Case 2 : Destin Brass Products Co. Question 1 Use the Ove Over head head Cost Cost Acti vity An alysis alysis in E xhi bit 5 and other dat data a on manu f acturi ng costs costs to es esti mate product costs costs for valves valves, pum ps and f low contr oll er s.
Standard Unit Cost Valves
Materials
@439%
Flow Controllers
$16.00
$20.00
$22.00
4.00
8.00
6.40
17.56
35.12
28.10
$37.56
$63.12
$56.50
Direct labor Overhead
Pumps
of
direct labor $ Standard unit cost
Revised Unit Costs Valves
Pumps
Flow Controllers
$16.00
$20.00
$22.00
7.68
9.60
10.56
Set-up labor
.02
.05
.48
Direct labor
4.00
8.00
6.40
21.30
21.30
8.52
$49.00
$58.95
$47.96
Material Material overhead (48%)
Other overhead (machine hour basis) Revised standard cost
Activity-Transaction-Based Costs
Material Direct labor Total direct cost
Valves
Pumps
Flow Controller
$16.00
$20.00
$22.00
4.00
8.00
6.40
20..00
28.00
28.40
Total indirect cost
17.76
20.87
72.17
$37.76
$48.87
$100.57
Budgeted quantity
Budgeted
indirect cost
of cost allocation
cost rate
$270000
10800 hours
$25 per hour
2688
168 hours
$16 per hour
129 transactions
$155.04
allocated Total cost per unit
* Worki ngs
Activity
Machine depreciation Set-up labor Receiving
Total
budgeted
20000
indirect
per
transactions Material handling
2000000
129 transactions
$1550.39
per
transactions Engineering Packing & shipping
1000000
20%/30%/50%
60000
30 transactions
$2000 transactions
Maintenance
30000
10800 hours
$2.78 hour
Valves Total
Unit
Direct materials
$120000
$16.00
Direct labor
30000
Total direct cost
$150000
$20.00
$93750
$12.50
Direct cost
4
Overheads
Machine depreciation Set-up labor
128
0.02
Receiving
620.16
0.08
6201.55
0.83
Materials handling Engineering
20000
2.67
per
Packing and shipping Maintenance
2000
0.27
10425
1.39
Total overheads
133124.71
17.76
Total cost
$283124.71
$37.76
Total
Unit
$250000
$20.00
100000
$8.00
$350000
$28.00
Machine depreciation
$156250
$12.50
Set-up labor
640
0.05
Receiving
3875.97
0.31
Materials handling
38759.70
3.10
Engineering
30000
2.40
Packing and shipping
14000
1.12
Maintenance
17375
1.39
Total overheads
$260900.67
$20.87
Total cost
$610900.67
$48.87
Total
Unit
Direct materials
$88000
$22.00
Direct labor
25600
6.40
Total direct cost
$113600
$28.40
$20000
$5
Pumps
Direct cost
Direct materials Direct labor Total direct cost Overheads
Flow Controllers
Direct cost
Overheads
Machine depreciation
Set-up labor
1920
0.48
Receiving
15503.88
3.88
Materials handling
155038.80
38.76
Engineering
500000
12.50
Packing and shipping
44000
11.00
Maintenance
2200
0.55
Total overhead
288662.68
72.17
Total cost
402262.68
100.57
Question 2 Compare the es esti mated costs costs you calcu l ate to existin g standar standar d un i t costs costs (Exh (E xh ibi t 3) and the revised unit costs (Exhibit 4). What causes the different product costing methods to produ ce such dif f erent r esul ts? ts?
PUMPS
$37.56
$63.12
$56.50
$49.00
$58.95
$47.96
(11.44)
4.17
8.54
STANDARD UNIT COST REVISED
FLOW
VALVES
UNIT
COST VARIANCE
CONTROLLERS
Based on the table above, there is a difference in the unit cost. The difference is due to the allocation of overhead of each activity. The calculation of unit cost is divided into direct cost and indirect cost.
The direct cost for both costing methods contain material and direct labor but for revised costing, they have an additional direct cost, which is the set-up cost taken from the overhead cost. As for the indirect cost, under the standard costing, allocation of total overhead cost was assigned to the production on the basis of production-run labor cost. For every $1.00 of run, it will cause $4.39 of overhead to be allocated to the product which labor was applied.
Under the revised costing, the overhead is being divided into material related and other overhead . The material related overhead includes includes the receiving and overhead and materials handling cost which has a rate of 48% of material cost and the rest of the overhead cost is allocated under other overhead. The total overhead under the other overhead is then divided by the total machine hour, which has a rate of $42.59 per
machine hour hou r.
