The Cylinder Manufacturing Company. The Cylinder manufacturing company is a large producer of oil...

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The Cylinder Manufacturing Company. The Cylinder manufacturing company is a large producer of oil tanks and is located in the North of Buckinghamshire in the United Kingdom. It was started as a company in 1970 and has enjoyed steady growth in both sales and profits. Davina Brinkwater, the founder’s daughter, joined the company in 1998 after graduating from university with a degree in accounting and finance. One of her first tasks was to revise the accounting system as there was a demand for more accurate product cost information to support the firm’s strategy of offering keen prices in a highly competitive market where a few firms dominated. Davina is surprised by the depth of opposition that she faces in trying to change the organisation. Some members of the firm appear to be happy to accept the shortcomings of the “old” system on the basis that they are comfortable with it and they understand its workings. However, with the support of her powerful and influential father, she wins the argument and now has the job of implementing her “new “system. Davina’s father has now retired and she is conscious that she must prove herself to the organisational members and is aware that disruption due to the implementation of a new system can be upsetting. However, at the same time, profits are down below budget and the accountant is very critical of the current costing system saying that it is out of line with the updated manufacturing systems as well as way behind current theoretical ideas on product costing. According to the accountant, they are still absorbing overheads on labour hours and that they have an artificially high overhead absorption rate of £150 per labour hour. He claims that they are pricing themselves out of the market on their established product line. He suggests that product costs would be more meaningful if absorbed on the basis of machine hours. Davina decides that she should investigate this matter. Over the past five years, overhead costs had risen to £599,300 per month, a 46% increase, while direct labour cost have risen from £168,200 to £170,000, a small increase in the same period. The product processes are now largely mechanised with a high level of automation. Direct labour hours are 4,000 compared with machine hours of 6,500 (it is possible that some labour is still being classed as direct cost when in fact the change in technology and automation has altered the nature to indirect). Davina asks the manufacturing manager about the rise in overhead costs but this result in him getting very upset and saying: “How can I keep costs down when marketing ignore our standard specifications and insist on 23 different versions of every product? I need more specialist engineers to monitor the changes and they do not come cheap. Also there are completely new parts coming through from design with huge material costs; materials handling is an increasing headache. And the number of specials going through on small production runs continues to increase. I need 2 many more set-ups per shift and it is skilled work, but you cannot pick up that sort of skilled labour easily, so overtime is going through the roof”. Davina then decides to talk to the marketing manager, who says: “We are facing fierce competition for our main high volume lines and we just can’t match the low prices in the marketplace. However, we have successfully increased our sales of the more specialised tanks despite an increase in prices forced on us by manufacturing. So, we are meeting our overall sales targets and as we encourage this trend towards the high margin specialist product lines, our profits will rise. I don’t see any problem at present but there will be many problems if manufacturing do not get control of their cost increases.” Davina starts to pull together the information and gets frustrated at the inconsistencies:

Robert · Accepted Answer

The Cylinder Manufacturing Company 
Introduction 
The Cylinder Manufacturing Company is an UK based company producing oil tanks. The 
Company is now handled by Davina the daughter of the founder. Her main objective after 
joining the company was to revise the accounting system of the company due to demand for 
more accurate information about product cost. Davina took a lot of steps to prove her to the 
organisational members. She investigated the reasons for declining profits despite of 
increasing sales. She discovered that over the last five years, overhead costs have increased 
by 46% whereas during the same period there was only a little increase in the labour costs. 
Thereafter she designed a new costing system and requires recommendations for the same. 
1. Analysis of the Problem 
When Davina joined the company she noticed that when she proposed to implement new 
accounting and costing system, the members of the company were reluctant in accepting the 
new system. But with the support of her father she successfully implemented the new system. 
While implementing new system she was reluctant to admit her fault and even her father is no 
more to her back up. Thus, she needs a consultant to identify the problem in the system.  
Advantages of switching to machine hours as an overhead recovery base: 
 By switching to machine hour rate the cylinder manufacturing company can allocate all 
the overhead expenses on the basis of machine hours. 
 With the machine hour as recovery rate, the company would come to know about the idle 
time of the machine, if any and would find ways to reduce it. 
 It would also help to increase the efficiency of the machines of company as with the 
machine hour as recovery rate, the machine would be used in the effective manner and 
overheads are dependent mostly on the effectiveness of the machines. 
 The scientific method of calculating the factory overheads is using machine hours as the 
recovery rate. 
 By allocating overheads on the basis of machine hours, total production cost can be 
calculated which can help in calculating the selling price of the product. 
 The result obtained by using the machine hours as the basis of recovery of overheads is 
more accurate and reliable as compared to that of labour hours. 
As per the information provided in the case study of cylinder manufacturing company, the 
overheads on the basis of labour hours and machine hours are as follows: 
On the basis of labour hours 
Particulars Working Amount 
Budgeted labour rate Given £149.825/labour hour 
Total overheads for standard product £149.825 x 2,500 hours £374,562.50 
Total overheads for specialised product £149.825 x 1,500 hours £224,737.50 
Total Overheads  £599,300 
On the basis of machine hours 
Particulars Working Amount 
Total Machine hours  6,500 
Total Overheads to be distributed From table above £599,300 
Budgeted Overhead burden per hour £599,300/6500 £92.20 
Total Overhead Burden on Std. product £92.2 x 3,500 £322,700 
Total Overhead Burden on Specialized 
product 
£92.2 x 3,000 £276,600
From the above tables it can be concluded that if machine hours is used for calculating the 
overhead rate by the Cylinder Manufacturing Company instead of labour hours, the result 
would be more accurate as compared to that of labour hours. As compared to labour hours, it 
is easier to ascertain the total machine hours as the machine is an automatic system, therefore 
it is easy to find correct machine hours consumed by the product. In addition to this, the 
efficiency of all the machines is same unlike the labour, being humans have different 
efficiency. 
The difference between the overheads for the standard product and the specialised product is 
very high in case of labour which is not so in case of machine hours. Thus, it can be 
concluded that overheads absorbed on the basis of machine hours are much more reliable and 
accurate as compared to that absorbed on the basis of labour hours.

The Cylinder Manufacturing Company. The Cylinder manufacturing company is a large producer of oil tanks and is located in the North of Buckinghamshire in the United Kingdom. It was started as a...

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