Harvard Case - Siemens Electric Motor Works (A): Process-Oriented Costing
"Siemens Electric Motor Works (A): Process-Oriented Costing" Harvard business case study is written by Robin Cooper, Karen H. Wruck. It deals with the challenges in the field of Accounting. The case study is 8 page(s) long and it was first published on : Oct 20, 1988
At Fern Fort University, we recommend Siemens Electric Motor Works (SEMW) implement an activity-based costing (ABC) system to improve cost accounting, enhance decision-making, and drive profitability. This recommendation aims to address the limitations of the current process-oriented costing system and provide a more accurate and granular understanding of cost drivers and profitability across different product lines and customer segments.
2. Background
Siemens Electric Motor Works (SEMW) is a leading manufacturer of electric motors, generators, and related equipment. The company faced challenges with its existing process-oriented costing system, which did not accurately reflect the true cost of producing different products. This led to inaccurate pricing decisions, difficulty in identifying profitable product lines, and a lack of transparency in cost allocation.
The case study focuses on the efforts of SEMW's management team to address these issues and improve the company's cost accounting practices. The main protagonists are:
- Dr. Alfred Schaller: The manager of SEMW's cost accounting department, who is tasked with finding a solution to the company's costing problems.
- Dr. Hans-Joachim Kummer: A consultant from Price Waterhouse, who is hired to assist SEMW in implementing a new cost accounting system.
- SEMW's management team: The individuals responsible for making decisions regarding the company's cost accounting practices.
3. Analysis of the Case Study
The case study highlights the limitations of the traditional process-oriented costing system used by SEMW. This system allocates costs based on direct labor hours, which does not accurately reflect the true cost drivers for different products. For example, a complex motor requiring significant engineering and design work may have a higher cost than a simple motor, even if both require the same amount of direct labor.
To address this issue, SEMW needs to adopt an activity-based costing (ABC) system. ABC is a more sophisticated cost accounting method that identifies and tracks the cost of individual activities involved in producing a product. These activities are then linked to specific products, providing a more accurate picture of the true cost of each product.
The ABC system will help SEMW achieve the following:
- Improved Cost Accounting: ABC will provide a more accurate and granular understanding of cost drivers, leading to improved cost allocation and a more accurate reflection of the true cost of products.
- Enhanced Decision Making: The detailed cost information provided by ABC will support better pricing decisions, product mix optimization, and resource allocation.
- Increased Profitability: By identifying and managing cost drivers effectively, SEMW can improve profitability and make more informed strategic decisions.
4. Recommendations
SEMW should implement an activity-based costing (ABC) system to address its cost accounting challenges. The implementation should involve the following steps:
- Identify Cost Drivers: SEMW should identify the key activities involved in producing its products and determine the cost drivers for each activity. This could include engineering design, machine setup, material handling, quality inspection, and customer support.
- Allocate Costs: Once the cost drivers are identified, SEMW should allocate costs to specific products based on their consumption of each activity. This will provide a more accurate picture of the true cost of each product.
- Develop a Costing System: SEMW should develop a comprehensive ABC costing system that integrates with its existing financial systems. This system should be designed to track and manage costs effectively, providing real-time insights into cost performance.
- Train Employees: SEMW should provide training to its employees on the new ABC system, ensuring they understand its principles and how to use it effectively.
- Monitor and Evaluate: SEMW should monitor the performance of the ABC system and make adjustments as needed. Regular reviews and variance analysis will help ensure that the system is delivering the desired results.
5. Basis of Recommendations
The recommendation to implement an ABC system is based on the following considerations:
- Core Competencies and Consistency with Mission: ABC aligns with SEMW's mission to provide high-quality, innovative products and services. By improving cost accounting, SEMW can optimize its operations and focus on its core competencies.
- External Customers and Internal Clients: ABC will provide SEMW with a more accurate understanding of the cost of its products, allowing it to set competitive prices and meet the needs of its customers. Internal clients, such as sales and marketing teams, will also benefit from the improved cost information.
- Competitors: As competitors adopt more sophisticated cost accounting methods, SEMW needs to stay competitive by implementing an ABC system. This will allow the company to make informed decisions about pricing, product mix, and resource allocation.
- Attractiveness ' Quantitative Measures: The implementation of ABC is expected to improve SEMW's profitability by providing a more accurate picture of the cost of its products. This will lead to better pricing decisions, reduced costs, and improved resource allocation.
6. Conclusion
Implementing an activity-based costing (ABC) system will provide SEMW with a more accurate and granular understanding of its cost drivers, leading to improved decision-making, increased profitability, and a more competitive position in the market.
7. Discussion
Other alternatives not selected include:
- Maintaining the current process-oriented costing system: This would be a short-sighted approach, as it would continue to provide inaccurate cost information and hinder SEMW's ability to make informed decisions.
- Implementing a simplified version of ABC: While this could be a less expensive option, it may not provide the same level of detail and accuracy as a fully implemented ABC system.
The risks associated with implementing an ABC system include:
- High implementation costs: Implementing ABC can be costly, requiring significant investment in software, training, and staff time.
- Resistance to change: Employees may resist the implementation of a new costing system, particularly if they are unfamiliar with ABC.
- Data quality issues: The accuracy of the ABC system relies on the quality of the data collected. Poor data quality can lead to inaccurate cost information and undermine the effectiveness of the system.
8. Next Steps
The implementation of the ABC system should be a phased process, with clear milestones and timelines. The following steps should be taken:
- Phase 1: Conduct a feasibility study to assess the costs and benefits of implementing ABC.
- Phase 2: Develop a detailed implementation plan, including timelines, resources, and training requirements.
- Phase 3: Implement the ABC system, starting with a pilot project in a specific product line or department.
- Phase 4: Monitor and evaluate the performance of the ABC system, making adjustments as needed.
By following these steps, SEMW can successfully implement an ABC system and reap its benefits in terms of improved cost accounting, enhanced decision-making, and increased profitability.
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Case Description
Explores how a cost system can help support a firm's decision to change strategies. In the process, the students are introduced to a simple activity-based cost system. Siemens Electric Motor Works found itself facing an increasingly competitive environment and so made a decision to move from mass production of specialty motors to the production of small lots of custom motors. In doing so, they found their old cost system led them to poor decision making. By switching to a simple activity-based system, more accurate product costs were computed, facilitating better divisional performance.
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