Describe the existing cost system and explain why it failed
The current cost system is based on two components: a direct and indirect cost measurement. There are only two types of cost: direct labor and burden. Burden is grouped into a single cost pool and represents the cost of both testing rooms, engineering burden costs (software and tooling development), plus the administrative costs of the division. Burden was then calculated for each lot, with a burden rate of 145% The lot’s total cost is the sum of the direct labor cost added to the burden cost.
This existing cost system failed because of three main reasons. The existing cost system is related to direct labor hours.
Vendor certification: with vendor certification, Selgrim’s suppliers do the primary testing of components which reduces the number of tests performed by the company. Indeed, from 2003 to 2005, because of vendor certification, the number of direct labor hours per lot has noticed a 30% decrease. Less tests done means less direct labor hours per lot.
The shift from simple inspection services to broader-based test technology: ETO became less competitive on elementary testing and on large lots. However, there were still cheaper regarding engineering support and high technology testing. This change has led to a shift in the labor mix, reducing the quantity of direct labor and increasing indirect labor hours.
The need for automatic equipment: the new high technology components required more automatic and longer testing. Increasing automation would then lead to a smaller need of direct labor and would increase expenses in terms of automated equipment.
Those are the three main reasons why the current cost system failed: they decreased the direct labor hours allocated per lot and increased burden. Finally, this would increase the final manufacturing cost and would make ETO less and less competitive.
Calculate the reported costs of the five components described...
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