Mar 27, 2013 1278 Words 6 Pages
1) What caused the existing system at ETO to fail?
This system was based on the assumption that direct costs and overhead are consumed in the same proportion for all product testing. However, this is not the case and therefore the system failed. For example, due to the implementation of the vendor certification and the just-in-time delivery, some products are already tested and do not need any further tests, and ETO faces a decreasing number of the tests performed.
On the other hand, new components require more high technology tests. They consume highly automated equipment and require different testing procedures compared to other products.
2) Calculate the reported costs of the five components using:
a. The existing system
With a burden rate of 145%:
Burdenproduct = Direct Labourproduct x Burden Rate (in this case, 145%)
Total costsproduct = Direct Labourproduct + Burdenproduct
Product Direct Labour Burden Total Costs
ICA 917 1330 2247
ICB 2051 2974 5025
Capacitor 1094 1586 2680
Amplifier 525 761 1286
Diode 519 753 1272
b. The system proposed by the accounting manager
The accountant proposes a division into machine hour and direct labor burden. According to Exhibit 5, the new burden rate is 21% and the machine hour rate is $80,10.
Burdenproduct = Direct Labourproduct x Burden Rate (in this case 21%)
Machine Burdenproduct = Machine Hourproduct x Machine Hour Rate (in this case $80,10)
Product Direct Labour Burden Machine Hour Machine Burden Total Costs
ICA 917 193 18,5 1482 2591
ICB 2051 431 40,0 3204 5686
Capacitor 1094 230 7,5 601 1924
Amplifier 525 110 5,0 401 1036
Diode 519 109 12,0 961 1589
c. The system proposed by the consultant
The consultant proposes a three-burden-pool system, treating the main test room and mechanical test room as different cost pools. According to Exhibit 5, the costs would be:
• For the main test room burden rate: 2.103.116/ 33.201 = $63.34
• For the mechanical test room burden rate: 1.926.263/ 17.103 = $112,63
Main room burdenproduct = Main room hourproduct x Main room hour burden (in this case $63,34)
Mechanical room burdenproduct = Mech. room hourproduct x Mech. room hour burden (in this case $112,63)
Test room burdenproduct = Main room burdenproduct + Mechanical room burdenproduct
Product Direct Labour Burden Main room hour Mech room hour Test room burden Total costs
ICA 917 193 8,5 10,0 1665 2774
ICB 2051 431 14,0 26,0 3815 6297
Capacitor 1094 230 3,0 4,5 697 2021
Amplifier 525 110 4,0 1,0 366 1001
Diode 519 109 7,0 5,0 1007 1635
3) Which system is preferable? Why?
Between the 3 options, the consultant’s system is preferable because it demonstrates the cost allocation more accurately.
The accounting manager proposes two cost pools, treating the machine hours as a separate cost pool because the automated operation process leads to large percentage of total cost comparing to direct labor. Measuring the machine hour costs can help us to assess the total burden more accurately.
However, given the same machine hours, there are different hours spend in the main room and in the mechanical room, with different costs. We can see from Exhibit 5 that the mechanical room has higher unit cost per hour. Therefore, the three-cost-pool system can trace the costs back to the actual operation factors more clearly.
4) Do you recommend any changes or enhancements to your preferred system? Why?
We would recommend creating a 4 cost pool, separating the technical support from the administrative support. The increased number of cost centers can show differences in the cost allocation more accurately. However, it also increases the cost of the process.
In this case, we feel it makes sense to separate the technical support from the administrative support because the technical is more relates with the core activity of the company.
5) Would you treat the new machine as separate cost center or as part of the main test room? Why?
Using the information on Exhibit 5 and Exhibit 7, we can calculate the burden rate if the machine is assigned a separate cost center and if the machine is considered part of the main room. If we treat the new testing machine as part of the main test room, the burden rate will be distorted, and therefore the new machine should have a separate cost center.
