Cost Accounting: Applying Shop Burden to Development Prototypes?
August 5, 2016 11:36 AM   Subscribe

The company I work for has a large machine shop. In addition to parts for our regular products for sale, the shop also makes engineering / development prototype parts for our development projects; parts which are charged to the projects, do not go into inventory and are not for sale.

Our accounting system applies full shop burden (based on machinist labor hours) to these engineering / development prototype parts. I believe this is "wrong;" instead, shop burden should be fully allocated only across parts that go into inventory and eventually get sold. The purpose of a "proper" allocation is to get a realistic Finished Goods cost for inventory valuation, and later, COGS and Gross Margin.

Furthermore, I believe that applying shop burden to engineering / development prototype parts may give a distorted view of development project costs, leading to poor decision-making and low risk-taking, eg., regarding design changes and experimentation in the development phase of the product life cycle.

So ...

1) Do I have a case that I can make to management for NOT including shop burden to engineering / development prototype parts?

2) Are there other considerations I need to include (eg. development tax write-offs)?

3) What are your recommendations (links, papers, reports, books) for the most authoritative sources on this topic?
posted by ZenMasterThis to Technology (6 answers total) 3 users marked this as a favorite
I do not have a good answer to this question other than noting that my organization also applies machinist labor hours to engineer/development prototype parts. I've always thought that makes sense, as the company should know the full cost of prototyping (which is quite high).
posted by saeculorum at 12:08 PM on August 5, 2016

It has been a while since I managed hardware engineering projects (for Hewlett-Packard and Tektronix), but I think I still remember how we accounted for project cost :). I'm not sure exactly what is counted in your "shop burden" number, but if it is things like depreciation on manufacturing equipment, facilities costs, etc.. , that would be applied to the Standard Manufacturing Cost for prototypes. Using these numbers as well as the standard or expected direct labor and parts costs is going to be a lot more favorable to a development project than using actuals, I think. You have to charge the project for prototypes -- on a hardware project, prototype cost and timing is a significant part of the project budget.

This will reduce the COGS for your production parts, but only slightly unless prototyping is a significant amount of what that shop does.
posted by elmay at 12:17 PM on August 5, 2016 [1 favorite]

Where would you allocate it if not to where it is? Especially with cost accounting, costs go where they are spent. Is there some sort of bonus tied to a department that is eating the cost and thus reduced bonus?
posted by AugustWest at 12:19 PM on August 5, 2016

Your should charge these costs to Research and Development, or some such cost center.

Another consideration, where it applies, is sales and use tax. Presumably your inputs are not charged sales tax because they will become outputs, and then will be sold to clients. Full sales tax is then charged. If, however, your inputs are used internally, like these prototypes, then use tax may be due. Consult your sales and use tax specialist to be sure.
posted by Midnight Skulker at 12:21 PM on August 5, 2016

At our company, fixed overhead only gets divided by the 1st quality, finished goods meant for sale. The denominator to this equation is based on a production schedule/forecast for 12 months and is reset once per year. (There is also some weighting of the overhead based on the labor minutes and machine minutes on the item route/BOM)

When we have to prototype, the cost of prototype is charged a labor rate that estimates the overhead. So for example, if the full burdened rate for the equation above is $30 / hour, the ROI/managerial accounting for the project is charge $30 / hour, but that $30 doesn't actually absorb overhead or anything. The actual cost of the prototyping is charged to PD (product development) at the tech's labor rate $20 / hour.

By no means is that what I'm saying you should do, but it's just an example of the costing model being different.
posted by TomFoolery at 12:23 PM on August 5, 2016 [2 favorites]

Canada has a quite favourable tax credit for research and development projects. It is normal to charge staff time to these projects to get a credit back.
posted by crazycanuck at 7:57 PM on August 5, 2016

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