Managerial Accounting Case Essay
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In the Seligram case, the existing cost accounting system measured two components of cost: direct labor and burden. All burden cost, which is the overhead, was grouped into a single cost pool and was calculated only by using a burden rate per direct labor dollar. This may cause problems since direct labor and overhead are not consumed by the products in the same proportion. Simply using the same burden rate is obsolescent. First of all, direct labor hours per lot tested had been steadily declining, especially with the increase of dependence on vendor certification.
This will result in the change of the burden rate. Besides, this system distorts the price to some extent, making the price for complex parts cheaper while price for elementary testing higher compared with price for outside services. What is more, the consequences brought from the introduction of high -technology components would decrease the direct labor hour. All of this was trending to higher burden rates and overall higher rates.
Cost allocation based on current burden rate of 145% is calculated within the Exhibit1.
Having noticed of the problems of the existing system, the accounting manager proposed a two-burden-pool method to allocate the burden cost. Under the two-burden-pool method, burden cost has been divided into two pools: one is the burden cost related to the administrative and technical functions and the other is test related burden. The former is calculated based on direct labor dollar, the latter one is calculated by using machine hours. This method takes other factors that cause the burden into account, which makes the cost allocation more accurate than the existing method. The result of two-burden-pool is as the follows.
The consultant proposed a more detailed cost allocation method, i.e. separate burden centers from each of each test room and common technical and administrative pool so that a three-burden-pool is formed. Under this method, burden cost in test rooms would be allocated on a machine-hour basis, and technical and administrative costs would continue to be charged on a rate per direct labor dollar. This method is more accurate in allocating the burden cost by providing a cost of each product or job.
Through this way, ETO could differentiate client and product and calculate the cost more accurately from direct data such as the machine hour to product a certain product, so that they need not to guess the real cost of that product by allocating cost according to estimation. Besides, due the process of automatic, direct labor dollar amount alone could not reflect the real picture of burden cost as before. So it is necessary to take other related factor into account when allocating burden cost and more detailed analysis of the allocation basis is needed. The allocation result of three-burden-pool is listed below:
Since the three-burden-pool system is most accurate in allocating burden cost among those three methods, it is preferable. However, it does not mean the three-burden-pool system is perfect. Because this system provides more accurate and detailed information of the production process, it will cost more than the other two methods. In addition, the redesign of the three-burden-pool system could be expensive too due to the complexity of the system. In order to improve this system, ETO needs to pay attention of the relationship of cost and benefit. Besides, ETO could set up a system that is easy and effective to perform to save the cost of implicating three-burden-pool.
Besides the consideration of proposed cost allocation methods, Seligram should also arrange the new equipment into an appropriate cost pool which indicates a more reliable estimation. Assuming that new equipment has a separate cost center, all variable cost, fixed cost and depreciation will be reported separately. The burden rate is only based on the machine hours of new equipment which are 400hr (Year1) and 2400hr (Year2-8). Additionally, we use Double-decline method for depreciation. Balance is shown in Exhibit4. The separate burden rate for Year 1 would be much higher than those in the following years due to set up costs (Exhibit 5). Burden rates combined with main testing room are calculated in Exhibit 6.
All combined burden rates are much lower than the separate costing rates. We recommend choosing a separate cost center for new equipment, even though the rates are much higher. Due to the current situation that lower costs for more complex components, which is abnormal, separate method would reflect more accurate and reliable costs of new imported machines. Obviously, combined method would influence the presentation of true costs. The costs are reduced by other factors in main testing room. Higher burden rates are more reasonable that these new machines have higher cost in essence and also they are just for testing components from several specific clients. Higher burden rates are more accurate.