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Elmahie Elshikh Elajab Elshikh MR08 1123
Haidar Habib Mustafa MR08 1124
Kaziwa Kader KhalidMR08 1142
Safnimarina Safian MR06 1029
As time goes by, it becomes clear to me that our competitions are crazy. Pumps are a
major product in a big market for all of us, but with the prevailing price cutting mentality
no one will be to sell pumps profitably as long as we all are forced to match each others’
lower prices. I guess we should be grateful that competitors don’t play the same foolish
game in valves and flow controllers. Even with the 12 ½% price increases, we don’t see
any new competition in flow controllers.
List of Tables
Table 1.0: TBM performance ...............................................................................6
Table 2.0: TBM Product Profitability Analysis ........................................................7
Table 3.0: Product cost for valves, pumps and flow controller .................................8
Table 4.0: Contribution margin for valves, pumps and flow controller .......................9
Table 5.0: Revised product costs ....................................................................... 10
Table 6.0: Comparison between standard costs and revised standard cost of TBM ... 11
Table 7.0: Product cost based on ABC approach ................................................. 12
Table 8.0: Product Profitability under 3 products costing system ........................... 13
1.0 Product Costs per unit for valves, pumps and flow controllers
Table 3.0: Product cost for valves, pumps and flow controller
Overhead rate
= $682,688
$155,600
= 4.387455013 or 439%
To estimate the contribution margins for the three products, the contribution
margin principle is used.
Taking the information from Mary Ford’s conversation, the product profitability will
be measured at the contribution margin level, which is price less all variable costs.
While the situation, only the short run variable cost is direct material.
Table 4.0: Contribution margin for valves, pumps and flow controller
After calculate the contribution margin, the Flow controller shows the most
contribution margin with $75.07 compare to valves and pumps are $41.78 and
$61.26 respectively.
But the amount of the contribution margin should not disregard the overhead cost
as because the marginal customers that willing to pay marginal prices are based
on marginal costs. From the outset, they have succeeded in part because they
insisted on trying to maintain the 35% gross margin including allocated
manufacturing overhead. So in order to try the modern view of the proper way to
allocate the cost question 3 leads to the revised product costs mentioned by Mary
Ford.
Based on the information in Exhibit 2, the revised product unit cost per “More
Modern View”
The significant of the calculation was first to identify the material related overhead
(the cost of receiving and handling material) and allocated that to each product
line based on the cost of material.
Receiving $20,000
Material Handling $200,000
Total $220,000
So material overhead
for the 3 products = 48% x Material Cost
The related overhead for the material of valves, pumps and flow controller are
$7.68, $9.60 and $10.56 respectively.
To calculate the revised standard cost, the other overhead is derived by calculating
the overhead allocation rate times the machine hours. This can be depicted in the
work flow below. To get the revised standard cost, the total up of materials,
material related overhead, setup labor, direct labor and other overhead is sum up.
Machines
Depreciation $ 270,000
Engineering $ 100,000
Packing and
$ 60,000
Shipping
Maintenance $ 30,000
Total $ 460,000
After the calculation, the revised standard cost for valves is $49.00, while pumps
are $58.95 and Flow controller is $47.96.The comparison calculation is depicted in
the table 6.0 below. The result of this revision made sense to the reason why the
competitors are chasing lower prices in the pump market. The revised standard
cost for pumps is more than $4.00 below the present standard and would show a
gross margin percentage of 27% compared to the current 22%.
Revised Standard
Products Standard Cost
Cost
Valves $37.56 $49.00
Pumps $63.12 $58.95
Flow Controller $56.50 $47.96
Based on the Exhibit 2 and Exhibit 3 information, the product costs for valves,
pumps and flow controllers is calculated using the “ABC” approach (Activity
Based Costing) as follows:
From table 7.0, it shows that using Activity Based Costing (ABC) the valves total
cost is $37.78, while a pump is $48.79 and the flow controller is $100.76. Based
from the ABC approach the cost can identify the costs pools, or activity centers
in the company and assigns the costs to products and services (cost drivers)
based on the number of transactions involve in the process of providing a
product. It is to be viewed to maximize shareholder value and improve the
company’s performance.
With the costing based on activities some advantages for the company is
identified:
Accurately predict costs, profits and resource requirements associated with changes
in production volumes, organizational structure and resource costs.
Easily identify the root causes of poor financial performance.
Track costs of activities and work processes.
