Katie Alvarez has recently been hired as controller of Empco Inc., a sheet-metal manufacturer. Empco has been in the sheet-metal business for many years and is currently investigating ways to modernize its production process. At the first staff meeting Alvarez attended, Bob Kelley, chief engineer, presented
a proposal for automating the Drilling Department. Kelley recommended that Empco purchase two robots that would have the capability of replacing eight direct laborers in the department. The cost savings outlined in Kelley's proposal included the elimination of direct labor cost in the Drilling Department, plus a reduction of overhead cost in the department to zero, because Empco applies production overhead on the basis of direct labor dollars using a plant wide rate.
The president of Empco was puzzled by Kelley's explanation of cost savings, believing it made no sense. Alvarez agreed with the president, explaining that as firms become more automated, they should rethink their overhead systems. The president then asked Alvarez to look into the matter and prepare a report for the next staff meeting.
To refresh her knowledge, Alvarez reviewed articles on overhead distribution for an automated facility and discussed the matter with some of her peers. Alvarez also gathered the following historical data on the factory overhead rates experienced by Empco over the years. Alvarez also wanted to have some departmental data to present at the meeting and, using Empco's accounting records, was able to estimate the following annual averages for each producing department in recent years.

Required:
(1) Disregarding the proposed use of robots in the Drilling Department, describe the shortcomings of the system for applying overhead that is currently used by Empco.
(2) Explain the misconceptions underlying Bob Kelley's statement that the overhead cost in the Drilling Department would be reduced to zero if automation eliminated all direct labor in the department.
(3) Recommend ways to improve Empco's way of applying overhead by describing how it should revise its overhead accounting system:
(a) In the Cutting and Grinding Departments.
(b) To accommodate the automation of the Drilling Department.

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Historical Data Average Average Annual Average Annual Manufacturing Direct Labor Manufacturing Overhead Application Rate Date CostOverhead Cost 100% 1960S$1,000,000 1,200,000 1970S.2.000,000 3,000,000 4,000,000 s 1,000,000 3,000,000 7,000,000 12,000,000 20,000,000 250 350 400 500 1980S 1990S 2000s Annual Averages Cutting Department Grinding Department $1,750,000 7,000,000 Drilling Department $ 250,000 Direct labor , - Manufacturing overhead11,000,000 . 2,000,000