Midterm Part 2: Roger Chemometrics, LTD.

Roger Chemometrics, LTD is a U.S. subcontractor company that designs and manufactures printed circuit board (PCB) systems for formula racing cars. Formula racing cars market is dominated by six manufacturers: Aston Martin, McLaren, and Red Bull in England, Ferrari in Italy, Mercedes in Germany, and Renault in France. However, there is a relatively small group of enthusiasts that manufacture entry-level open-wheel single-seater formula racing cars. Roger Chemometrics does contract work with the six major manufacturers plus three companies in the second tier.

Because competition is intense in the industry, Roger Chemometrics has always been operated on a thin gross profit margin; hence it is crucial that it manage overhead cost effectively to achieve an acceptable net profit margin. With declining profit margin in recent years, Roger Chemometrics' CFO, Ms. Kate Fischer, has become concerned that the contract cost and maintaining relations with its major customers may be getting out of hand. Ms. Fischer suspects the current situation could be due to inaccurate costing system and production process inefficiencies.

You are hired as an accounting consultant to conduct cost analysis and recommend business solution to Roger Chemometrics. You discover that Roger Chemometrics uses a traditional (plantwide) costing system, with overhead costs allocated based on total direct labor hours. After weeks of interviews and investigation, you realize that Roger Chemometrics should modernize the accounting system by implementing Activity-Based Costing (ABC) method. In doing so, Roger Chemometrics can improve the accuracy of the cost estimation process. Furthermore, the ABC method facilitates activity-based management (ABM), such as value chain analysis and re-engineering initiative to improve strategic and operational decisions in an organization.

You identify four manufacture activities:

1. Production activity. Highly automated etching processes that print the copper tracks (i.e., the conductive pathways) on the copper-clad laminate film. Few workers oversee several machines during the etching process. This is a large cost pool, as it includes the depreciation on the factory facilities (i.e., millions of dollars of property, plant, and equipment), and the wages of these production employees is directly traced to the job.

1. Material Activity. The direct material is etching solution. Before each batch production, workers thoroughly sterilize the metal etching tanks, adjust tank temperature, and fill the tank with industry-standard etching solution. Wages of these workers is considered indirect labor.

1. Cleansing Activity. Workers cleanse the surplus etchant off the circuit board after etching. Surplus etchant can build up due to tank contamination and sub-optimal temperature during the etching process. This cleansing process is also where parts that are defective and are thrown out. Thus, this activity also includes the cost of wasted materials. Wages of these workers is directly traceable to the job.

1. Inspection Activity. Inspectors randomly select and inspect completed PCB systems. The inspection is performed through a 'burn-in' test, which involves running diagnostic software on the circuit system for a protracted time while it's subjected to high temperatures and temperature cycles. Inspectors' wages are considered indirect labor.

You then summarize the estimated overhead costs and the activity level of underlying cost driver with respect to each manufacture activity (see Table 1 below). You make a mental note that the estimates are still a work-in-progress. You plan to make several recommendations to the ABC implementation to further improve the cost estimates.

Ms. Fischer informs you that the company is putting together a bid for a potential new customer, and she wants to make sure the price is competitive, but still profitable. The proposed job is somewhat different. For example, the job requires customized etching solution mixture, instead of industry-standard solution. In addition, solutions mixing can only be done in-house by specially trained chemists (see Table 2 below for details). Historically, customer jobs have required customized solution mixture. While Roger Chemometrics has not needed to support these types of requests in the past, several recent bids (all rejected) have had similar needs. The plant manager believes that these types of jobs will increase in the future. Proving that they can support these requests may result in new business in the future.

Table 1: ABC activities, cost drivers, and cost pools

Activity	Activity cost driver	Estimated activity usage	Estimated cost
Production	Machine hours	600,000	$ 1,650,000
Materials	Lbs of etching solutions	175,050	525,150
Cleansing	DLH (cleansing)	85,000	275,000
Inspection	# of inspections	3,500	122,600

Table 2: Job proposal (resources)

Direct materials cost	$ 8,750
Direct labor cost	$ 14,600

Direct labor hours (in production)	1,175
Direct labor hours (in cleansing)	780
Lbs of material	6,850
Number of setups	15
Types of etching solution	6
Number of inspections	275
Number of machine-hours	3,570

Required:

Prepare memo, as the accounting consultant of Roger Chemometrics, LTD, addressed to Ms. Kate Fischer describing your analysis and the recommendation. Make sure you respond to the following items:

1. Using current traditional costing (plantwide) method, estimate the total cost estimate of the proposed job. Ms. Fischer expects to use a total of 125,000 direct labor hours for the upcoming fiscal year.
2. Using current ABC method, estimate the total cost estimate of the proposed job.
3. Explain to Ms. Fischer which cost estimate should be used to develop her bid, and why.
4. UseABM to address to Ms. Fischer's concern about process inefficiencies driving up costs.
5. Evaluate the ABC method as it currently stands. Explain what specific change(s) you recommend for the ABC implementation, and how that could affect your cost estimates.