Analyses and Recommendations for the Different Cost Accounting Systems of Seligram, Inc

SUBJECT: Analyses and Recommendations for the Different Cost Accounting Systems of Seligram, Inc.: Electronic Testing Operations

This memo is to provide professional recommendations for Seligram, Inc.: Electronic Testing Operations to handle the critical issues faced in cost accounting system. We have discovered a number of key successes as well as areas need improvement. The analyses and recommendations for Seligram, Inc.: Electronic Testing Operations are found below：

ANALYSES:

For the existing cost accounting system, it only has two components: direct labor and burden. Burden was grouped into a single cost pool and was calculated by burden rate times direct labor dollar. The current burden rate is 145%. See exhibit A for calculation details.

For the new cost accounting system suggested by the division’s manager, burden was divided into two cost pools. The first one is direct labor based, which calculated by direct labors times the burden rate (which is 20% under this new system). The second part is based on machine hours, which calculated by total machines hours times machine-hour rate, $80. See exhibit B for calculation details.

For the new cost accounting system proposed by the consultant, it uses separate burden rate for each test rooms and a common technical and administrative pool based on direct labor. In order to calculate the total cost, we have to figure out different burden rate. Exhibit C provides the different burden rates. And for the common technical and administrative cost based on direct labor, we use total direct labor times the 20% effective burden rate per direct labor. See exhibit D for calculation details.

From the calculation above, it is apparent that the critical problem that causes ETO to fail is its single cost pool accounting system. In its single cost pool system, all products consume direct labor and overhead in the same rate. However, it is extremely unlikely that all products can consume direct labor and overhead in the same proportion. Just as stated in the case description, some products need more direct labors while others require automated machinery operation. In the technological future, the division would replace current, old equipment with new one, and the impact of this new equipment would result incredible decline in direct labor hours. Also there are several trends pointed to the obsolescence of the labor-based burden allocation process. This obsolescence can bias the calculation of burden rate, which causes the total budgeted cost to be inaccurate.

System proposed by the consultant, the three-center system is definitely the most appropriate cost system because it provides the most accurate cost information. First of all, separate a single cost pool into different parts capture differences, because overhead is consumed in different parts of the production process. It is extremely unlikely that all products can consume direct labor and overhead in the same proportion. Then when we calculate the total cost under the system proposed by the accounting manager, we use the same machine-hour rate ($80) for the main room and mechanical room. But when we use the three-center system, we can see clearly in the Exhibit.3 that mechanical room has higher unit cost per hour than main room. Therefore, the three-cost-pool system can trace the costs back to the actual operation factors more clearly.

RECOMMENDATIONS:

We recommend some changes to the system proposed by the consultant in the following aspects. First of all, it would be better to introduce a four-cost-pool system, allowing ETO to separate the engineering cost and administrative cost. According to the consultant, he uses the same rate per direct labor dollar for technical and administrative cost, which is not accurate and unreasonable. Some products may need more engineering with the design, construction and operation of engines or machines.

Other products may need more administrative function, such as helping ETO to mange resources and people in an efficient manner. Therefore, using different rate for technical and administrative cost would be more reasonable and precise when calculating total cost.

Second, it would be better for ETO to allocate cost by machines rather than machine hours. If the machines are very different in price, lifetime and performance, using machine hour to allocate cost is not very precise. Due to the significant difference of prices and depreciation times among machines, it is more accurate to allocate cost by different machines. By measuring different cost rate of different machines, ETO would be able to get a more accurate machine burden cost. If ETO only use machine hours to allocate cost, it will experience higher or lower cost than it is supposed to be which can be misleading for the company.