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Unit 5 Research Project

Terra OBrien

Destin Brass Products Company is concerned with its level of competition and their product costing system. Peggy has discussed some of the issues facing the company with Roland and John. The following are overhead activities and the cost drivers associated with them: Overhead Activities Machine depreciation Setup labor Receiving Materials handling Engineering Packing and shipping Maintenance Cost Driver Increases with the amount of machine usage Increase with the amount of setup hours. Increases with the amount of shipments received Increases when products are produced and shipped Increases with amount of products produced Increase with amounts of products sent out Increases with the amount of machine hours used

After recalculating the costs with regards to the level of activity required by each product line, it was found that the prices charged for each product may not be appropriately aligned with the amount of resources required for each one. Specifically, valves and pumps are somewhat overpriced, flow controllers are underpriced. This discrepancy in pricing is due to how overhead is allocated to each product line in the different methods. It is clear from Exhibit 5 that flow controllers consume greater than 50% of the resources per month, with the exception of machine time (7%). However under the Standard Unit Cost and Revised Standard Cost methods, the other two product lines are actually subsidizing the cost of production of Flow Controllers (Table 1). This makes sense considering that management stated the increased price has not hurt demand; Destin is the only company willing to sell Flow Controllers at the low price(Table 2). From this analysis, I would recommend the following actions to the management team of Destin Brass: First, the price charged for flow controllers should be increased according to their high cost of production based upon activity. To meet the target gross margin of 35%, the cost of the flow controllers should be increased to $176.07 (130.42 x 1.35). Because the flow controllers are now bearing their share of the production costs, Destin can lower the price of their pumps to $52.64 and still recognize a 35% margin. This reduced price will likely make them more competitive in the pump market. Likewise, the price of valves could be reduced, however since only one customer is served and supply and demand seem matched, the higher price is likely acceptable and a better policy for maintaining income. If Destin would choose to

implement only the ABC cost method, the net income would remain the same. The accounting method only reallocates expenses; it does not increase or reduce any of the variables present. However, if Destin were to enact the changes in pricing suggested, and all other activities remained the same, we could expect an increase in net income. Hopefully, we could also anticipate an increase in sales of pumps as well, as the new pricing would be more competitive. Overall, a switch to the ABC method of cost accounting makes good sense for Destin Brass Co. The switch will help them better understand and respond to the pricing structure of their competitors and fairly price their products while maintaining adequate income. While a simple change of accounting methods will not directly affect their income, understanding the costs associated with each part of the production process, especially overhead, will help guide management to remain competitive within the industry. Costing Table Comparisons:

ABC Costing
Valves-7,500 120,000.00 (20*12500) Pumps-12,500 250,000.00 (22x4000) Flow Controllers-4,000 88,000.00

Direct Materials Labor: Setup Labor Manufacturing Labor Labor hours Total: Labor Cost Total: Overhead Cost Activites: Receiving Materials Handling Packing and Shipping Engineering Maintenance Overhead Total Total Units produced Cost Per Unit

(16*7500)

(0.25x7500)

8.00 8.00 1,875.00 (0.5x12500) 6,250.00 (0.4x4000) 1,883.00 6,258.00 30,128.00 100,128.00

12.00 1,600.00 1,612.00 25,792.00

6,000.00 6,000.00 1,800.00 20,000.00 10,500.00 44,300.00 194,428.00 7,500.00 25.92

38,000.00 38,000.00 13,800.00 30,000.00 17,400.00 137,200.00 487,328.00 12,500.00 $ 38.99

156,000.00 156,000.00 43,800.00 50,000.00 2,100.00 407,900.00 521,692.00 4,000.00 $ 130.42

Comparison of Costs per unit with various Accounting Methods


Valves Cost Per Unit Pumps Cost Per Unit Flow Controllers Per Unit 37.56 63.12 56.50 49.00 58.95 47.96 25.92 38.99 130.42

Standard Costs Revised Standard ABC

Table 2