Costing Systems I - Elements and Design

Assignment: Seligram Analysis

Module 2: Costing Systems I- Elements and Design

Date: 23 August 2016

Group Members

Christopher E. Gimco;       Hemant Jethwani;       Kazim Bayindir;       Seth E. Friedman;      Vanessa L Georg

Introduction Summary:

In this case study, we compare the cost methods of the five components according to the existing system, the account manager’s and the consultant’s method to evaluate which cost system might be more beneficial to the company. Cost breakdown analysis suggests that the consultant’s three cost pool method provides a beneficial  cost system as it splits costs into each test room separately and the admin, engineering and technical costs separately. This system gives us an accurate analysis and accounts for the different costs rather than adding them all together and dividing them all by the machine hour rate.

Case Analysis

In general, a cost system is a framework which supports the pricing decisions of the organization.  Therefore, estimating product costs accurately is extremely important for profitable operations. Seligram Inc has a complex business model with over 200 process flows, multiple software programs, testing capabilities, tools and fixtures. Yet they follow a cost system that’s overly simplistic.  Saligram’s existing cost system uses an aggregated cost center for the entire facility. All overhead costs are lumped together into a single cost pool. In order to calculate a single direct labor dollar burden rate for all product types, the overhead costs were divided by the total number of direct labor hours. Please refer to Appendix I which shows the existing situation at Saligram.

It’s important to note here that current system at Saligram uses the assumption that their products use direct labor and overhead in the same proportion.

• With the implementation of vendor certification and the just-in-time delivery, some products are already tested and don’t need any further testing, and therefore ETO see a decrease in number of tests performed.
• In addition, new components require advanced technology tests utilizing highly automated equipment and different testing procedures compared to other products. Some products require much more machine hours then direct labor hours

Therefore, the assumption that all products consume direct labor and overhead equally is incorrect. As automation increases, the overhead assigned to products will only get more flawed. Product requires requiring higher number of machine hours will appear to be less costly. This flawed assumption of equal direct labor and overhead for all products caused the existing cost system to fail.

To help alleviate this situation at Saligram, their internal account and consultant provided their view points on how these overhead costs should be allocated. Appendix II shows the calculation based upon the suggestion made by the accounting manager and Appendix III shows the calculation based upon their internal consultant.

The system proposed by the internal consultant (three burden pool system) provides the most accurate cost information. This is because the three burden pool system applies costs based upon the actual product testing/usage and doesn’t apply the overhead costs, across all products testing, in the same proportion. Therefore this system removes the flaw in the existing system and the system proposed by the accountant, i.e. lumping overheads together.