White Hills Architects, Inc.

White Hills Architects, Inc.

1. If the outside bid is accepted, the firms profit will fall by $20,000.  If  Mr.Harp’s bid is accepted, we need to analyze the differential nature of the costs.

The analysis of the same is as follows:

Item                        Behavior                Differential Amount

Materials                All differential                        7,000

Direct Labor                Non differential                       0

Variable overhead        All differential                        2,000

Fixed overhead        Non differential                       0

Markup                 Non differential                       0

                                                        ______

                                                         9,000

                                                        =====

The issue of direct labor is a little tricky.  The questions to be addressed are many. If no one would be hired to do this job, could someone be laid off if the job were not undertaken?  If so, that is the differential amount. If no one would be hired for the job and no one would be laid off without the job, labor sounds pretty fixed, which is consistent with Mr. Harp’s description of his staff, i.e., the need for a wide variety of technical skills.  It seems as though Mr. Harp is treating his staff as a fixed cost and attempting to find a sufficient volume of business to keep them all busy.  That being the case, there are no differential costs associated with direct labor. Even if the entire amount is considered to be differential, the total impact on the museum’s profit is $19,000.  This is still less than the amount of the proposed contract.

2. Mr. Sampson’s decision to intervene would appear to depend to a certain extent on what he thinks will happen if he does not.  More importantly, though, the decision depends on his decentralization philosophy.  The ideal thing to do would be to avoid intervening.  There is no conclusive evident that Mr. Harp is unwilling to lower his price or that Ms. Sweeney is unwilling to pay extra $7,000.  Moreover, we don’t know about quality or on-time performance.

Two things are quite evident.  First, if Ms. Sweeney uses the outside contractor, she will not get free design and drawing assistance again from Mr. Harp.  Second, if she uses Mr. Harp, she may not be able to get the contractor to give her a legitimate bid again.

3. The only way that Mr. Sampson could solve this problem to everyone’s satisfaction would be to absorb the difference internally.  That is, allow Mr. Harp to earn $27,000 for the job but charge Ms. Sweeney’s profit center only $20,000.  The difference would go into some sort of special account.  At the end of the year the amount would reflect the total of the differences between internal bid and market prices.

        The problem with this approach is that it motivates buying profit centers to get cheap, no-frills bids.

        Mr. Sampson could order Mr. Harp to charge $20,000 but require Ms. Sweeney to pay for the design and drawing costs.  It is likely that both managers will end up unhappy with this solution.

4.  It’s hard to say what will happen.  In the worst case scenario, Ms. Sweeney uses the outside contractor.  The firm will be $11,000 worse off.  This certainly appears bad in the short run, but is it, and, even so, is it bad in the long run?  At least one scenario is not so bad.

        Suppose, Mr. Harp has the opportunity to use the same direct labor for an outside job that brings in $18,000 in contribution.  He then is indifferent.  But, the firm overall loses $11,000 on the job with Ms. Sweeney but gains $18,000 on the outside job. Overall, it is $7,000 better off.

Particulars                                           Original Bid                       Possible Revision

Revenue                                                27,000                                20,000

Less:          Variable expenses                        7000

        Overhead                                2000       9,000                          9,000

Contribution to fixed expenses                         18,000                         11,000

Less: fixed expenses

        Direct Labor                                10,000