Engineering Economic Analysis

j

550 ACCOUNTINGAND ENGINEERINGECONOMY

Direct

Material Overhead

FIGURE 18-4 Activity-based costing versus traditional overhead allocation. (Based on an example

by Kim LaScola Needy.)

flows? For example, vacation and sick leave accrual may be part of overhead, but will they

change if the labor content is changed? The changes in costs incurred must be estimated.

Loadings, or allocations, of overhead expenses cannot be used..

This issue has become very important because in some firms, automation has reduced

direct-labor content to less than 5% of the product's cost. Yet in some of these firms, ~e

basis for allocating overhead is still direct-labor hours or cost.

Other firms are shifting to activity-basedcosting (ABC),l where each activity"is linked

to specific cost drivers, and the number of dollars allocated as overhead is minimized.

Figure 18-4illustratesthe differencebetween activity-basedcosting and traditionaloverhead

allocations.2 "

Other Problems to Watch For

Centralized accounting systems have ofteribeen accused by project managers of being too

slow or being "untimely."Because engineering economyis not concerned with the problem

of daily project control, this is a less critical issue. However,if an organization establishes

multiple files and systems so that project managers (and others) have the timely data they

need, then the level of accuracy in one or all systems may be low. As a result, analy!)ts

makingcostestimateswillhaveto considerotherinternaldata sources. "

There are several cases in which data on equipment or inventory values may be ques-

tionable. When inventory is valued on a "last in, first out" basis, the remaining inventory

may be valued too low. Similarly,land valued at its acquisition cost is likely to be signifi-

cantly undervalued. Finally,capital equipment may be valued at either a low or a high value,

depending on allowable depreciation techniques and company policy.

1Liggett, Hampton R., Jaime Trevino, and Jerome P. Lavelle, "Activity-Based Cost Management

Systems, in an Advanced Manufacturing Environment." InEconomic and Financial Justificq.tion of

Advanced Manufacturing Technologies,1992, H. R. Parsaei (editor), Elsevier Science.

2Tippet, Donald D., and Peter Hoekstra, "Activity-Based Costing: a Manufacturing Management

Decision-Making Aid,"Engineering Management Journal,Vol. 5, No.2, June 1993, American Society

for Engineering Management, pp. 37-42.