ENGLE TIRE COMPANY
INTRODUCTION
Though it is nearly impossible to calculate the precise cost of a manufactured product, companies make each effort to decide the most correct cost estimates for decision-making functions. This case illustrates the distinction in a conventional costing system utilizing a single overhead charge and an activity-based costing system.
Direct supplies and direct labor are prices which can be straight traceable to the precise product and, due to this fact, are the easiest prices to embody in product cost approximations. In distinction, overhead prices are oblique prices that can not be readily traced to particular merchandise so firms should allocate these prices to merchandise on an estimated foundation utilizing both a conventional costing system or activity-based costing (Kimmel, Weygandt, & Kieso, 2016).
Conventional cost accounting techniques accumulate overhead prices into a number of cost swimming pools after which allocate the overhead prices to particular person merchandise utilizing an allocation base comparable to direct labor cost or hours, machine hours, or the quantity of items. These allocation bases are more and more considered as arbitrary as they seldom symbolize a product’s use of sources in advanced manufacturing processes (Eldenburg & Wolcott, 2011). As a consequence, organizations that use a conventional costing system could expertise substantial product cost distortions due to the lack of correlation between the allocation bases and overhead prices (Kimmel, Weygandt, & Kieso, 2016).
Exercise-based costing (ABC) is a system that allocates overhead prices to distinct duties or actions (exercise cost swimming pools) carried out in a manufacturing course of. The overhead prices in the cost swimming pools are then assigned to particular merchandise using cost drivers that replicate every product’s use of the actions. Thus, ABC makes use of a number of exercise cost swimming pools and cost drivers that improve the accuracy of product prices (Eldenburg & Wolcott, 2011).
COMPANY INFORMATION
Engle Tire Firm (ETC) is a manufacturing firm that produces tires and manufactures over 200 totally different tires and sizes in its Memphis plant. In 2018, ETC automated the Memphis, Tennessee plant to take benefit of fairly priced cutting-edge know-how. Earlier than automation, ETC used a single plantwide charge to allocate conversion prices utilizing direct labor hours. At the moment, the correlation between conversion prices and direct labor hours was zero.815. As a result of of the technological enhancements, the quantity of direct labor hours was reduce in half.
Alfred Olson, the Controller at ETC, was involved with the accuracy of the project of product prices. Alfred had not too long ago attended a seminar on activity-based costing and was concerned with how it could enhance ETC’s capability to assign oblique prices to the tires and thus could likewise improve its pricing selections.
James Jetter is the Chief Government Officer (CEO) of ETC in Memphis, Tennessee. Earlier than changing into the CEO in 2012, he served as the Chief Working Officer (COO) for eight years. ETC has its worldwide headquarters in Memphis, Tennessee. At present, ETC has three manufacturing crops in the United States, in addition to a plant in Cortez, Mexico. The opposite two places in the United States are in Casper, Wyoming and Cleveland, Ohio.
ETC manufactures tires in seven totally different tire varieties; all-season, gentle/medium truck, passenger, efficiency, summer time, touring and winter. Moreover, ETC produces seven totally different manufacturers with over 70 totally different fashions, and produces 20 totally different tire widths, with side ratios from 20 to 85, and tire diameters between 15 and 20 inches. As talked about beforehand, ETC produces greater than 200 totally different tires and sizes in the Memphis plant and employs between 2,000 to three,000 staff throughout its sluggish and busy seasons, respectively.
As the Controller of ETC, Alfred Olson has gathered knowledge after the automation of the Memphis manufacturing plant. He has offered this knowledge in a Microsoft Excel spreadsheet file referred to as Knowledge Set 1. On this knowledge file, he has offered the whole conversion prices and direct labor hours for 48 every day observations.
Knowledge Set 1 gives sufficient knowledge to do a easy regression mannequin and/or measure the correlation between variables. Once more, Alfred is involved with the relationship between whole conversion prices and direct labor hours, as a result of of the funding in new know-how. At present, ETC allocates conversion prices utilizing direct labor hours based mostly on a mean of the 48 observations. In different phrases, ETC finds the sum of the whole conversion prices and direct labor hours over the 48 observations. Then ETC finds the predetermined conversion prices charge by dividing the whole conversion prices by the whole direct labor hours. In the meantime, materials prices are assigned straight to the tires. Direct labor prices are assigned as half of the conversion prices.
Final month, ETC manufactured 20,000 ETC/A105 and 5,000 ETC/B107 tires. ETC/A105 is a extra fashionable tire that is produced in bigger batches than ETC/B107. Moreover, the common direct supplies prices for ETC/A105 and ETC/B107 are $55 and $80, respectively. Whereas the ETC/A105 matches on a frequent household automotive or van, the ETC/B107 is not appropriate for the household autos as a result of it is a bigger tire.
The direct labor hours used to produce ETC/A105 and ETC/B107 final month have been:
ETC/A105 – 9,000 direct labor hours
ETC/B107 – three,000 direct labor hours
REFERENCES
Eldenburg, Leslie G., & Wolcott, Susan Okay. (2011). Cost Administration: Measuring, Monitoring, and Motivating Efficiency (2nd ed.). John Wiley & Sons, Inc.
Kimmel, Paul D., Weygandt, Jerry J., & Kieso, Donald E. (2016). Accounting: Instruments for Enterprise Resolution Making (sixth ed.). John Wiley & Sons, Inc.
Case 1:
Alfred Olson has offered you with the first knowledge set. Additionally, he has knowledgeable you that ETC is at present assigning conversion prices to all tires based mostly on the common conversion cost per direct labor hour for the 48 observations.
James Jetter, the CEO of ETC, would really like to know the whole product prices and unit prices for ETC/A105 and ETC/B107. As well as to the whole product prices and unit prices for ETC/A105 and ETC/B107, he would additionally like to know the power of the relationship between direct labor hours and whole conversion prices. Has this relationship improved or weakened since automation?
Present James Jetter with a brief paper summarizing your findings. This brief paper ought to 1) summarize the info and findings of your Assessment, comparable to manufacturing cost per tire, 2) examine the outcomes of your present correlation Assessment with the correlation Assessment prior to automation, and three) talk about your ideas on how to enhance the total calculation of whole product and unit prices for the totally different tires.
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