Below is the summary of the allocation of overhead for each type of costing method.
COSTING
DIRECT
METHOD
COST
STANDARD UNIT COST
INDIRECT COST (OVERHEAD)
Machine depreciation
Material
Set-up labor
Direct labor
Receiving
Materials handling
Engineering
Packaging and shipping
Maintenance
Total Labor run = 9,725 hours h ours x $16 = $155,600
Overhead rate = 682,688/155,600 = 439%
Material related
Material
Direct labor
Set-up cost
REVISED
Other overhead
overhead
Receiving
Materials handling
Machine depreciation
Engineering
Packaging
and
shipping
UNIT COST
Overhead
absorption
Maintenance
rate = $220,000/$458,000 = 48% (material cost
Overhead absorption rate = $460,000/10,800hours =$42.59/machine hour
basis)
Questions 3 What are the strategic implications of your analysis? What actions would you recommend recommend to t o th e managers at Desti Desti n B r ass ass Products Co? Co?
Valves
Pumps
Flow Controllers
Standard unit cost
$37.56
$63.12
$56.50
Revised standard cost
$49.00
$58.95
$47.96
ABC Total Total cost per pe r unit
$37.76
$48.87
$100.57
As per the above summary calculation, we believe that the activity based costing system ABC is the best choice for the managers at Destin Brass Products Co in order that they can solve their over costing problem of their pumps, which covered almost 55% of the company's revenue, and to maintain their position as a competitive supplier in the market. By following the activity based costing system; the company would reduce the pump cost by almost 30% in comparison to the standard cost and about 20% in comparison to the revised cost. Although, the ABC system will raised the cost of the flow controllers to $100.57 (+50%) but we believe that this increased will not affect the company since the competition in this products is very low and this product is representing only 21% of the total revenue. The valve price will not have a significant change by applying the ABC system in comparison to the standard price.
Generally, the activity based costing is the best system for Destin Brass Products Co to reinforce their position and standing as being competitive in their products pricing.
Question 4 Assume Assume that i nte nt er est in i n a ne n ew basi basi s f or cost accoun accounti ti ng at D esti n B r ass ass Products Pr oducts remains hi gh. I n th e f oll owing mon th, quan titi es produced produced and sold, sold, activiti es, and cost cost were were all at standard. standard. H ow much hi gher or lower woul d the net net in come come reported reported under under the th e activi ty-tr ansacti ansacti on-based on-based sys system tem be than th an th e net in come th at wil l be reported un der der the th e prese present, nt , more tr aditi onal system? ystem? Why?
Total production/sold
Valves
Pumps
Flow Controllers
7,500 units
12,500 units
4,000 units
Cost per unit:
Traditional
$37.56
$63.12
$56.50
Activity-transaction- based
37.76
48.87
100.57
Selling price (actual)
57.78
81.26
97.07
NET INCOME (TRADITIONAL) Valves
Pumps
Flow Controllers
Sales
Valves (7,500 unit x $57.78)
433,350
Pumps (12,500 unit x $81.26)
1,015,750
Flow Controllers (4,000 unit x $97.07)
388,280
Less : Cost of Goods Sold
Valves (7,500 unit x $37.56)
281,700
Pumps (12,500 unit x $63.12)
789,000
Flow Controllers (4,000 unit x $56.50) Gross Profit/Net Income
226,000 151,650
TOTAL TOT AL NET INCOME
Gross Margin
226,750
162,280
540,680
35%
22%
42%
NET INCOME (ACTIVITY-TRANSACTION-BASED) Valves
Pumps
Flow Controllers
Sales
Valves (7,500 unit x $57.78) Pumps (12,500 unit x $81.26) Flow Controllers (4,000 unit x $97.07) Less : Cost of Goods Sold
433,350 1,015,750 388,280
Valves (7,500 unit x $37.76)
283,200
Pumps (12,500 unit x $48.87)
610,875
Flow Controllers (4,000 unit x $100.57) Gross Profit/Net Income
402,280 150,150
TOTAL TOT AL NET INCOME
on
the
above
(14,000)
541,025
Gross Margin
Based
404,875
35%
calculation,
the
40%
net
income
(4%)
reported
under
activity-transaction-based system is higher than traditional system by $345. This is due to the difference of gross margin for pumps and flow controllers under the two systems. The gross margin for valve is same under both systems while pumps and flow controllers is 18% higher and 46% lower than traditional system respectively. Even though flow
controllers gross margin is much lower under activity-transaction-based, but higher gross margin and higher demand for pumps will generate more revenue to the company and could cover loss make by flow controllers.
