Activity-Based Management Improves Processes and Profitability - Case Study Example

Tijuana Bronze Machining Use the information in Exhibit 2 to calculate the EXACT product costs PER UNIT for valves, pumps and flow controllers that are reported in Exhibit 1, Show your calculation. This would include a detailed presentation of the predetermined overhead rate used in the calculations. 35 % of Depreciation of machine = $270000 55 % of Engineering = $100000 Receivable = $20000 Packing and shipping= $60000 Handling =$200000 Maintenance = $30000 Labor set up = No. of hours spend on work by LPh = 168 x 16 =2688 Total Cost = $(30,000+200,000+60,000+20,000+100,000+270,000+2,688) = $ 68,2688 Thus total run labor = Cost of labor per hour by total run labor hours Hence = ($16 x 9,725 hrs) = $155, 600 Since (total overhead cost/total run labour) is equal to predetermined over head rate then POR= {Total overhead cost / Total Run labor} POR= ${68, 2688/ 155, 600) = 4.39% In order to determine manufacturing overhead we calculate; = Direct labor X 439(16lph X Run labor hours per unit) hence we are able to determine total production per unit as follows: Product (Valves) Explanation Cost Manufacturing overhead (4.39% X 4) 17.548 Materials   $16 Direct labor based on run labor (16% X 0.25) 4 Total standard cost   $38 Pumps     Manufacturing overhead (4.39% X 8) 35.096 Materials   $20 Direct labor based on run labor (16 X 0.50) 8 Total standard cost   $63 Flow Controllers     Direct labor based on run labor (16 X 0.40) 6.4 Materials   $22 Manufacturing overhead (4.39% X 6.4) 28.0768 Total standard cost   $56 2. No change Contribution margin = Sales - variable cost Since Mary Ford stipulated that, “In our situation, the only short-run variable cost is direct material" then the material cost can be considered to be the variable cost 3. This is using Mary Ford’s comments on a “more modern view” that uses material related overhead as well as additional overhead allocations. All products should have Per Unit Costs calculated and show all overhead computations Overhead cost = Materials handling + receiving cost MOC= $ (20,000+ 200,000) = $220000 Overhead rate based on materials cost= $ {220,000/458,000} Overhead rate based on materials cost= 0.480 (48%) Other overhead costs include Engineering = $100,000 Machine depreciation = $ 270,000 Main = $30,000 Packing and shipping = $60,000 Total overhead = $ 460,000 Overhead rate based on machine hours= ($460,000/ 10,800 hours) One machine =$ 42.59/hr Setup labor cost= [(Labor hour x Set-up Labor)/total units] = [ ($16 X8)/7500] = $0.02 Pumps = ($16 X 8)/12,500 = $0.01 Flow Controllers= ($16 X12)/4000 = $0.048 As a result, the product costs per unit is as shown in the table below: Product Explanation Cost Valves     Direct labor (16 X 0.25) 4 Setup labor   $0.02 Materials   $16 Other overhead ($42.59 X 0.5) 21.30 Materials overhead (0.480 X 16) $7.68 Total cost   49.00       Pumps     Setup labor   0.01 Materials overhead (0.480 X 20) 9.6 Other overhead ($42.59 X 0.5) 21.30 Direct labor (16X 0.50) 8 Materials   $20 Total cost   58.91 Flow Controllers     Direct labor (16 X 0.40) 6.4 Materials overhead (0.480 X 22) 10.56 Other overhead ($42.59 X 0.2) 8.52 Materials   $22 Setup labor (439% X 6.4) = 0.048 Total cost   $48 4. ABC method – show Per Unit and Total costs for all three products 5. No change 6. Prepare table that compares the results for the 3 products. You should show the Standard Cost, Gross Margin, and Gross Margin percentage-- Per Unit— for each product. Describe which system you favor and briefly explain your reasoning. You will be doing a more thorough analysis of your recommendations in Question 8 PUMPS Activity Rate Activity ABC Cost Materials 20 12,500 250,000 Labor 8 12,500 100,000 Overhead: Setup Labor 0.05 640 Receiving 0.3 3,800 Material Handling 3.04 38,000 Pack/Ship 1.11 13,800 Engineering "2.40" 30,000 Maintenance "1.39" 17,400 Machine Deprec "12.5" 156,250 Total Overhead "20.79" 259,890 Total Cost "$48.79" $609,890.00 FLOW CONTROLLER FLOW CONTROLLER Activity Rate Activity ABC Cost Materials 22 4,000 88,000 Labor "$6.40" 4,000 25,600 Overhead: Setup Labor 0.48 1,920 Receiving 3.9 15,600 Material Handling 39 156,000 Pack/Ship 10.95 43,800 Engineering "12.50" 50,000 Maintenance "0.53" 2,100 Machine Deprec 5 20,000 Total Overhead "72.36" 289,420 Total Cost "$100.76" $403,020.00 Valves Pumps Flo Contr Total Materials 120,000 250,000 88,000 458,000 Labor 30,000 100,000 25,600 155,600 Overhead: Setup Labor 128 640 1920 2688 Receiving 600 3800 15,600 20,000 Material Handling 6000 38,000 156,000 200,000 Pack/Ship 2400 13,800 43,800 60,000 Engineering 20,000 30,000 50,000 100,000 Maintenance 10,500 17,400 2,100 30,000 Machine Deprec 93,750 156,250 20,000 270,000 Total Overhead 133,378 259,890 289,420 682,688 Total Cost "$37.78" $48.79 $100.76 $1,296,288 Valves Pumps Flo Contr Total Materials 120,000 250,000 88,000 458,000 Labor 30,000 100,000 25,600 155,600 Overhead: Setup Labor 128 640 1920 2688 Receiving 600 3800 15,600 20,000 Material Handling 6000 38,000 156,000 200,000 Pack/Ship 2400 13,800 43,800 60,000 Engineering 20,000 30,000 50,000 100,000 Maintenance 10,500 17,400 2,100 30,000 Machine Deprec 93,750 156,250 20,000 270,000 Total Overhead 133,378 259,890 289,420 682,688 Total Cost "$37.78" $48.79 $100.76 $1,296,288 When one compares two systems of cost, no difference comes up in the net income. This is so since different systems of assigning cost are displayed in each month, which in turn results in identical costs being reached. 