HBSP Product Number TCG011. Rev.

12Jun13

THE CRIMSON PRESS CURRICULUM CENTER

THE CRIMSON GROUP, INC.
Huron Automotive Company
Sandy Bond, a business school graduate who had recently been employed by Huron Automo-
tive Company, was asked by Huron’s president to review the company’s present cost accounting
procedures. In outlining this project to Bond, the president had expressed three concerns about the
present 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.
Huron Automotive was a relatively small supplier of selected vehicle parts to the large automo-
bile and truck companies. Huron competed on a price basis with larger suppliers that were long-es-
tablished in the market. Huron had competed successfully in the past by focusing on parts that,
relative to the industry, were of small volume and hence did not permit Huron’s competitors to take
advantage of economies of scale. For example, Huron produced certain parts required only by "off-
the-road" equipment such as front loaders.
Bond began the cost accounting study in Huron’s carburetor and fuel injector (CFI) division,
which accounted for about 40 percent of Huron’s sales. This division contained five production de-
partments: casting and stamping, grinding, machining, custom work, and assembly. The casting and
stamping department produced cases, valves, and certain other parts. The grinding department pre-
pared these parts for further machining and precision ground those parts requiring close tolerances.
The machining department performed all necessary machining operations on standard products,
whereas the custom work department performed part of the machining and certain other operations
on custom products, which usually were replacement carburetors for antique cars or other highly
specialized applications. 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. 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.
Bond’s investigation showed that with the exception of materials costs, all product costing was
done based on a single, plant-wide, direct labor hourly rate. This rate included both direct labor and
factory overhead costs. Each batch of products was assigned its labor 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 number by the hourly rate. Exhibit 1 shows how the July hourly rate of
$55.96 was calculated.
It seemed to Bond that because the average labor skill level varied from department to depart-
ment, each department should have its own hourly costing rate. With this approach, time would be
charged to each batch by department; then the hours charged by the department would be multiplied
by that department’s costing rate to arrive at a departmental labor and overhead cost for the batch;
and finally these departmental labor and overhead costs would be added (along with materials cost)
to obtain the cost of a batch.
Bond decided to see what impact this approach would have on product costs. The division’s
accountant pointed out to Bond that labor hours and payroll costs were already traceable to depart-
ments. Also, some overhead items, such as departmental supervisors’ salaries and equipment de-
preciation, could be charged directly to the relevant department. However, many other overhead
items, including heat, electricity, property taxes, and insurance, would need to be allocated to each
department if the new approach were implemented. Accordingly, Bond determined a reasonable al-
location basis for each of these joint costs (e.g. cubic feet of space occupied as the basis of allocat-
ing heating costs), and then used these bases to recast July’s costs on a departmental basis. Bond
then calculated hourly rates for each department (shown in Exhibit 2).

This case was prepared by Professor James S. Reece and modified by Professor David W. Young. It is intended as a
basis for class discussion and not to illustrate either effective or ineffective handling of an administrative situation.
Copyright © 2013 by James S. Reece and The Crimson Group, Inc. To order copies or request permission to repro-
duce this document, contact Harvard Business Publications (http://hbsp.harvard.edu/). Under provisions of United
States and international copyright laws, no part of this document may be reproduced, stored, or transmitted in any
form or by any means without written permission from The Crimson Group (www.thecrimsongroup.org)
This document is authorized for use only by Albara Alwegaisi in Acctg for Strategic Decision Making taught by John R. Twombly, Illinois Institute of Technology from January 2017 to July 2017.
 2 of 4
TCG011 • Huron Automotive Company

To obtain some concrete numbers to show the president, Bond decided to apply the proposed
approach to three CFI division activities: model CS-29 fuel injectors (CFI’s best-selling product),
production of spare parts for inventory, and work done by the division for other Huron divisions.
Exhibit 3 summarizes the hourly requirements of these activities by department. Bond then costed
these three activities using both the July plant-wide rate and the pro forma July departmental rates.
Upon seeing Bond’s numbers, the president noted that there was a large difference in the indi-
cated cost of CS-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 prod-
uct, the president surmised. The impact of the proposed method on spare parts inventory valuation
was similarly noted. The president therefore was leaning toward adopting the new method, but told
Bond that the department supervisors should be consulted before any change was made.
Bond’s explanation of the proposal to the supervisors prompted strong opposition from some
of them. The supervisors of the outside departments for which the CFI division did work each
month felt it would be unfair to increase their costs by increasing charges from the CFI division.
One of them stated:

The CFI division handles our department’s overflow machining work when we’re at capacity. I can’t con-
trol costs in the CFI division, but if they increase their charges, I’ll never be able to meet my department’s cost
budget. They’re already charging us more than we can do the work for in our own department, if we had enough
capacity, and you’re proposing to charge us still more!

Also opposed was the production manager of the CFI division:

I’ve got enough to do getting good quality output to our customers on time, without getting involved in
more paperwork! What’s more, my department supervisors haven’t got time to become bookkeepers, either.
We’re already charging all of the division’s production costs to products and work for other departments; why
do we need this extra complication?

The company’s sales manager also did not favor the proposal, telling Bond:
We already have trouble being competitive with the big companies in our industry. If we start playing
games with our costing system, then we’ll have to start changing our prices. You’re new here, so perhaps you
don’t realize that we have to carry some low-profit—or even loss—items in order to sell the more profitable
ones. As far as I’m concerned, if a product line is showing an adequate profit, I’m not hung up about cost
variations among the items within the line.

