Case: COST CLASSIFICATION, INCOME STATEMENT

Gateway Construction Company is a family-operated business that was founded in 1950 by Samuel Gateway. In the beginning, the company consisted of Gateway and three employees laying gas, water, and sewage pipelines as subcontractors. Currently, the company employs 25 to 30 people; Jack Gateway, Samuel's son, directs it. The main line of business continues to be laying pipeline.

Most of Gateway's work comes from contracts with city and state agencies. All of the company's work is located in Nebraska. The company's sales volume averages $3 million, and profits vary between 0 and 10 percent of sales.

Sales and profits have been somewhat below average for the past three years due to a recession and intense competition. Because of this competition, Jack Gateway is constantly reviewing the prices that other companies bid for jobs; when a bid is lost, he makes every attempt to analyze the reasons for the differences between his bid and that of his competitors. He uses this information to increase the competitiveness of future bids.

Jack has become convinced that Gateway's current accounting system is deficient. Currently, all expenses are simply deducted from revenues to arrive at operating income. No effort is made to distinguish among the costs of laying pipe, obtaining contracts, and administering the company. Yet all bids are based on the costs of laying pipe.

With these thoughts in mind, Jack began a careful review of the income statement for the previous year (see next page). First, he noted that jobs were priced on the basis of equipment hours, with an average price of $165 per equipment hour.  However, when it came to classifying and assigning costs, he decided that he needed some help. One thing that really puzzled him was how to classify his own salary of $114,000. About half of his time was spent in bidding and securing contracts, and the other half was spent in general administrative matters.

Required:

1. Classify the costs in the income statement as (1) costs of laying pipe (production costs), (2) costs of securing contracts (selling costs), or (3) costs of general administration. For production costs, identify direct materials, direct labor, and overhead costs. The company never has significant work in process (most jobs are started and completed within a day).

2. Assume that a significant driver is equipment hours. Identify the expenses that would likely be traced to jobs using this driver. Explain why you feel these costs are traceable using equipment hours. What is the cost per equipment hour for these traceable costs?