7. This question is asking about the potential problem with the flow controllers. We have 10 components and 10 runs per month. What are some potential changes (ABM) that we might consider and what are the potential savings? Make some changes and assumptions to some factors and show how there is a potential for savings on this product cost Values Pumps Flow Controller Standard Cost 37.56 56.56 3.12 Actual Selling Price 57.78 97.07 81.26 Gross Margin 20.22 40.57 18.14 %Gross Margin 35% 42% 22% Revised Cost 49 47.96 58.95 Gross Margin 8.78 49.11 22.31 %Gross Margin 15% 51% 27% ABC Cost 37.78 100.76 48.79 Gross Margin 20 -3.69 32.47 %Gross Margin 35% -4% 40% The analysis shows that the Gross margin changes significantly as a result allocations in accounting for three product lines. The Gross margin is influenced by the flow of controllers falling. Higher proportions on flow controllers are given out by the ABC system. Thus, I prefer the ABC system over the others. 8. What recommendations do you have for management regarding all 3 products. Be specific. Support your recommendations with explicit analysis. You should investigate how the firm is doing overall (using the sales and cost estimates given and how your recommendations might change the results. Each product requires discussion of the product (price, market competition, etc) and recommendations for each. This should be detailed and supported by calculations where appropriate. Your case grade is heavily dependent on the quality of your analysis and recommendations for this question The organization requires 10 components/ten runs/month for one hundred receipts and two hundred materials handling with suppliers. Receiving Materials = $ (20,000 + 200,000) = $220,000 = $20,000 +( 0.6x 200,000) = $140,000 The total receiving and material handling costs is 1/10 the cost ($14,000). Total Cost of Flow controller purchased = $88,000/month 9. NEW QUESTION – After reviewing the recommendations and discussion, TBM decided to investigate the effects of some changes to the Flow Controllers that could simplify the production process and potentially reduce the cost of this product line. You have been asked to recalculate the cost of Flow Controllers using the following information and report back on the potential results. You should calculate the new per unit cost (only for the Flow Controllers) and give you opinion as to whether you would recommend the changes. Engineering decided to redesign the flow controllers and with the help of a couple key suppliers was able to come up with the following: Flow controllers redesigned to consist of only 4 components costing a total of $20. We would still produce 4000 units, but the number of production runs would be reduced to 5 per month—which had a significant impact on the number of material handling transactions (see recalculation below!!). The potential savings in material handling is significant—reducing MH costs room $200,000 to $80,000. We would still have 22 shipments. Calculate the potential savings and the effect on the product cost. Remember to check changes in: 1. Flow controllers will now have 20 transactions (4 components x 5 runs) or 41% of the total transactions (Valves 8%, Pumps 51% and Flow controllers 41%), and 2. Setup labor— what is the effect if we make these changes. Run Labor will also be reduced to 0.25 hours per unit. Discuss your analysis and your recommendations. I would recommend the management to reduce the Cost used for pumps. This is can be achieved by reengineering processes in order to use a lower cost on production. This can be done by introducing automatic pumps, which will reduce labor cost significantly. The organization can also consider increasing the price of their products in order to complement the high cost of production. The changes made in the production of flow controllers are responsible for the tremendous change in costs such as material handling costs from $200,000 to 80,000. This is more than 50% of the cost reduction. The analysis shows that the reduction in production runs helps reduce the costs of producing flow controllers. This is because fewer hours are spent on the production runs as compared to the previous case. This paper recommends that the company should adopt the new change; that is, reduce the number of production runs for flow controllers from 10 to 5 so as to reduce the costs. Also the run labor has been reduced to 0.25 hours hence reducing labor costs. Finally the, machine handling costs should also be maintained at $80,000.This would in the long-run increase the gross margin of the company in production of flow controllers. Product cost per unit = Material cost of components per unit + Labour cost (standard run labor times) + Overhead cost per unit. Depreciation of machine = $270000 Engineering = $100000 Receivable = $20000 Packing and shipping= $60000 Handling =$200, 000 Maintenance = $30000 Labor set up = No. of hours spend on work by LPh = 168 x 16 =2688 x 0.25 = 672 Total Cost = $(30,000+200,000+60,000+20,000+100,000+270,000+672) = $ 680,672 Thus total run labor = Cost of labor per hour by total run labor hours Hence = ($20 x 9,725 hrs) = $194,500 Since (total overhead cost/total run labour) is equal to predetermined over head rate then POR= {Total overhead cost / Total Run labor} POR= ${680, 672/ 194, 500) = 3.48% Work Cited Plowman, Brian. Activity based management improving processes and profitability. Aldershot, Hants, England: Gower, 2001. Print. Read More