John Patrick has recently been hired as controller of Valdosta Vinyl Company (VVC), a manufacturer of vinyl siding used in residential construction. VVC has been in the vinyl siding business for many years and is currently investigating ways to modernize its manufacturing process. At the first staff meeting, Patrick attended, Jack Kielshesky, chief engineer, presented a proposal for automating the Molding Department. Kielshesky recommended that the company purchase two robots that would have the capability of replacing the eight direct-labor employees in the department. The cost savings outlined in the proposal include the elimination of direct-labor cost in the Molding Department plus a reduction of manufacturing overhead cost in the department to zero because VVC charges manufacturing overhead on the basis of direct-labor dollars using a plantwide rate. The president of VVC was puzzled by Kielshesky's explanation: "This just doesn't make any sense. How can a department's overhead rate drop to zero by adding expensive, high-tech manufacturing equipment? If anything, it seems like the rate ought to go up." Kielshesky responded by saying, "I'm an engineer, not an accountant. But if we're charging overhead on the basis of direct labor, and we eliminate the labor, then we eliminate the overhead." Patrick agreed with the president. He explained that as firms become more automated, they should rethink their product-costing systems. The president then asked Patrick to look into the matter and prepare a report for the next staff meeting. Patrick gathered the following data on the manufacturing-overhead rates experienced by VVC over the years. Patrick also wanted to have some departmental data to present at the meeting and, by using VVC's accounting records, he is able to estimate the following annual averages for each manufacturing department over the five decades since VVC's formation. Historical Plantwide Data Decade Avg. Annual Manufacturing OVH cost Avg. Annual Direct-Labor Cost Avg. Manufacturing OVH application rate 1st $2,200,000 $2,000,000 110% 2nd $6,240,000 $2,400,000 260% 3rd $13,600,000 $4,000,000 340% 4th $24,600,000 $6,000,000 410% 5th $38,710,000 $7,900,000 490% Annual Averages during Recent Years Cutting Department Finishing Department Molding Department Manufacturing OVH $22,000,000 $14,000,000 $4,000,000 Direct Labor $4,000,000 $3,500,000 $500,000 Disregarding the proposed use of robots in the Molding Department, describe the shortcomings of the system for applying overhead that is currently used by Valdosta Vinyl Company.
John Patrick has recently been hired as controller of Valdosta Vinyl Company (VVC), a manufacturer of vinyl siding used in residential construction. VVC has been in the vinyl siding business for many years and is currently investigating ways to modernize its manufacturing process. At the first staff meeting, Patrick attended, Jack Kielshesky, chief engineer, presented a proposal for automating the Molding Department. Kielshesky recommended that the company purchase two robots that would have the capability of replacing the eight direct-labor employees in the department. The cost savings outlined in the proposal include the elimination of direct-labor cost in the Molding Department plus a reduction of manufacturing overhead cost in the department to zero because VVC charges manufacturing overhead on the basis of direct-labor dollars using a plantwide rate. The president of VVC was puzzled by Kielshesky's explanation: "This just doesn't make any sense. How can a department's overhead rate drop to zero by adding expensive, high-tech manufacturing equipment? If anything, it seems like the rate ought to go up."
Kielshesky responded by saying, "I'm an engineer, not an accountant. But if we're charging overhead on the basis of direct labor, and we eliminate the labor, then we eliminate the overhead."
Patrick agreed with the president. He explained that as firms become more automated, they should rethink their product-costing systems. The president then asked Patrick to look into the matter and prepare a report for the next staff meeting. Patrick gathered the following data on the manufacturing-overhead rates experienced by VVC over the years. Patrick also wanted to have some departmental data to present at the meeting and, by using VVC's accounting records, he is able to estimate the following annual averages for each manufacturing department over the five decades since VVC's formation.
Historical Plantwide Data
| Decade | Avg. Annual |
Avg. Annual Direct-Labor Cost | Avg. Manufacturing OVH application rate |
| 1st | $2,200,000 | $2,000,000 | 110% |
| 2nd | $6,240,000 | $2,400,000 | 260% |
| 3rd | $13,600,000 | $4,000,000 | 340% |
| 4th | $24,600,000 | $6,000,000 | 410% |
| 5th | $38,710,000 | $7,900,000 | 490% |
Annual Averages during Recent Years
| Cutting Department | Finishing Department | Molding Department | |
| Manufacturing OVH | $22,000,000 | $14,000,000 | $4,000,000 |
| Direct Labor | $4,000,000 | $3,500,000 | $500,000 |
Disregarding the proposed use of robots in the Molding Department, describe the shortcomings of the system for applying overhead that is currently used by Valdosta Vinyl Company.
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