shun electronics company

SHUN ELECTRONICS COMPANY

By: Bacho Khorava

Giorgi Papuashvili

Salome Kvaratskhelia

Tata Jajanashvili

Vazha Nutsubidze

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Table of Contents Prologue ........................................................................................................................................ 3

Existing Cost Calculation Structure ........................................................................................ 3

Actual Proof Checking System .............................................................................................. 4

Current Changes ......................................................................................................................... 4

Q&A on Divisional Meeting .................................................................................................. 4

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Prologue The Shun Electronics Company is a medium-sized, family-owned firm in the Malaysian electronics industry. The company has two operating divisions. The KB Monitor Division manufactures computer monitors that are primarily sold to off-brand computer companies. The KL Radio Division makes two basic radios: a shelf model and a portable model. Each of the two models are available in three versions: one version was for use in a bathroom shower (a popular option especially in the American market); another has a 1950’s-style metal cabinet; and the third version has a wooden cabinet. All six radios were distributed primarily through high-end catalog retailers. Production process is carried out in 3 departments:

1. Assembly 2. Fabrication 3. Finished Goods

The Assembly department assembles the basic chassis using parts purchased from outside the company. In this department, Section 1 was where the various electronic components were staged for production and assembled into functioning, modular units. In Section 2, the modular units were tested and any electronic problems were rectified. In Section 3, the modular units were mounted on a basic chassis and tested again before being passed on to the Fabrication department. In the Fabrication department, the radios take one of three routes. Those intended for in-the shower use go to Section 1 where they were sprayed and treated to protect them against moisture. Before leaving Section 1, the sprayed modular units are encased in a colorful plastic cabinet the division bought from a vendor. Those radios destined to receive a 1950’s-type metal cabinet go to Section 2. In that section the cabinets are cut from sheet metal, punched, bent to shape, and painted. The metal cabinet is then mounted on the chassis. In Section 3, Shun’s distinctive wooden cabinets are crafted, finished and fitted to the chassis. In the Finished Goods department, all radios are given a final testing and adjustment in one area and are packed for storage or shipment in another area. The Assembly and Fabrication departments are run by foremen. Reporting to them are section leaders for each of the sections. The Finished Goods department has no foreman or section leaders and only part of its efforts are devoted to the KL Radio Division. The test area is under the supervision of a quality control engineer who is part of the company’s engineering department. The packing area is run by a supervisor.

Existing Cost Calculation Structure

For many years the company has been using standard cost system in which a standard product cost was computed for each of the six radios on divisional bases, divisions were cost pools used to allocate indirect cost to each type of radio. Budgeted direct material and direct labor costs per radio are based on standard quantities and hours and expected material costs and labor rates. A standard overhead cost allocation rate was applied to direct labor plus direct materials in the Assembly department, and on direct labor alone in the other two departments. The percentage used for the overhead rate was derived from the expected relationship between budgeted direct labor, direct

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material, and overhead costs, all at an assumed normal production volume. Additional Information and calculations can be observed on Exhibit 1 in appendices.

Actual Proof Checking System

Actual costs were collected periodically by the departments for comparison with the standard cost of work completed in the department. Overhead cost allocation rates usually had to be revised annually, but the standards for direct labor and direct material costs were changed only when prices, production methods, or product designs changed significantly. The standard costs were used in the division for a number of purposes. The cost system produced monthly labor, material, and overhead variances which were checked by Azraf Tahir to see if any were significantly out of line. Though he kept in close touch with what was going on in the plant, a variance would occasionally show a deviation over time that was not easy to spot in daily observations.

Current Changes Existing costing system has some bearing on pricing, particularly in bidding on larger orders. The standard cost figures were also used in a variety of longer-run functions such as in determining changes in the product offerings, make or buy decisions, financial planning, and corporate management’s evaluation of divisional performance. The company has decided to change the way it calculates the costs of products. For that purpose a new employee Manjit Singh was hired and was given the task to analyze the existing departmental costing system and to modernize to as much as possible. Manjit has done his job and submitted it to Chan Choong Tho, Controller of the Shun Electronics Company’s KL Radio Division. Mr, Chan has checked Manjit’s output. He didn’t like the fact that new costing system assigned four of six types of radio showed a higher factory cost and two a lower cost. He thought that May Hwang, the division’s sales manager and Azraf Tahir, the Division Manager would not delighted by that numbers. Still they decided to present these calculations (calculations can be observed in Exhibit 1) in front of their colleagues. On the meeting with the Division management Manjit has been given a few questions. He has done his best to make everything clear to his colleagues.

