1. The primary cause of the current system to fail is the use of a single burden rate. Burden costs of the testing rooms as well as other costs such as admin were grouped into a single cost pool and then divided by the total labor dollars. This resulted to a single burden rate of 145% of direct labor dollars (cost driver).
This method is not appropriate for Seligram because the information on the case present that direct labor hours and machine hours vary by product line and activity. In addition, the burden cost of the main and test room also significantly vary. Therefore, using a single burden rate does not provide the true cost of the product, as it assumes all products consume direct labor and overhead in the same proportion.
2. Cost for each system are as follows:
3. I prefer the system proposed by the consultant because it is the most detailed, therefore will produce more accurate costs.
4. The ideal allocation base should have a direct cause-and-effect relation with the costs incurred. Based on the data provided in the case, it appears that the consultant’s proposed cost system is adequate because it considers the appropriate cost pool and allocation base. However, it should be noted that developing a cost system that is more detailed require the use of more time and resources. There needs to be a proper balance between accuracy and cost.
5. There is significant cost involved in the purchase of new equipment. Although the machine will be located in the Main Room, I would use a separate cost pool when calculating the burden rate of the new machine. The purchase price of the machine is $2 million. I will add the one-time installation and programming cost to the acquisition cost of the machine since these costs are required in order to get the machine ready for use.
I will calculate depreciation based on the machine’s practical capacity over its estimated life, instead of double declining method. It seems that the use of double declining balance method of depreciation is inappropriate for allocation of costs because this method incurs higher depreciation in the early years, although the utilization is lower in the early years. By using practical capacity as the base, I am able to properly match the cost with the use of the machine.