now make it feasible to document and trace these costs to individual jobs.

As an experiment, in December Brenda McCoy arranged to trace these costs to six audit engagements. Two job records showed the following:

1. Compute the overhead application rate based on last year’s costs.

2. Suppose last year’s costs were reclassified so that $3 million would be regarded as direct costs instead of overhead. Compute the overhead application rate as a percentage of direct labor and as a percentage of total direct costs.

3. Using the three rates computed in numbers 1 and 2, compute the total costs of engagements for Eagledale Company and First Valley Bank.

4. Suppose that client billing was based on a 30% markup of total job costs. Compute the billings that would be forthcoming in number 3.

5. Which method of costing and overhead application do you favor? Explain.

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Engagement Eagiedale Company First Valley Bank Direct-professional labor $15,000 $15,000 Fringe benefits to direct labor 3,000 3,000 Phone call time with clients 1,500 500 Computer time 3,000 700 Secretarial costs 2,000 1,500 Photocopying 500 300 Total direct costs $25,000 $21,000