There are mainly three factors leading to the failure of the existing system at ETO. First, there has been a steady decline in direct labor hours per lots and fewer test lots. Such a decline is mainly due to an increased dependence on vendor certificate, which is a key component of JIT delivery. Number of tests being done by ETO reduces because the suppliers did the testing by themselves. Second, there is a shift from simple inspection services to broader-based test technology. Although ETO provides engineering supports on complex parts, outside testing services are even cheaper, esp. on large lots when only elementary testing is required. Lastly, the existing testing equipment is getting out-dated and is unable to cope with the pace with new developments in high-technology components. Also, the very expensive highly automated equipment is required to test the new high-technology components. That equipment provides longer test cycles and more test data per part. Such an increased automation would reduce direct labor needed to absorb depreciation costs for ETO.
Charges for testing go up due to an increase in burden rates. Therefore, ETO notices that the number and frequency of complaints from the customers are amplified.
The Reported Cost of 5 Components under the Existing System
ProductDLBurden=DL*Burden RateAllocated Overhead
@ @ @ @
The Reported Costs of the 5 Components under the System proposed by the Accounting Manager (Two-Cost Pool)
ProductDirect Labor $DL $ RateMachine HourMachine Hour RateAllocated Overhead
IC B 20512461.24032005661.2
Reported costs of the five components described in the system proposed by the consultant
ProductDL DL rate * 0.2Main Test * 63.34Mech. Test * 112.63TOTAL
As for the comparison of the 3 methods used, the first method, the existing one, would relatively bias against jobs with high direct labor cost but low machine hours. But for the second method, the one proposed by the accounting manager, penalizes jobs with relatively more main machine hours than mechanical machine hours. The third method, the one proposed by the consultant, is relatively the best among the three as it divides direct labor cost from the machine cost(Main-Test Room and Mechanical Test Room), which makes more sense and more fair, yielding a more accurate estimate. The downside of it, thou, is that this method would increase the total cost
As for recommendation, we would suggest the company to allocate their cost according to the real usage of the material. With the cost being driven by the consumption of the resources, the production capacity is likely to be at it's fullest as it utilizes the resources more efficiently. It also has a higher chance of calculating the true cost of a product which would lead to better management decision.
Under the existing system, whether the manufacturing division of Seligram should be required to purchase their testing from ETO depends on the simplicity/ complexity of the inspection services. Since "low technology" outside laboratories is often cheaper, especially on large lots, the division should be required to purchase the testing from outside services. On the other side, since "complex parts" require sophisticated engineering resources in which ETO has its competitive advantage in doing that. Therefore, ETO could provide cheaper, rapid and cost-effective engineering services, the divisions should purchase their...
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