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On all what counts the Prokasta was different from the old costing system? 1.

Two new cost pools for support related costs Prokasta System was a process oriented costing system in which two new cost pools were introduced Costs related to Order Processing o Billing o Order Receiving o Product Costing and bidding o Shipping Costs related to Special Components o Inventory Handling o Product Costing and bidding o Product Development o Purchasing o Receiving o Scheduling and Production Control o Technical Examination of Incoming Orders

After Siemens changed its strategy to move from production of standard motors to customized motors, the support related costs increased. Though the number of orders increased, the number of motors per order reduced increasing the load on production support. Under the old costing system, the support related overheads were allocated to each motor based on its consumption of direct materials, direct labor and either direct or indirect labor or machine hours. But in Prokasta system, two new cost pools were created to assign the overheads based on number of orders received and number of special components in the order. 2. Determining factory cost and transfer price The new Prokasta system was used to determine Factory Cost and price at which motors were transferred from EMW to Sales Division (transfer price of the motors).

How did it support new strategy?

In 1985, EMW decided to move from the production of standard motors to the production of low volume customized motors. While implementing this strategy management realized the old systems inability to capture the relation between the increased support costs and the change in product mix. Under the old costing system, the support related overheads were allocated to each motor based on its consumption of direct materials, direct labor and either direct or indirect labor or machine hours. In reality, the support costs increased as the number of orders increased but the number of motors per order reduced. So the support related costs were driven by number of orders and number of special components in an order. In the Prokasta system, two new cost pools were created to assign the overheads based on number of orders received and number of special components in the order. It helped managers determine which orders were profitable and which were unprofitable. It also helped to determine the price at which motors were transferred from EMW to Sales Division. This is how the new Prokasta costing system supported the new strategy.

Do you agree with Siemenss decision to set up both sales and EMW as profit Centre? What are the cost and benefits? The decision to set up both Sales and EMW as profit Centre had following costs and benefits: Costs Separate profit centers for Sales and EMW caused them to ensure profitability of their own divisions rather than the overall profitability of the business. The revenues from each order were split between EMW and Sales to ensure the breakeven for both. This actually reduced the actual profitability of EMW. The selling price was decided by Sales division based on relationship with customer, competitive prices and other factors rather than the cost of production, sometimes causing losses on the orders.

Benefits Helps in assessment of profitability of Sales and EMW division separately The selling price is set based on market demand, price set by competitors and relationship with the customer as the Sales division decides the selling price.

Does transfer pricing system make sense? Why do you think so?

The transfer price was calculated as follows: Factory Cost = Standard Cost per unit (from Prokasta costing system) * Discount Factor If the factory cost > Selling Price Transfer Price = Factory Cost + 1/3* Profit If the factory cost < Selling Price Transfer Price = Variable Cost + 3/4* Contribution There are few critical issues with the transfer pricing system: 1. The Selling price is set by the Sales division based on the relationship with the customer, competitive prices and other factors. Sometimes this price was lower than the factory cost thus causing loss on that order. 2. These selling prices were also recorded in the catalogues and thus used next time similar orders are accepted. So even if the selling price was lower than factory cost in the first place, it was used again and again for similar orders. 3. Instead of trying to increase the profits on an order, the transfer pricing was just dividing the profits/contribution gained on the order between EMW and Sales. Thus the transfer pricing was faulty and needed to be changed.