1. What caused the existing system at ETO to fail?
As we learned in chapter 7 initially,”… cost systems designs were simple…“(Brewster et.al, p. 236). The goal of the allocation process is to assign overhead in a manner that most appropriately reflects the cause /effect relationship of incurred costs. These cost systems were based on belief that there was a high correlation between direct labor hours and units produced (Brewster et. al, p. 237). ETO’s current cost system only factors in two of their cost components;” direct labor and burden” (Seligram, 1993 p.2 ) Burden is grouped into a single cost pool that includes costs associated with each of the testing rooms, engineering burden costs related to software and tooling development as well as administrative costs for the division. The major assumption that caused ETO’s existing system to fail is that all costs are divided equally among direct labor costs and burden despite the variety of services. As described in the case study, components significantly varied in number and type of electrical and mechanical testing required. For example, some components required six different flows through the facility while others only required electrical testing at room temperature (Seligram 1993 p 2). Therefore, ETO’s flaw is to assume that dividing costs equally will give them an accurate breakdown of their costs. As direct labors hours decreased and ETO is testing smaller samplings, some products needed more direct labor while others do not require as much. In addition, ETO’s has lower market prices in contract to their competition for testing complex parts. Their prices are higher for elementary testing and engineering support is increasing. This leads to increased burden costs, which also varied from part to part. Most importantly, the high-technology components are tested using more automated test equipment. These tests do not require as many hours of direct labor. As...
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