1) The machine is assigned a separate cost center:
If assigned a separate cost center
Year Variable Depreciation Other Total (1) Hours (2) Burden rate (1/2)
Year 1 100.000 500.000 225.000 825.000 400 2.062,5
Year 2 100.000 375.000 150.000 625.000 1.4001 446,4
Year 3 100.000 281.250 150.000 531.250 2.400 221,4
Year 4 100.000 210.938 150.000 460.938 2.400 192,1
Year 5 100.000 158.203 150.000 408.203 2.400 170,1
Year 6 100.000 118.652 150.000 368.652 2.400 153,6
Year 7 100.000 88.989 150.000 338.989 2.400 141,2
Year 8 100.000 66.742 150.000 316.742 2.400 132,0
2) The machine is considered part of the main room:
If part of the main room
Year Variable Depreciation Other Total (1) Hours (2) Main room costs (3) Main room hours (4) Burden rate (1+3)/(2+4)
Year 1 100.000 500.000 225.000 825.000 400 2.103.116 33.201 87,1
Year 2 100.000 375.000 150.000 625.000 1.400 2.103.116 33.201 78,8
Year 3 100.000 281.250 150.000 531.250 2.400 2.103.116 33.201 74,0
Year 4 100.000 210.938 150.000 460.938 2.400 2.103.116 33.201 72,0
Year 5 100.000 158.203 150.000 408.203 2.400 2.103.116 33.201 70,5
Year 6 100.000 118.652 150.000 368.652 2.400 2.103.116 33.201 69,4
Year 7 100.000 88.989 150.000 338.989 2.400 2.103.116 33.201 68,6
Year 8 100.000 66.742 150.000 316.742 2.400 2.103.116 33.201 68,0
Additional note on the depreciation method:
The method used for the depreciation of the new testing equipment was the double declining balance. This is an accelerated method since a large part of the cost of the fixed asset is expensed at the beginning of the life of that asset. To calculate declining balance depreciation the depreciable basis of the fixed asset is multiplied by a factor. The factor is the double of what would be depreciated each year under straight line depreciation (in this case under straight line the factor would be 12,5% and the double is 25%). The depreciable basis is the book value of the fixed asset, i.e. cost less accumulated depreciation.
Year Depreciable basis Depreciation calculation Depreciation expense Accumulated depreciation
1 2.000.000 2.000.000*0,25 500.000 500.000
2 1.500.000 1.500.000*0,25 375.000 875.000
3 1.125.000 1.125.000*0,25 281.250 1.156.250
4 843.750 843.750*0,25 210.938 1.367.188
5 632.813 632.813*0,25 158.203 1.525.391
6 474.609 474.609*0,25 118.652 1.644.043
7 355.957 355.957*0,25 88.989 1.733.032
8 266.968 266.968*0,25 66.742 1.799.774
This system was based on the assumption that direct costs and overhead are consumed in the same proportion for all product testing. However, this is not the case and therefore the system failed. For example, due to the implementation of the vendor certification and the just-in-time delivery, some products are already tested and do not need any further tests, and ETO faces a decreasing number of the tests performed.
On the other hand, new components require more high technology tests. They consume highly automated equipment and require different testing procedures compared to other products.
2) Calculate the reported costs of the five components using:
a. The existing system
With a burden rate of 145%:
Burdenproduct = Direct Labourproduct x Burden Rate (in this case, 145%)
Total costsproduct = Direct Labourproduct + Burdenproduct
Product Direct Labour Burden Total Costs
ICA 917 1330 2247
ICB 2051 2974 5025
Capacitor 1094 1586 2680
Amplifier 525 761 1286
Diode 519 753 1272
b. The system proposed by the accounting manager
The accountant proposes a division into machine hour and direct labor burden. According to Exhibit 5, the new burden rate is 21% and the machine hour rate is $80,10.
Burdenproduct = Direct Labourproduct x Burden Rate (in this case 21%)
Machine Burdenproduct = Machine Hourproduct x Machine Hour Rate (in this case $80,10)
Product Direct Labour Burden Machine Hour Machine Burden Total Costs
ICA 917 193 18,5 1482 2591
ICB 2051 431 40,0 3204 5686
Capacitor 1094 230 7,5 601 1924
Amplifier 525 110 5,0 401 1036
Diode 519 109 12,0 961 1589
c. The system proposed by the consultant
The consultant proposes a three-burden-pool system, treating the main test room and mechanical test room as different cost pools. According to Exhibit 5, the costs would be:
• For the main test room burden rate: 2.103.116/ 33.201 = $63.34
• For the mechanical test room burden rate: 1.926.263/ 17.103 = $112,63
Main room burdenproduct = Main room hourproduct x Main room hour burden (in this case $63,34)
Mechanical room burdenproduct = Mech. room hourproduct x Mech. room hour burden (in this case $112,63)
Test room burdenproduct = Main room burdenproduct + Mechanical room burdenproduct
Product Direct Labour Burden Main room hour Mech room hour Test room burden Total costs
ICA 917 193 8,5 10,0 1665 2774
ICB 2051 431 14,0 26,0 3815 6297
Capacitor 1094 230 3,0 4,5 697 2021
Amplifier 525 110 4,0 1,0 366 1001
Diode 519 109 7,0 5,0 1007 1635
3) Which system is preferable? Why?
