...Individual Paper: Activity-Based Costing Matija Karaula Individual Paper: Activity-Based Costing Sippican Corporation Course: B2B Pricing: Negotiation, Calculation, and Strategy Matija Karaula B2B Pricing: Negotiation, Calculation, and Strategy Individual Paper: Activity-Based Costing 1) Defining the problem The main problem of a Sippican corporation was a low pre-tax operating income (1.8%). To solve that problem, a cause had to be found. Sippican reported gross margins of 35% on valves, 5% on pumps and 38% on flow controllers. After looking at a gross margins of the three product lines, one would think that pumps were an issue to work on, and a main cause for a low operating income, because the pump sales accounted for 47,36% of a total sales in March with just 5% operating margin. However, the method of measuring the product profitability had to be questioned. To be more accurate, the method of assigning the overhead costs to each product line was the reason for inaccurate gross margins of the Sippican´s product lines. Exhibit 1 – Result of a wrong overhead cost assignment Wrong assignment of overhead costs Innacurate product profitability Inappropriate product pricing strategy Lower operating income The method of calculating the manufacturing overhead used by Sippican would be accurate if every of their three product lines was of the same or similar complexity. More complex products require more indirect work so one cannot simply...
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...Sippican Case 1. What are the pitfalls for companies who do not allocate overhead costs to its products? (See Knight’s comments on page 2 regarding his competition). How can this influence pricing and profitability? Why might a company do this and what other controls would they have to implement to insure optimal performance? 2. Based on Sippican’s current method for allocating overhead costs, See page 2 “overhead costs are allocated to products @ 185% of direct labor costs,” calculate the amount of total overhead costs allocated and applied to each product during the month of March? Based on this allocation, was the amount of overhead under or over applied for the month? Whether under/over applied, why do you think this was the case? Provide some insight as to why direct labor cost may not be an optimal cost driver in allocating indirect costs? 3. Using the monthly production data in Exhibit 4, allocate the actual (5) overhead costs pools to each of the 3 Sippican products. How does this revised allocation impact gross margin and targeted selling price for each product? Comment on the cost benefit of Sippican moving away from a single cost driver allocation of indirect expenses to a multiple, what are the additional benefits and cost and how would you advise the company to proceed. 4. Take a look at the Apple article, what other indirect costs might be allocated to this product within Apple, and how do you think such costs should be allocated between the...
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...Sippican Corporation Questions: 1. Given some of the apparent problems with Sippican’s cost system, should executives abandon overhead assignment to products entirely and adopt a contribution margin approach in which manufacturing overhead is treated as a period expense? Why or why not? Answer: Consider Sippican is a manufacturer company with multiple products, using simple cost accounting system that directly allocate factory overhead to unit of product entirely through one single allocation base (i.e. 185 % of production run direct labor cost in this case) is although an inexpensive way while is sometimes distort actual contribution of the product. To our understanding from reading the article, Sippican is spending more on overhead than on either direct material or direct labor. Further, Sippican has considerable diversity in its product mix. Each product may contain different degree of spending on indirect or supporting resources, and high variety on product and consumer characteristics. As such, activity-based cost system is considered to be a more accurate costing of present resource that will enable Sippican to project its future resource demands more effectively. 2. Calculate the practical capacity and the capacity cost rates for each of Sippican’s resources: production and setup employees, machines, receiving and production control employees, shipping and packaging employees, and engineers. Answer: See the Q2 worksheet. 3. Use these capacity cost rates...
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...------------------------------------------------- Sippican Corporation A manufacturer of hydraulic control devices – valves, pumps & flow controllers. Currently the company is undergoing a severe economic impact from price cutting in pumps one of its major product lines. This has led to decline in its profits in this line of business – (as illustrated below) | Sales | 1847500 | | | | Variable Expenses | 809000 | | | | Contribution | 1038500 | 56.21% | | | | | | | | Machine related expense | 334800 | | | | Setup Labour | 117000 | | | | Receiving & production control | 15600 | | | | Engineering | 78000 | | | | Packaging & Shipping | 109200 | | | | | | | | | Manufacturing Overhead | 654600 | 35.43% | | | | | | | | Gross Margin | 383900 | 20.78% | | | Other Expenses | 350000 | | | | Operating Income (pre-tax) ROS | 33900 | 1.83% | | The company’s gross margin is expected to be 31% whereas as shown in the exhibit it is currently at 21%. Return on sales is 1.8% which is far below the target of 15-20% that the company has been realising in the past. Sippican had recently raised the price of its flow controllers by more than 10% but yet failed to achieve any good financial results It operates at a simple cost accounting system that directly charges each unit of product for its direct labour and material cost (exhibit 3) * Material cost is based on the prices paid for components under annual purchasing...
