Seligram Inc. Case Study

The current cost system allocates overhead costs once a year, as a function of direct labor dollars. This allocation strategy results in:

Cost drivers can be identified for each activity or cost category based on observation, discussions with management, simulations and statistical studies. The key is to determine the behavior of indirect costs with respect to activity or resource usage in each activity center (Leslie, 2009). These efforts have identified the eight cost drivers shown in Table 3.

The Hampshire Company was evaluating on which cost system would best fit their needs as a tool to measure the business activity. When conducting this process, Hampshire Company took a look at traditional cost method versus activity based costing.

The costing approach should be based on per Transaction Basis rather than on per kit or per pound basis because of the following reasons:

According to this method, every unit of the product is assigned all direct, fixed, and variable costs. This method includes the cost of direct materials and labor as well as a portion of the overhead costs associated with it in the final costing of every unit of the product.

3. Under the new activity-based costing (ABC) system, compute the indirect cost allocation rates for each of the three activities:

Under the existing cost system for the turning machine area, there are two direct costs and three cost pools for overhead costs. The two direct costs are simply Direct Labor and Direct Material, which are traced to the cost object, which is Machine Parts. The total overhead is split into three cost pools, which are the following: overhead applied on direct labor, overhead applied on material dollars, and overhead applied on ACTS machine hours. Furthermore, each cost pool is broken down into direct and period sub categories. The mentioned cost pools for the following cost drivers: Direct Labor dollars, Material dollars, and machine hours.

• This cost method does not provide the best system for JDCW’s cost allocation. By using only three overhead rates the present system grossly undermines the true production costs since other activities of the production process are not acknowledged.

unit, two types of costs are distinguished. Firstly the direct costs, consisting of the direct

Q3. How were the limitations of the existing cost system overcome by the ABC Cost System? What are the implications of the ABC system?

The consultant proposed a plan that would trace burden to three cost pools. The first pool would include burden related to the administrative and technical functions and would allocate costs per direct labor dollar. The second pool would contain burden assigned to the main test room and would be based on machine hours. The third pool would contain the burden allocated to the mechanical test room and would also be allocated

With this costing technique , a Manager can easily determine if there is a weak link in production chain by keeping an eye on the cost per unit each day. Using the accounting programs involved in process costing, a manager can figure out where in the process the item 's per unit cost is going up. This way a single manager or a team of managers can monitor millions of units being produced without needing to check on each department unless a problem comes up. By the same token, these numbers need to be watched diligently, as a change of even a fraction of a cent can cost thousands of dollars quite quickly.

Under the new cost system, two broad sources of costs were identified: manufacturing and SM&A. All costs within these categories were reclassified as either volume driven or order driven. Hence, four cost pools were set up.

ABC refers to cost attribution to cost units on the basis of benefit received from indirect activities e.g. material ordering, material handling, machine setups, quality assuring, customer support services etc. For each such activity, it is necessary to identify a cost driver that causes incurrence of cost relating to that activity. For example, hours spent on testing for a quality assurance activity may be used as application base of cost driver for this activity.