SEIMENS ELECTRIC

MOTOR WORKS
Case Submission

Submitted by –

Sarthak Jalali - B19044

Shashwat Nandan - B19047
Shobhit Sharma - B19048
Shrey Bhala - B19049
Executive summary

Siemens used the traditional approach of costing for a while but started facing problems with the
method when it was unable to capture the relation between increased support costs and the
change in product mix. Siemens came up with an alternative to use Process Oriented costing
method to resolve the issues. On analyzing both the approaches, we have identified the Process
oriented costing approach to be the viable option.

Problem statement

The case talks about reorientation of manufacturing process from traditional to Process Oriented
Costing method (PROCASTA). There were some issues faced by Siemens while using
traditional approach as it was not able to capture the relation between increased support costs and
the change in product mix. Many of the major expenses such as cost related to order processing,
special components. Additionally many costs such as shipping, inventory handling, purchasing
etc. were not traceable as well. We need to decide if switching from traditional approach to
process based costing would be a wise decision or not.

Alternatives to address the problem

1. Traditional Costing System

In this system, material costs and labor costs are assigned directly to the products. The
overhead costs are treated by dividing them into three categories:

● Material-related overhead – This overhead was assigned based on the deutsche marks of
direct materials consumed by a product.
● Production-related overhead – These overheads were mapped to cost pools and allocated
to products using either direct labor hours or machine hours. For labor intensive
machines, direct labor hours were used. For machines that required few labor hours,
machine hours were used.
● Support-related overhead – This overhead was assigned to products based on the sum of
direct material and labor costs, production related overhead and material related
overhead.

2. Process-Oriented Cost System

In this system, support-related overheads are treated differently than in the traditional system.
The support-related overheads were attributed to two drivers: processing orders and processing
special components. To this extent, two new overhead cost pools were created:

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 ● Costs related to order processing: This includes the costs of order receiving, cost of
product costing and bidding, cost of shipping, cost of billing.
● Costs related to special components: This includes the cost of technical examination of
incoming orders, cost of scheduling and production control, cost of inventory handling,
cost of product costing and bidding, cost of product development, cost of purchasing, cost
of receiving.

Once these costs are identified, they are removed from the support-related overhead cost pool
and assigned to the two new pools.

Evaluation of Alternatives

Case A - Traditional Approach

Using Exhibit 4, we were able to derive the following table for average total costs under
traditional method

Older System
Order A B C D E
Base motor cost 247 247 247 247 247
Special Component cost 32.2 64.4 96.6 161 322
Total materials and
MFG costs 279.2 311.4 343.6 408 569
Support overheads cost 97.72 108.99 120.26 142.8 199.15
No. of special
components Average Total Costs
1 376.92 420.39 463.86 550.8 768.15
10 3769.2 4203.9 4638.6 5508 7681.5
20 7538.4 8407.8 9277.2 11016 15363
100 37692 42039 46386 55080 76815

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Case B - PROCASTA Approach

By this approach, total cost for each order will come out using the formula -
(Base motor cost + special component cost) x # of sp. Components + Sp. component handling
costs + order processing costs

To get a better idea, we can take a look at the table below -

Cost ('000) Amount Rate

Special components 19500 325000 60
Order Processing 13800 65625 210.29

PROCASTA Method
Order A B C D E
Base motor cost 304 304 304 304 304
Special Motor Cost 39.6 79.2 118.8 198 396
Special Component
handling cost 60 120 180 300 600
Order Processing costs 210.29 210.29 210.29 210.29 210.29
No. of special components Total Costs
1 613.89 713.49 813.09 1012.29 1510.29
10 3706.29 4162.29 4618.29 5530.29 7810.29
20 7142.29 7994.29 8846.29 10550.29 14810.29
100 34630.29 38650.29 42670.29 50710.29 70810.29
No. of special components Average Total Costs
1 613.89 713.49 813.09 1012.29 1510.29
10 370.629 416.229 461.829 553.029 781.029
20 357.1145 399.7145 442.3145 527.5145 740.5145
100 346.3029 386.5029 426.7029 507.1029 708.1029

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Most Viable Alternative

The traditional cost system worked until management realized the system’s inability to capture
the relation between the increased support costs and the change in product mix. As the
production increased the traditional cost system failed in allocating costs properly. However,
under the new system, overheads are allocated more efficiently which minimizes the overall cost
burden on motors.
The calculations above show that the new system’s identification of support costs driven by
special component and order processing is effective.

Exhibits

Chart explaining Cost per Unit of production