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...Harvard Business School 9-195-165 Rev. April 21, 1998 AT&T Paradyne Our Design and Manufacturing Engineering groups are using Activity-Based Cost (ABC) along with quality and cycle time information to make life-cycle cost decisions. —ABC/ABM Team Leader The Company AT&T acquired Paradyne Corporation, a company specializing in the data communications equipment, in February, 1989. Operating as a wholly-owned AT&T subsidiary, AT&T Paradyne designed and produced medium-and high-speed data communications equipment that provided the interface between telephone networks and computers. AT&T Paradyne, in 1994 employed approximately 3,000 team members and generated about $500 million in sales. The company faced intense competition in all of its market segments —digital service units, modems, network management systems and services, multiplexers, and channel extension devices. No competitor had more than one-third of any market, each product market had a different leader, and, in most cases, five or six competitors represented 95% of the market. The company's headquarters was located in Largo, about midway up the western (Gulf) coast of Florida, in a 525,000 square foot facility. Product research and development were done both at the Largo facility and at AT&T Bell Laboratories facilities in Middletown, New Jersey. Total Quality Management AT&T Paradyne's General Management Team (GMT), consisting of the President and direct reports, launched a Total Quality...
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...Introduction Hindustan Unilever Limited (HUL) is India's largest Fast Moving Consumer Goods Company with a heritage of over 80 years in India and touches the lives of two out of three Indians. With over 35 brands spanning 20 distinct categories such as soaps, detergents, shampoos, skin care, toothpastes, deodorants, cosmetics, tea, coffee, packaged foods, ice cream, and water purifiers, the Company is a part of the everyday life of millions of consumers across India. HUL works to create a better future every day and helps people feel good, look good and get more out of life with brands and services that are good for them and good for others. By combining multinational expertise with our deep roots in diverse local cultures, HUL is continuing to provide a range of products to suit a wealth of consumers. HUL is thriving to strengthen strong relationships in the emerging markets as they believe that it will be significant for the future growth of the organization. With these economic and social objectives in mind HUL started project Shakti to tap the vast market of rural India. Project Shakti Intense competition and saturated urban markets made FMCGs look at rural markets. 70% of India’s population lives in rural areas and therefore they hold great potential notwithstanding the low income levels. Government measures like loans waiver, national rural employment guarantee scheme (NREGS) and higher minimum support price for agriculture produce have resulted in higher disposable...
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...Overview The review of the financials at Sippican Corporation provided some interesting insights. Due to the apparent issues with the company’s current cost system, executives at Sippican Corp. have some decisions to make regarding the future of the company’s costing system. Appendix A offers a time-driven activity-based costing system approach to Sippican’s financial woes. Quantitative Summary Calculations (Appendix A) reveal that utilization of an time-based activity costing system provides a more detailed analysis of the amount of time (in minutes) each unit, or employee/machine actually uses versus the amount of time that is actually available for work. This analysis also details how much money is being wasted under Sippican’s current system. For example, none of the activities listed are being used at 100% capacity, meaning that a percentage of the dollars being attributed to any given activity are being attributed in excess. Sippican could reduce their own costs by only paying for resources consumed, rather than using a more general overhead allocation system. Recommendations Based on revised cost and profitability estimates, Sippican’s management team should first consider implementing a time-driven activity-based costing system. Such a system will provide clearer insight into where direct labor and machine hours are really going, making it easier to better allocate machine and labor time wherever needed. Currently, some workers are operating several of the machines...