Between the 3 options, the consultant’s system is preferable because it demonstrates the cost allocation more accurately.
The accounting manager proposes two cost pools, treating the machine hours as a separate cost pool because the automated operation process leads to large percentage of total cost comparing to direct labor. Measuring the machine hour costs can help us to assess the total burden more accurately.
However, given the same machine hours, there are different hours spend in the main room and in the mechanical room, with different costs. We can see from Exhibit 5 that the mechanical room has higher unit cost per hour. Therefore, the three-cost-pool system can trace the costs back to the actual operation factors more clearly.
4) Do you recommend any changes or enhancements to your preferred system? Why?
We would recommend creating a 4 cost pool, separating the technical support from the administrative support. The increased number of cost centers can show differences in the cost allocation more accurately. However, it also increases the cost of the process.
In this case, we feel it makes sense to separate the technical support from the administrative support because the technical is more relates with the core activity of the company.
5) Would you treat the new machine as separate cost center or as part of the main test room? Why?
Using the information on Exhibit 5 and Exhibit 7, we can calculate the burden rate if the machine is assigned a separate cost center and if the machine is considered part of the main room. If we treat the new testing machine as part of the main test room, the burden rate will be distorted, and therefore the new machine should have a separate cost center.
1) The machine is assigned a separate cost center:
If assigned a separate cost center
Year Variable Depreciation Other Total (1) Hours (2) Burden rate (1/2)
Year 1 100.000 500.000 225.000 825.000 400 2.062,5
Year 2 100.000 375.000 150.000 625.000 1.4001 446,4
Year 3 100.000 281.250 150.000 531.250 2.400 221,4
Year 4 100.000 210.938 150.000 460.938 2.400 192,1
Year 5 100.000 158.203 150.000 408.203 2.400 170,1
Year 6 100.000 118.652 150.000 368.652 2.400 153,6
Year 7 100.000 88.989 150.000 338.989 2.400 141,2
Year 8 100.000 66.742 150.000 316.742 2.400 132,0
2) The machine is considered part of the main room:
If part of the main room
Year Variable Depreciation Other Total (1) Hours (2) Main room costs (3) Main room hours (4) Burden rate (1+3)/(2+4)
Year 1 100.000 500.000 225.000 825.000 400 2.103.116 33.201 87,1
Year 2 100.000 375.000 150.000 625.000 1.400 2.103.116 33.201 78,8
Year 3 100.000 281.250 150.000 531.250 2.400 2.103.116 33.201 74,0
Year 4 100.000 210.938 150.000 460.938 2.400 2.103.116 33.201 72,0
Year 5 100.000 158.203 150.000 408.203 2.400 2.103.116 33.201 70,5
Year 6 100.000 118.652 150.000 368.652 2.400 2.103.116 33.201 69,4
Year 7 100.000 88.989 150.000 338.989 2.400 2.103.116 33.201 68,6
Year 8 100.000 66.742 150.000 316.742 2.400 2.103.116 33.201 68,0
Additional note on the depreciation method:
The method used for the depreciation of the new testing equipment was the double declining balance. This is an accelerated method since a large part of the cost of the fixed asset is expensed at the beginning of the life of that asset. To calculate declining balance depreciation the depreciable basis of the fixed asset is multiplied by a factor. The factor is the double of what would be depreciated each year under straight line depreciation (in this case under straight line the factor would be 12,5% and the double is 25%). The depreciable basis is the book value of the fixed asset, i.e. cost less accumulated depreciation.
Year Depreciable basis Depreciation calculation Depreciation expense Accumulated depreciation
1 2.000.000 2.000.000*0,25 500.000 500.000
2 1.500.000 1.500.000*0,25 375.000 875.000
3 1.125.000 1.125.000*0,25 281.250 1.156.250
4 843.750 843.750*0,25 210.938 1.367.188
5 632.813 632.813*0,25 158.203 1.525.391
6 474.609 474.609*0,25 118.652 1.644.043
7 355.957 355.957*0,25 88.989 1.733.032
8 266.968 266.968*0,25 66.742 1.799.774