Equip managers with cost intelligence to drive improvements.
Achieve better Positioning of products
From table 7.0 too, the company detect that the flow controller product cost
much more compared to the standard cost and the range of high or lower
amount is calculated for the following month, when the quantities produced and
sold, activities and costs were all standard.
After made a comparison between the two systems, there will be no difference.
Each month reflects two different methods of assigning the same actual costs to
the three products. The total results for the company will be identical.
ABC Cost
37.78 48.79 100.76
Gross Margin 20.00 32.47 -3.69
Gross Margin
% 35% 40% -4%
The total reported results are the same for the company under the three
methods. The accounting allocations for individual product lines change the gross
margins significantly. Product line profitability changes most significantly for
flow controllers under ABC, dropping from the highest gross margin product to a
loser. Given the "complexity" reflected in Exhibit 3 for flow controllers, the
activity/transactions costing system bears out the higher proportion of costs.
Therefore it is "better" than other systems. Also, although there could be
differences in some cost allocations such as engineering and maintenance, 100%
of the costs are allocated on a reasonable resource consumption basis using
ABC.
According to the case study, Flow Controllers require ten components for each of
ten runs per month for a total of 100 receipts and 200 material handling
transactions under the JIT arrangement with suppliers.
The total cost of both receiving and material handling is $220,000 ($20,000
receiving and $200,000 material handling).
Receiving and inbound handling is $140,000 of this total
($20,000 + 0.6 x $200,000)
Under a "just-in-case" or JIC practice where all components for a month's Flow
Controller production will be purchased together, the total receiving and material
handling costs will be only $14,000 (1/10 the cost). Some assumptions will be
necessary for calculating inventory storage and carrying cost charge. The total
cost of flow controller components purchased each month is $88,000. Assume
uniform production during the month so that the average inventory cost is
$44,000 (50% x $88,000). Assume carry costs are 100% per year, including a
capital charge for space, space costs (maintenance, etc.), handling costs (labor,
etc.), carrying costs (insurance, taxes, etc.), and cost of funds. Applying a
monthly carrying cost rate of 8.5% (100% / 12 months), the monthly storage
and carrying cost is $3,740 (.085 x $44,000). With a lower overall carry cost
percentage, this number is even lower.
If TBM can reduce the receiving and in-bound material handling costs, there is a
potential net savings of almost $1.5 million per year ($122,000 for 12 months)
by using monthly purchasing, versus JIT.
If we assume the $140,000 total costs are fixed, then there are no savings. But,
if all costs are totally fixed, who cares about any allocation scheme anyway?
This alone lowers cost by ~$30.5 per unit ($122,000 / 4,000 units) which yields
a 28% gross margin at current prices! [(97-70) / 97 = 28%].
Flow controllers
Even though TBM has added Flow
controllers to use idle capacity, but the
expenses for this product is very high it
is more obvious when we allocate ABC
system. It ensures that the company
makes losses on selling Flow controllers.
Looking back at the Planned Sales (assume volumes have not changed)
calculation:
Actual annual sales were only about $22 million at current prices. By assuming the
profit plan at planned prices produced an adequate return on investment; the
current situation is about 2 million of negative economic income.
They need to be earning about $2 million more profit per year, somehow!
As for the first option suggested to the management team, they can adding flow
controllers to the product line (to use idle capacity?) or doubled the manufacturing
complexity (4 or 5 components versus 10 components).
But one thing that they might have to consider is, is this a reasonable thing to do
in the factory?
Reason
If flow controllers were dropped, how much short-run cost-savings could be
realized? This question cannot be answered by ABC, which is not based on a
variable cost and fixed cost dichotomy. For example, one half the engineering
costs are subjectively assigned to flow controllers. But will $50,000 of engineering
cost be avoided if flow controllers were dropped?
This does not change the conclusion that on a fully allocated basis, flow controllers
have a negative gross margin, let alone providing any bottom line profit.
Given the "no-competition" market for flow controllers, perhaps the selling price
could be increased gradually, but who knows? Who are the customers? What do
they want? How much will they pay?
Given the uncertainty expressed by management in this market, there seems to
be little harm in this pricing strategy, assuming management wishes to keep the
product line after seeing the ABC results. But, one must note that the higher the
selling price, the more likely TBM will see some competition and/or reduced
demand.
And, if the purchasing policy is changed per Question 7, there is really no major
problem at all with flow controller profitability.
