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BUDGET AUTO COMPONENTS LTD$.$

Sandy Kaur is a recent graduate who completed her master$$s degree in professional

accountancy. Upon completing her master$$s degree, Sandy took up a job at Budget Auto

Components Ltd $($BAC$).$ BAC is a relatively small supplier of selected vehicle parts to large

automobile and truck manufacturers. BAC competed on a price basis with large suppliers that

were long established in the market. BAC had competed successfully in the past by focusing

on parts that, relative to the industry, were of small volume and hence did not permit BAC$$s

competitors to take advantage of economies of scale. For example, BAC produce certain parts

required only by "off$-$the$-$road$$ equipment such as front loaders.

As her first project on the job, BAC$$s Chief Executive officer $($CEO$)$ asked Sandy to review

the company$$s present cost accounting procedures. In outlining this project to Sandy, the CEO

had expressed three concerns about the present cost accounting system: $(1)$ its adequacy for

purposes of cost control, $(2)$ its accuracy in arriving at the true cost of products, and $(3)$ its

usefulness in providing data to judge the supervisor$$s performance.

Sandy began the cost accounting study in BAC$$s carburetor and fuel injector $($CFI$)$ division,

which accounted for about $50\%$ of BAC$$s sales. This division contained five production

departments: Casting and stamping, Grinding, Machining, Custom Work, and Assembly. The

casting and stamping department produced cases, valves, and certain other auto parts. The

grinding department prepared these parts for further machining. The machining department

performed all necessary machining operations on standard products, whereas the custom work

department performed part of the machining and certain other highly specialised operations on

custom products. The assembly department assembled and tested all products, both standard

and custom. Thus, custom products passed through all five departments and standard products

passed through all departments except Custom Work department. Spare parts produced for

inventory went through only the first three departments. Both standard and custom products

were produced to order; there were no inventories of completed carburetors or fuel injectors.

Sandy's study revealed that except for materials cost, all product costing was done based on a

single plant$-$wide direct labour hourly rate. This rate included both direct labour and factory

overhead costs. Each batch of products was assigned its labour and overhead cost by having

workers charge their time to the job number assigned to the batch and then multiplying the total

hours charged to the job by the hourly rate. Exhibit $1$ shows how the July hourly rate was

calculated.

It seemed to Sandy that because the average labour skill varied from department to department,

each department should have its own hourly costing rate. With this approach, time would be

charged to each batch by the department; then the hours charged by the department would be

multiplied by that department$$s costing rate to arrive at a departmental labour and overhead

cost for the batch; and finally, these departmental labour and overhead costs would be added

$($along with the materials cost$)$ to obtain the full cost of a batch.

Sandy decided to see what impact this approach would have on product costs. The division

accountant pointed out to Sandy that labour hours and payroll costs were already traceable to

departments. Also, some overhead items, such as department supervisor$$ssalary and equipment

depreciation, could be charged directly to the relevant department. However, many other

overheads including water, electricity, property taxes, and insurance, would need to be

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allocated to each department if the new approach were implemented. Accordingly, Sandy

determined a reasonable allocation basis for each of these costs and used these bases to recast

July$$s costs on a departmental basis. Sandy then calculated hourly rates for each department

$($shown in Exhibit $2).$

To obtain some concrete numbers to show the CEO, Sandy decided to apply the proposed

approach to three CFI division activities: model BAC$-29$ fuel injectors $($CFI$$s best$-$selling

product$),$ production of spare parts for inventory, and work done by the CFI division for other

BAC$$s divisions. Exhibit $3$ summarizes the hourly requirements of these activities by

department. Sandy then costed these three activities using both the July plant$-$wide rate

$($existing method$)$ and her proposed method of July departmental rates.

Upon seeing Sandy$$s numbers, the CEO noted that there was a large difference in the indicated

cost of BAC$-29$ injectors as calculated under the present and proposed methods. The present

method was therefore probably leading to incorrect inferences about the profitability of each

product, the CEO surmised. The CEO therefore was leaning toward adopting