Rose Bach 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 manufacturing process. At the first staff meeting Bach attended, Bob Kelley, chief engineer, presented a proposal for automating the drilling department. Kelley recommended that Empco 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 Empco charges manufacturing overhead on the basis of direct labor dollars using a plantwide rate.

The president of Empco 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 Empco over the years. Bach also wanted to have some departmental data to present at the meeting. Using Empco's accounting records, she was able to estimate the annual averages presented below for each manufacturing department in the 1990s.

Historical Data
Date	Average Annual Direct Labor Cost	Average Annual Manufacturing Overhead Cost	Average Manufacturing Overhead Application Rate
1950s	$1,000,000	$1,000,000	100%
1960s	1,200,000	3,000,000	250
1970s	2,000,000	7,000,000	350
1980s	3,000,000	12,000,000	400
1990s	4,000,000	20,000,000	500

Annual Averages
	Cutting Department	Grinding Department	Drilling Department
Direct labor	$ 2,000,000	$1,750,000	$ 250,000
Manufacturing overhead	11,000,000	7,000,000	2,000,000

Required:

a. Disregarding the proposed use of robots in the drilling department, describe the shortcomings of Empcos 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 Empco'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.

Source: CMA adapted.