The selling price for flow controllers increased more than 12% this past month
while the selling price for pumps decreased more than 16%.
The ABC analysis indicates that pumps still have the highest gross margin (40%)
at the actual selling price. The gross margin would be 35% at a price of $75.06,
which would allow still further price cuts of $6.20 per unit.
Given by the commodity pricing pressure on pumps and if 35% is really TBM's
necessary gross margin before SG&A expenses to earn an adequate rate of
return, then a further 5% decrease to approximately $75 can be made without
harming the target gross margin. This assumes the ABC costs per unit do not
change.
There is a lot of buyer power in this market, so TBM must undertake cost
reduction and re-engineering programs to be the low cost producer. The case
says pumps require less precision manufacturing than valves. Pumps involve
only one more component than valves.
There are approximately 58 workers on board and average wage (plus benefits)
is $16 per hour. At 25% benefits, an approximate wage rate is $13 per hour,
which is on the high side for industrial manufacturing jobs along the Mexican
border at the time of the case.
Perhaps less skilled machinists could be used on the pumps (and flow
controllers)? Although automation is touted by management, direct labor
represents 12% of the total manufacturing costs. Again, some cost savings may
be possible. Also, eight hours for a set-up!
Apparently, the one valve customer is pleased with their quality and competitive
price. Competitors are not attempting price cuts. The case implies that
automation and efficient production processes are helping control costs and
efficiency. But is it good strategy for TBM to be dependent on a single customer
for valves?
The ABC gross margin is 35% for valves so no action seems necessary to raise or
lower prices.
As a result here is the general conclusion on what the team gets in the end of
this case study:
Based on the case study, the team had found out most of the questions asked
revolving around the ABC approach calculation which is approximately 50% of
the overall content of the case study. While another 30% revolved around on
how to determine the decision making by using the ABM concept and other 10%
respectively were on how to analyze the data generally and the correlation of
team work to determine the solution for the case study.
B OOKS
Drury, C. (2004). Management and Cost Accounting, 6th Edition. In C. Drury. Thomson.
Websites
(n.d.). Retrieved from stock.xchng - the leading free stock photography site: http://www.sxc.hu
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APPENDIX
23
Managerial Accounting: Group Project
Activity Based Costing
Question 1
Product Cost per Unit - Current System
tbm_CASESTUDY
Managerial Accounting: Group Project
Activity Based Costing
Question 2
Estimated Contribution Margin for the 3 products
tbm_CASESTUDY
Managerial Accounting: Group Project
Activity Based Costing
Question 3
Revised Product Unit Cost per "More Modern View"
Receiving $20,000
Material Handling $200,000
Total $220,000
So material overhead
for the 3 products = 48% x Material Cost
tbm_CASESTUDY
Managerial Accounting: Group Project
Activity Based Costing
Question 4
Products Costs Using Activity Based Costing
tbm_CASESTUDY.xlsx
Managerial Accounting: Group Project
Activity Based Costing
Question 5
Comparisons of Reported Income Between the Two Methods
There will be no difference. Each month reflects two different methods of assigning the same actual costs to the three products. The total results
for the company will be identical.
tbm_CASESTUDY
Managerial Accounting: Group Project
Activity Based Costing
Question 6
Comparison of Product Profitability Under Three product Costing System
tbm_CASESTUDY
GROUP ACTION PLANS
(Haidar; Elmahie; Kaziwa; Safni)
1. The case study title Case study All Review and read the
Tijuana Bronze handed on case study
Machining 29/08/09 Get the general idea
(Saturday) on what the case
study discussed
9. Recheck and correct Due till one day Recheck with Prof and members of classmates- Are we in
before the right track?
submitted date
Tijuana Bronze
25/10/09
11. Submit and present All Machining Case Study
(Sunday)
Complete
Need to be concise and precise in developing the report
Time to meet and discuss the project
Barriers Need full understand the ABC concept and trivial challenge
calculation questions
yang besar
1. Company’s Background
Description of the company history including:
o Business involved
o The company’s performance (for benchmark)
2. Company’s Effort
What they have done to capture the essence of global competitive
advantage
o The accounting calculation (questions given 1-7)
5. Conclusion
The report would be more precise on the calculations and the reasons behind it
(answering all the questions requirements)
Please feel free to add or delete as needed. Ideas on the outlines would be
much appreciated. Kindly inform me what you think (agree or do not agree or
want to change) about the dates provided on the table so that we can include
this group action plans in our report too.