John Patrick has recently been hired as controller of Valdosta Vinyl Company (VVC), a  manufacturer of vinyl siding used in residential construction. VVC has been in the vinyl siding business for many years and is currently investigating ways to modernize its manufacturing process. At the first staff meet- ing Patrick attended, Jack Kielshesky, chief engineer, presented a proposal for automating the Mold- ing Department. Kielshesky recommended that the company purchase two robots that would have the capability of replacing the eight direct-labor employees in the department. The cost savings outlined in the proposal include the elimination of direct-labor cost in the Molding Department plus a reduction of manufacturing overhead cost in the department to zero, because VVC charges manufacturing overhead on the basis of direct-labor dollars using a plantwide rate. The president of VVC was puzzled by Kielsh- esky’s explanation: “This just doesn’t make any sense. How can a department’s overhead rate drop to zero by adding expensive, high-tech manufacturing equipment? If anything, it seems like the rate ought to go up.”

Kielshesky responded by saying “I’m an engineer, not an accountant. But if we’re charging over- head on the basis of direct labor, and we eliminate the labor, then we eliminate the overhead.”

Patrick agreed with the president. He explained that as firms become more automated, they should rethink their product-costing systems. The president then asked Patrick to look into the matter and pre- pare a report for the next staff meeting. Patrick gathered the following data on the manufacturing- overhead rates experienced by VVC over the years. Patrick also wanted to have some departmental data to present at the meeting and, by using VVC’s accounting records, he was able to estimate the following annual averages for each manufacturing department over the five decades since VVC’s formation.

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Historical Plantwide Data

 

 

 

Average

 

 

 

Decade

 

Average Annual Manufacturing- Overhead Cost

 

Average Annual Direct-Labor Cost

 

Manufacturing- Overhead Application Rate

 

1st ............................................... $ 2,200,000                          $2,000,000                              110%

2nd ..............................................    6,240,000                           2,400,000                              260

3rd  ..............................................   13,600,000                           4,000,000                              340

4th ...............................................  24,600,000                           6,000,000                              410

5th ...............................................  38,710,000                           7,900,000                              490

Annual Averages during Recent Years

 

Cutting Department

 

Finishing Department

 

Molding Department

 

Manufacturing  overhead ................  $22,000,000                        $14,000,000                         $4,000,000 Direct labor ..................................                                                                   4,000,000                               3,500,000                             500,000

 

Required:

1.      Disregarding the proposed use of robots in the Molding Department, describe the shortcomings of the system for applying overhead that is currently used by Valdosta Vinyl Company.

2.      Explain the misconceptions underlying Kielshesky’s statement that the manufacturing-overhead cost in the Molding Department will be reduced to zero if the automation proposal is implemented.

3.      Recommend ways to improve VVC’s method for applying overhead by describing how it should revise its product-costing system for each of the following departments:

a.      In the Cutting and Finishing Departments.

b.      To accommodate automation in the Molding Department.

(CMA, adapted)

 

 

 

 

 

■   Problem 5–52 Activity Cost Pools; Cost Drivers; Pool Rates

(LO 5-1, 5-2, 5-5)