Rose Bach Has Recently Been Hired as Controller of Lempco

Essay

Rose Bach has recently been hired as controller of Lempco Inc., a sheet-metal manufacturer. Lempco has been in the sheet-metal business for many years and is currently investigating ways to modernize its manufacturing process. At the first staff meeting Bach attended, Bob Kelley, chief engineer, presented a proposal for automating the drilling department. Kelley recommended that Lempco purchase two robots that could replace the eight direct labor workers in the department. The cost savings outlined in Kelley's proposal include two elements. First, direct labor cost in the drilling department is eliminated. Second, manufacturing overhead cost in the department is reduced to zero because Lempco charges manufacturing overhead on the basis of direct labor dollars using a plantwide rate.
The president of Lempco felt that Kelley's explanation of the cost savings made no sense. Bach agreed and explained that as firms become more automated, they should rethink their manufacturing overhead systems. The president asked Bach to look into the matter and prepare a report for the next staff meeting.
To refresh her knowledge, Bach reviewed articles on manufacturing overhead allocation for an automated factory and discussed the matter with some of her peers. She also gathered the historical data presented below on the manufacturing overhead rates experienced by Lempco over the years. Bach also wanted to have some departmental data to present at the meeting. Using Lempco's accounting records, she was able to estimate the annual averages presented below for each manufacturing department in the 1990s. $$\begin{array}{l}\begin{array} { | c c | c | c | } &&\text { Historical Data }\\\\&\text { Average } &&\text { Average } \\\text { Date }&\text { Annual }&\text { Average Annual } &\text { Manufacturing }\\&\text { Direct }&\text { Manufacturing } &\text { Overhead } \\&\text { Labor Cost } &\text { Overhead Cost }&\text { Application Rate }\\ \hline 1950 \mathrm {~s} & \$ 1,000,000 & \$ 1,000,000 & 100 \% \\\hline 1960 \mathrm {~s} & 1,200,000 & 3,000,000 & 250 \\\hline 1970 s & 2,000,000 & 7,000,000 & 350 \\\hline 1980 s & 3,000,000 & 12,000,000 & 400 \\\hline 1990 s & 4,000,000 & 20,000,000 & 500 \\\hline\end{array}\end{array}$$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$ $\quad$$\text { Annual Averages }$
$\begin{array} { | l | r | r | r | } \hline & \begin{array} { r } \text { cutting } \\\text { Department }\end{array} & \begin{array} { r } \text { Girinding } \\\text { Department }\end{array} & \begin{array} { r } \text { Drilling } \\\text { Department }\end{array} \\\hline \text { Direct labor } & \$ 2,000,000 & \$ 1,750,000 & \$ 250,000 \\\hline \begin{array} { l } \text { Manufacturing } \\\text { overhead }\end{array} & 11,000,000 & 7,000,000 & 2,000,000 \\\hline\end{array}$ Required:
a. Disregarding the proposed use of robots in the drilling department, describe the shortcomings of Lempco's current system for applying overhead.
b. Do you agree with Bob Kelley's statement that the manufacturing overhead cost in the drilling department will be reduced to zero if the automation proposal is implemented? Explain.
c. Recommend ways to improve Lempco's method for applying overhead by describing how it should revise its overhead accounting system:
(i) in the cutting and grinding departments.
(ii) to accommodate the automation of the drilling department.