Q&A on Divisional Meeting

1. Where did the figures in Exhibits 1, 2, and 3 come from and how were they computed? The KL Radio Division used a standard cost system in which a standard product cost was

computed for each of the six radios. Budgeted direct material and direct labor costs per radio were based on standard quantities and hours and expected material costs and labor rates. Actual costs were collected periodically by the departments for comparison with the standard cost of work completed in the department. A standard overhead cost allocation rate was applied to direct labor plus direct materials in the Assembly department, and on direct labor alone in the other two departments. The percentage used for the overhead rate was derived from the expected relationship between budgeted direct labor, direct material, and overhead costs, all at an assumed normal production volume. For example, in the Assembly department, budgeted overhead equaled 50 percent of budgeted direct labor and direct

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material costs combined. The standard overhead charge for each radio was therefore 50 percent of the standard direct labor and direct material costs for that radio. Also in the Fabrication and Finished goods departments budgeted overhead equaled 200% and 100% of direct labor respectively. Manjit Singh began to consider the existing definition of cost centers. He wondered if the total product costs would be different if the aggregation of costs was in more detail than just at the departmental level. Specifically, he wondered if better information could be obtained by using eight cost centers: the six sections in the Assembly and Fabrication departments and the two areas in the Finished Goods department. In order to identify the overhead costs incurred within the sections he asked the department foremen for estimates of the resource costs incurred in each of their various sections for such items as indirect labor, equipment repair, and supplies. In addition, an examination of recent invoices helped him verify some of the details the foremen submitted. Exhibit 2 shows the existing departmental overhead budget and the results of Manjit Singh’s further distribution of those amounts to the six sections and two areas With this more detailed identification of costs, and based on dropping direct material costs as part of the allocation based used in the Assembly department, Manjit recalculated the standard cost sheets to see if product costs changed. Exhibit 3 shows the results of these calculations

2. To date, the shelf shower radio was thought to cost M$61.00. Manjit Singh says it’s more

accurately determined cost is M$67.56. Why the difference?

The following table clears all obscurity around this subject.

3. Does Manjit Singh’s proposal make him the “bearer of bad news” or a “team player

concerned with the future” of the company?

Manjit Singh was given the task of examining the division’s cost accounting system to see if the product costs it produced were reasonably accurate. At first glance Manjit seems to be bearer of bad news because after he had reconstituted the basic cost data, of the six types of radios sold four showed a higher factory cost that could lead to decreased contribution from these products and because of that the company could decide to reduce the production of these products. However, from the other hand, he is a team player concerned with the future of the company because his investigation of the cost system make it possible for the company to obtain more realistic information about which products are more profitable than others and increase the firm’s performance in the future.

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4. How was the Fabrication department’s 200% overhead allocation rate in case Exhibit 1 derived?

200% of overhead allocation rate in Exhibit 1 comes from the past experience of the company. The employees who are in charge of measuring the amount of resources needed in production except of Direct Labor and Direct Materials, look at actual amount of overhead costs during some observation period. By analyzing the correlation between the DL,DM and OH they assign some, the most sage percentile to each department. And as a result of past observations workers at Shun Electronics have found that the fabrication department as a rule required twofold as much overhead as Direct Labor. That is why 200% is used in allocating overhead costs to six types of radios produces by the company. See the little abstract fro Exhibit 1.

5. Recreate (arrive to this number by calculus) the 291% overhead allocation rate

applied to the radios coming through Section 1 of the Fabrication department To fully understand how the number was derived, you need to look at Exhibit 1 and Exhibit 3. The necessary extracts are here, the additional info can be observed at the end of this report.

Exhibit 1 (Extract)

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Exhibit 2(Extract)

Exhibit 3 (Extract)

The Section 1 from fabrication Department only incurs costs for production of radios, that are intended for in-shower use. Thus the in-shower radios use only 5,500$ costs as visible from exhibit one. That number is divided by total cost allocated to the Section 1 of Fabrication Department, that amounts 16,000$. As a result you get about 291%, the overhead allocation rate for the Section 1

6. Let’s focus on Exhibit 2 and line items reported there. Would you agree all those are overhead costs?

If you look at Exhibit 2 you will see that overhead cost list in Assembly Department Include Supplies, which I think should and must be considered as Direct Material. Also Storage and handling of material can directly go into the price of materials, like transportation cost is included in materials. Also it should be noted that most of cost need to have further clarifications in order to decide whether to include it in direct cost to treat it as overhead.

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Exhibit 1

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Exhibit 2

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Exhibit 3

shun electronics company

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