Seligram Case Answer

1 what caused the existing system at ETO to fail?

Seligram had ETO-a one-burden-pool system,which measured two components of costs: direct labor and burden. This burden(overhead) was grouped into a single cost pool that included other costs except for direct labor cost. However, this initial system did not accurately reflect the costs of products in a reasonable way. By using this system, the company assumed that all costs including labor and burden are allocated proportionally to all products and all overhead costs (burden) changed proportionally with direct labor costs. Because of the introduction of high-technology components and the declining direct labor content and fewer test lots, Seligram needed more automatic testing equipment while decreasing the need for labor testing equipment. In the total cost of products, the proportion of burden would increase and simultaneously the proportion of labor cost would decrease. Under this situation, some consumers had to pay more money for their testing because Seligram increased the charge in order to cover amortization cost of some new expensive equipment. This calculation misled the Seligram to assess the costs of its products. Therefore, it is not reasonable that Seligram calculated cost of products in the same proportion way. This is why the existing system was failed.

2 Calculate the reported cost of the five components described in Exhibit 6 under:

A The existing cost system

Burden rate = Total Burden/ Direct Labor =145%

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B The system proposed by the accounting manager

Under this new system, burden would be directly traced to two buckets. The first one would contain burden related to the administrative and technical functions, which would be charged on a rate per direct labor dollar. The second one would include all other burden cost, which would be charged based on machine hours. In Exhibit 5, we find that effective Machine-hour rate is $80 and effective burden rate per direct labor is 20%.

Machine-hour rate=other burden/Machine hours=80

Burden rate=Admin Burden/Direct Labor=20%

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C The system proposed by the consultant

Under this recommended system, the company will use three-burden-pool system, including burden of main test room, burden of mechanical test room and a common technical and administrative pool. The burden of former two would be allocated on a machine-hour basis and the burden of latter one would be charge on a rate per direct labor dollar.

Burden rate of main test room=main test room/ machine hours for main test room