Denim Finishing Company Case

Topics: Costs, Decision making, Marginal cost Pages: 9 (3382 words) Published: February 13, 2013
Mrs. Kelsey Bowser using the ABC method decided to use the number of garments as the cost driver of the change-over costs. Nevertheless, I argue that this was not the best possible choice. I will try to defend my point using the following example. Let’s assume that Guess Who Jeans demands 600, not 500 garments per shipment. Although the number of garments changes, the total change-over costs would stay the same, because no additional retooling of the machine would be necessary. The whole change-over process takes 3 hours regarding if the number of garments is 200, 500 or 800. Furthermore, let’s strictly theoretically assume that the company is able to achieve some extra capacity and one batch is now composed of 150 garments instead of 100 garments. Still, although the total number of garments would vastly increase, the change-over costs would be altered only partially. The opportunity cost measured as a lost contribution margin would slightly increase, but the out-of-pocket costs would stay the same, as the wages of the employees and supplies costs will not change. Thus, it is clear that the number of garments is not the proper cost driver for the change-over costs. In my opinion the number of shipments would be a much better cost driver for the change-over costs. Regarding the number of garments or the number of batches Guess Who Jeans demands every shipment requires the change-over costs to be incurred twice. For instance, if 99 shipments were made, the total change-over costs would equal $351 * 198 = $69,498, because two change-overs ($702) would not have to be undertaken. Thus, the number of shipments clearly drives the analyzed costs. Unlikely the previous example with the number of garments per batch increasing to 150, the number of shipments fully ‘drives’ the change-over costs. Every time the number of shipments rises or falls, the change-over costs change by the full amount of the two per-changeover costs which properly reflect the real situation. Using such a cost driver may be problematic when the allocation of the change-over costs is analyzed. Nevertheless, I argue that those cost should be solely allocated to the propriety denim finishing. The demand for the stonewashing services exceeds the company’s capacity. Thus, if the Guess Who Jeans’ offer was declined, the company would use the whole capacity for stonewashing. However, if the offer was accepted the stonewashing processes would be somehow ‘interrupted’ by the propriety denim finishing. Each ‘interruption’, and therefore each shipment would require incurring the change-over costs twice. No factor connected with stonewashing ‘drives’ those costs. Regarding the number of batches or garments used in the stonewashing process each shipment necessitates the cost of $702. Therefore, I believe this cost should be associated with every shipment done by Guess Who Jeans. In Appendix A I present the product profitability analysis using the number of shipment as the cost driver. Moreover, Mrs. Kelsey Bowser claims that the change-over costs should be treated as product-sustaining costs. Nevertheless, I believe her opinion is wrong. I believe these costs should be on the batch level in the cost hierarchy. Hence, I believe the initial analysis undertaken by Mrs. Bowser was correct, although the cost driver she selected was improper. Product-sustaining level costs could be defined as ‘activities that are needed to support an entire product line but are not performed every time a new unit or batch of products is produced’ [Hilton 2010]. Although the first part of the definition applies to the change-over costs, it is clearly not the case when the second part of the definition is concerned. The change-over costs have to be incurred every time the shipments is delivered and the propriety denim finishing has to be done. Therefore, I believe these costs should be rather placed as the batch-level costs in the cost hierarchy. Batch-level costs are believed to ‘arise...
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