The strongest criticism of Bond’s proposed new system came from Huron’s director of finan-
cial planning:

Departmentalizing the costing rate may be a good idea, but I’m not sure you’re attacking the main problem.
How can we do anything with these cost estimates when you change the rates every month? When volume is
rising, all our products make money, no matter which system you use. But when overall volume is falling,
some products begin to show losses even though their own sales continue to hold up. I don’t know whether
they’re really losing money or whether they just can’t carry a full share of the costs of idle capacity. I don’t see
how your system is going to help me answer that question.

Faced with all of these arguments, Bond decided to make some more calculations before going
back to the president. First, Bond asked the industrial engineering department to estimate the
monthly volume at which each of the five production departments typically operated over the course
of a year (normal volume). Then Bond assembled a new set of overhead cost estimates and recalcu-
lated the proposed overhead rates, as shown in Exhibit 4. Finally, Bond recalculated the labor and
overhead costs of a 100-unit lot model CS-29 injectors and of a typical month’s spare parts pro-
duction and work for other divisions, based on the "normalized" departmental rates.
When Bond circulated these new calculations, the production manager of the CFI division was
even more perturbed than before:

"That’s even worse! Now you’re piling paperwork on paperwork! And on top of everything, we won’t be
able to charge out all of our costs. What am I supposed to do with the costs in machining and assembly if I
can’t charge them to products or spare parts or the work we do for other divisions?

This document is authorized for use only by Albara Alwegaisi in Acctg for Strategic Decision Making taught by John R. Twombly, Illinois Institute of Technology from January 2017 to July 2017.
 TCG011 • Huron Automotive Company 3 of 4

When Bond reported the various managers’ opposition to the president, the president replied:

You’re not telling me anything that I haven’t already heard from unsolicited phone calls from several su-
pervisors the last few days. I don’t want to cram anything down their throats, but I’m still not satisfied our
current system is adequate. Sandy, what do you think we should do?

Assignment

1. Using data in the exhibits, determine the cost of a 100-unit batch of model CS-29, a month’s spare parts, and a
month’s work done for other divisions under the present method, Bond’s first proposal, and his revised proposal.

2. Are the cost differences among the methods significant? What causes these differences?

3. Assume that producing a batch of 100 model CS-29 injectors requires 126 hours, distributed by department as
shown in Exhibit 3, and $4,200 worth of materials. Huron sells these carburetors for $113 each. Should the CS-
29 price be increased? Should the CS-29 be dropped from the product line? (Answer using both the present and
the first proposed costing methods.)

4. Assume that Huron also offers a model CS-30 that is identical to a CS-29 in all important aspects, including
price, but is preferred for some applications because of certain design features. Because of the CS-30’s relatively
low sales volume, Huron buys certain major components for the CS-30 rather than making them in-house. The
total cost of materials and purchased parts for 100 units of model CS-30 is $8,000; the labor required per 100
units is 12, 7, 17, and 35 hours respectively, in the casting/stamping, grinding, machining, and assembly de-
partments. If a customer ordered 100 units and said that either model CS-29 or CS-30 would be acceptable,
which model should Huron ship? Why? (Answer using only the first proposed costing method and the assump-
tions regarding CS-29 from Question 3.)

5. What benefits, if any, do you see to Huron if either proposed costing method is adopted? Consider this question
from the standpoint of (a) product pricing, (b) cost control, (c) inventory valuation, (d) charges to outside depart-
ments, (e) measuring departmental performance, and (f) diagnostic uses of cost data. What do you think Huron
should do regarding their costing procedures?

This document is authorized for use only by Albara Alwegaisi in Acctg for Strategic Decision Making taught by John R. Twombly, Illinois Institute of Technology from January 2017 to July 2017.
 HURON AUTOMOTIVE COMPANY
Exhibit 1. Calculation of Plant-wide Labor and Overhead Hourly Rates for July

Department Dollars Hours

Labor
Casting/stamping 54,604 2,528
Grinding 38,520 2,140
Machining 191,876 7,675
Custom work 81,664 3,712
Assembly 291,784 15,357
Total 658,448 31,412
Overhead 1,099,321
Total labor and overhead 1,757,769

Labor Overhead Total

Hourly rates 20.96 35.00 55.96

Exhibit 2. Proposed Departmental Labor and Overhead Hourly Rates

Labor Rate Overhead Total Cost Total

Department per Hour per Hour per Hour Overhead Labor
Casting/stamping 21.60 31.37 52.97 79,303
Grinding 18.00 30.14 48.14 64,500
Machining 25.00 62.52 87.52 479,841
Custom work 22.00 40.48 62.48 150,262
Assembly 19.00 21.19 40.19 325,415
1,099,321

Exhibit 3. Direct Labor-Hour (DLH) Distribution for Three Carburetor Division Activities

CS-29 Spare Parts Work for Other

Injectors for Inventory Divisions
(Hours per (Hours per (Hours per
Department batch of 100) typical month typical month
Casting/stamping 21 304 674
Grinding 12 270 540
Machining 58 1,115 2,158
Custom work 0 0 0
Assembly 35 0 0
Total 126 1,689 3,372

Exhibit 4. Departmental Overhead Rates Based on Normal Volume

Normal Normal Overhead

Volume Overhead Per Direct
Department (DLH) Cost* Labor Hour
Casting/stamping 2,500 78,800 31.52
Grinding 2,400 69,000 28.75
Machining 8,000 492,000 61.50
Custom work 3,600 147,820 41.06
Assembly 17,500 352,450 20.14
Total/Average 34,000 1,140,070 33.53

* Estimated overhead cost if each department operates at its normal volume

This document is authorized for use only by Albara Alwegaisi in Acctg for Strategic Decision Making taught by John R. Twombly, Illinois Institute of Technology from January 2017 to July 2017.