Siemens Electric Motor works

How does the “new system” trace the overhead costs of order processing and special components handling to the products? Overhead cost per order (order processing rate) = DM$13800000/65625 =DM$210.29 per order Overhead cost per special component (special component rate) = DM$19500000/325000= DM$60 per special component In order to adapt the new strategy of SEMW, new costing system uses the order processing rate and special component rate to trace the overhead costs of order processing and special components handling to the specific product. In the first formula, the order processing cost which is removed from support related costs of old system is DM13.8 million. The number of orders that the EMW actually filled is 65625 orders. In the second formula, use total special component cost is DM19.5 million and the number of times to call special components is 325000 times. In this way, the support costs of SEMW would be accurately allocated to each order according to the load on the production support departments rather than the number of special components product.

Using the information in Exhibit 4, calculate the cost of the five orders (A – E) under the “new” costing system. In order to calculate of the five orders under the new system, we need to calculate the cost of order processing and special components. Meanwhile, the cost of order processing is driven by the number of orders and special components cost is driven by the number of times processed. As Q5 shown, the cost of each order processed is $210.29 and the cost of per special processed is $60.00.

In the new costing system of SEMW, the support-related overhead includes in the cost of base motor and cost of special motor. We calculate the support cost of each order according to the order processing rate and special components rate. As illustrated in the Table 1 above, the cost of order increasing with more types of special components are needed. It is becausenot only higher cost of manufacturing those special components but also  higher cost of spending in calling from special components from inventory or initiate special component production (e.g. design of special components). The increasing of total cost of each order mainly results from the increasing work loading on the production support department. Additionally, as Table 2 shown, more motors in an order would result in less support costs of special components for each motor. Only when base motor cost and special motor cost change, more motors are product in an order. What is more, the order processing cost and special components cost change when more types of special components are needed. Therefore, the more motors are produced in an order, the more profitable it will be. On the other hand, just 74% of the order accepted for production by EMW after the change in strategy was for less than five motors. Thus, the support cost is crucial for managers to decide whether accept the order or not.

Using the information in Exhibit 2 and 3, calculate the reported costs of the five orders (A – E) under the “traditional” costing system.

According to Exhibit 4, the base motor cost under traditional system is $247 and the cost of one type of special components per motor is $32.2. The calculation of the reported costs of the five orders (A-E) under the traditional costing system is shown below.

Under the old costing system, we could calculate the base motor cost and cost of special components without support-related overhead, and calculate the support-related overhead separately which equals to 35% of pre-support manufacturing cost. The consideration of cost does not include the cost of resources required to process an order. Therefore, the number of types of special components can only affect the cost of special components. That means the more special component the order required, the more money the order costs. Compared with new costing system, the total cost of each order is understated. The cost driver in old system is the number of special components while the cost drivers in new system are the number of special components, the number of times to call special components and the number of orders. The old system do not adapt to the new strategy because it does not consider the increase of work load of support department, thereby preventing the manager from choosing profitable orders to produce. On the other hand, more motors in an order would not reduce the total cost due to the homogeneous goods in each order. As shown in Table 4, Order A cost DM3769.20 to produce 10 motors. It is 10 times of the cost to produce 1 motor. The cost of producing one motor is the same (DM376.92).

In conclusion, old system underestimates the cost of per unit. Meanwhile, the total cost is multiplied by the increase of number.