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 divisions 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.
To decide whether to treat the new machine as a separate cost center or as a part of the
main test room, we compared the machine-hour rate for the main test room only, for
the new machine only, and for the combined total rate.
Machine-Hour Rate for Main Test Room Only
$ 2,103,116
$ 63.34
33,201
Machine-Hour Rate for New Machine Only for Year 1
Year 1

Variable
$100,000.00

Depreciation
$500,000.00

Other
$225,000.00

Total
$825,000.00

$ 825,000
=$ 2,062.50
400
Total Machine-Hour Rate for Year 1
$ 2,103,116 +$ 825,000
$ 87.14
33,201+400
As shown above, there is significant difference between the main test rooms original
machine-hour rate and the new machines machine-hour rate in Year 1, which cause
the combined machine-hour rate is over $20 more than the original rate, so the new
machine should be a separate cost center in Year 1.
Then, let us compare the rates of the following years, for example, Year 5. (The
calculation of depreciation of the new machine is shown in Exhibit E)
Machine-Hour Rate for New Machine Only for Year 5

Year 5

Variable
$100,000.00

Depreciation
$158,203.13

Other
$150,000.00

Total
$408,203.13

$ 408,203.13
$ 74.74
2,400
Total Machine Hour Rate for Year 5
$ 2,103,116 +$ 408,203.13
$ 70.54
33,201+2,400
Comparing to the $63.34 original burden rate, the new machine still makes a great
difference in the Year 5. Therefore, the new machine should be always treated as a
separate cost center.

Exhibit A: The reported cost of the existing system

Exhibit B: The reported cost of the system proposed by the accounting manager

Exhibit C: different burden rates using accounting manager proposed system

Exhibit D: The reported cost of the system proposed by the consultant

Exhibit E: Depreciation of the new machine (double declining balance)

Depreciation
Year Depreciation Expense
1
$500,000.00
2
$375,000.00
3
$281,250.00
4
$210,937.50
5
$158,203.13
6
$118,652.34
7
$88,989.26
8
$66,741.94