1. The existing system at ETO began to fail because direct labor hours per lot began to decrease due to vendor certification. Vendors would do the primary testing and ETO would only be required to test a small sample of each lot to verify the results were valid. In the marketplace, ETO’s prices were lower than outside competition for testing complex parts, yet the prices were higher for elementary testing. Another important factor to consider is that engineering support increased. This led to additional burden costs, which also varied from part to part. High-technology components were tested using more automated test equipment. These tests took longer, but did not require as many hours of direct labor. The test equipment also had a higher depreciation expense. It is common for a cost system to become obsolete when the process experiences increased automation. In these situations parts being tested through automation are not charged enough overhead while other, more labor intensive tests are charged too much (Cooper, HBR, Reading Packet p50-51). Q2) The cost for the five components described in exhibit 6 can be shown as follows: 2. Formulas used for calculations can be found in the Appendix: (Most values from Exhibit 3, 5, and 6. See Appendix for additional calculations.) a) The existing system: Using the given burden rate of 145%, the calculated costs of the existing system follows: Existing: Direct Labor Hours x (100% + 145%) Product | Direct Labor | Burden | Total Costs | Manager: Direct Labor Hours x (100% + 20%) + Total Machine Hours x 80.1 ICA | 917 | 1,330 | 2,247 | Consultant: Direct Labor Hours x (100% + 20%) + Main Room Machine Hours x 63.34 + Mechanical Room Hours x 112.63 ICB | 2,051 | 2,974 | 5,025 | Capacitor | 1,094 | 1,566 | 2,680 | | Direct Labor | Main Room | Mech Room | Total Hours | Existing | Manager | Consultant | Amplifier | 525 | 761 | 1,286 | ICA | $917 | 8.5 | 10 | 18.5 | $2,246.65 | $2,582.25 | $2,765.09 | Services 1 Diode | 519 | 753 | 1,272 | ICB | $2,051 | 14 | 26 | 40 | $5,024.95 | $5,665.20 | $6,276.34 | Personnel Allocations 2 | | | | Capacitor | $1,094 | 3 | 4.5 | 7.5 | $2,680.30 | $1,913.55 | $2,009.66 | Service Allocations 3 Amplifier | $525 | 4 | 1 | 5 | $1,286.25 | $1,030.50 | $995.99 | B) Using the manager’s proposal the system is separated by machine hour burden and direct labor burden. The revised labor burden rate is 21%, while the machine hr burden rate is $80.1. The calculated costs are updated as follows: Diode | $519 | 7 | 5 | 12 | $1,271.55 | $1,584.00 | $1,629.33 | Product | Direct Labor | Burden | Mach. hr | Mach. Burden | Total Costs | Totals | | | | | $12,509.70 | $12,775.50 | $13,676.41 | ICA | $917.00 | $192.57 | 18.50 | $1,481.85 | $2,591.42 | 1 Includes tool repair, computer expenses, maintenance stores, and service cost transfers from other divisions. ICB | $2,051.00 | $430.71 | 40.00 | $3,204.00 | $5,685.71 | 3. The consultant’s approach (c) best matches the actual costs incurred by ETO to prices being charged to the customer. Previously, prices charged for elementary testing were higher than industry prices while prices were lower than the industry average for complex testing. Using the cost system proposed by the manager, the prices for the more automated tests would go up as the amount of machine hours used would be accounted for.
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