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...1. Given some of the problems with Sippican’s cost system, should executives abandon overhead assignment to product entirely and adopt a contribution margin approach? Why or why not? The overhead spending is greater than the direct labour costs or the direct material costs for all three product lines- Valves, Pumps and Flow Controllers (Exhibit 2). Overheads are simply charged at 185% constant for three diverse products. The fact that there is huge variance in the number of units produced per production run- it is 375 for valves and 18 for flow controllers per production run. This shows the reason for high overheads cost too. Hence it calls for checking the cost allocation system of the company. Since Sippican produces three different products which comprise of different components, processes for all three need to be customised and refined to bring in any kind of standards. Variations in batch size owing to the machining constraints etc. are brought in by a disparity in the time required for production runs of all three products. Even on increasing the price of the flow controllers the demand for the product did not go down, this gives an indication of the faulty pricing system. Because of these reasons it seems that we should check the cost allocation system of the company. 2. Calculate the practical capacity and the capacity cost for each of the Sippican’s resources: production and setup employees, machines, receiving and production control employees, shipping...
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...What-If Analysis and Activity-Based Budgeting Forecasting Resource Demands Excerpted from Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits By Robert S. Kaplan, Steven R. Anderson Harvard Business Press Boston, Massachusetts ISBN-13: 978-1-4221-2227-3 2227BC Copyright 2008 Harvard Business School Publishing Corporation All rights reserved Printed in the United States of America This chapter was originally published as chapter 5 of Time-Driven Activity-Based Costing: A Simpler and More Powerful Path to Higher Profits, copyright 2007 Harvard Business School Publishing Corporation. No part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwise), without the prior permission of the publisher. Requests for permission should be directed to permissions@harvardbusiness.org, or mailed to Permissions, Harvard Business School Publishing, 60 Harvard Way, Boston, Massachusetts 02163. You can purchase Harvard Business Press books at booksellers worldwide.You can order Harvard Business Press books and book chapters online at www.harvardbusiness.org/press, or by calling 888-500-1016 or, outside the U.S. and Canada, 617-783-7410. chapter five WHAT-IF ANALYSIS AND ACTIVITY-BASED BUDGETING Forecasting Resource Demands the full benefits from Time-Driven ABC only if they adjust the supply of...
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...ASSIGNMENT QUESTIONS CASE SIPPICAN (A) 1 – What is the competitive situation faced by Sippican? 1 - Qual é a situação da concorrência enfrentada pela Sippican? • Produtos maduros • lucros em declínio • Incapacidade de explicar as decisões de preços no mercado local - altas margens e pouca concorrência de preços em uma linha; pressão sobre os preços continua. 2 – Given some of the apparent problems with Sippican’s cost system, should executives abandon overhead assignment to products entirely and adopt a contribution margin approach in which manufacturing overhead is treated as a period expense? Why or why not? 2 - Tendo em conta alguns dos problemas aparentes com o sistema de custo de Sippican, os executivos devem abandonar custeio por absorção aos produtos inteiramente e adoptar uma abordagem de custeio por margem de contribuição em que a absorção de produção é tratada como despesa do período? Por que ou por que não? Os executivos da Sippican não deve abandonar o custeio por absorção dos produtos. A margem de contribuição é a receita menos os custos variáveis. • Análise com base em margens de contribuição unitária pode ser útil para as decisões de curto prazo, tais como se a aceitar uma ordem de uma só vez quando estiver operando com excesso de capacidade. Neste caso, a gestão está preocupada com recorrentes vendas. • custos indiretos é considerável (654,6 mil dólares, o que ultrapassa qualquer mão de obra direta ou os custos de materiais diretos) ...
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...Teaching Plan This is an introductory case, and yet it introduces a powerful new approach for building an ABC model. Considerable theory is illustrated in how we build the Sippican time-driven ABC (TDABC) model. Also, the (B) case introduces an important link, previously recognized but not exploited, in how to embed an ABC model into the budgeting process, replacing line-item budgeting with an integrated, analytic approach. The case discussion provides insight and confidence about the feasibility of building a TDABC model, especially in the face of resistance from finance people who claim that ABC is too complex to implement. 1. Given some of the apparent problems with Sippican’s cost system, should executives abandon overhead assignment to products entirely and adopt a contribution margin approach in which manufacturing overhead is treated as a period expense? Why or why not? 2. Calculate the practical capacity and the capacity cost rates for each of Sippican’s resources: production and setup employees, machines, receiving and production control employees, shipping and packaging employees, and engineers. 3. Use these capacity cost rates and the production data in Exhibits 3 and 4 to calculate revised costs and profits for Sippican’s three product lines. What difference does your cost assignment have on reported product costs and profitability? What causes the shifts in cost and profitability? 4. Based on the revised cost and profitability...
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