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 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? Answer:
Currently, Sippican assigns overhead costs at a flat rate across all three products. While our analysis of cost and profitability reveals a dramatic difference between the cost to produce each product as reported using Sippican’s traditional costing structure and the detailed analysis using time driven activity based costing (see Q3 worksheet). Under the traditional costing structure, all three products are reported to have a positive gross profit margin. Pumps are reported to be the least profitable product with a 5% gross profit margin while flow controllers are reported to be the most profitable product with a gross margin of 38%. Our time based activity based costing analysis provides a clear picture of costs as they relate to the production of each specific product. Where flow controllers were thought to be the most profitable product, activity based costing reveals that flow controllers are actually produced at a negative margin. The shift in cost and profitability for flow controllers is found to be mostly related to the substantial costs to engineer the product and high cost of setup. 4. Based on the revised cost and profitability estimates, what actions should Sippican’s management team take to improve the company’s profitability? Answer:
Recently, Sippican was forced to lower prices on pumps to compete in the marketplace. Our analysis reveals that Sippican could improve their situation by allocating unused capacity to pump production. The price of flow controllers was increased recently without any negative impact on demand. Sippican could improve the performance of their flow controller activities by further raising the price of flow controllers. Sippican Case
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 | |...
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