Destin Brass is a large manufacturer of water purification equipment. Valves, pumps and flow controllers are three main products they make. The management was bothering by the rapid competition of valve market, wondering why their competitors can offer a lower sale price than theirs. In the end, they came up with the conclusion the cost allocation method was not accurate, and it led to the inappropriate pricing strategy. The company uses three methods to compute the unit cost of each product—traditional cost method, revised cost method and activity-based cost method. Under traditional cost method, allocation of manufacturing overhead is simply based on direct labor. This method will be only precise when the overhead cost is highly related to the labor cost. Being aware of this problem, the management revised its allocation base according to machine hours and direct labor cost. However, this method still won’t be as accurate as activity-based cost method. The following table shows the unit cost of each product under different cost method (Computation please refers to exhibit 1). Unit Cost| Valves| Pumps| Flow Controllers|
Activity-Based Cost method| $37.73| $48.81| $100.81| Revised method| $49.00| $58.95| $47.96|
Traditional method| $37.56| $63.12| $56.50|
As we can see, the unit cost of flow controller is way higher than valves and pumps under activity-based cost method than any other two methods. Under activity-based cost method, cost is accumulated by different activities, such as material handling, and packing and shipping. Since flow controllers have more components and more shipments, the allocation of overhead in regards to material handling, and packing and shipping should be higher than other two products (Exhibit 2). But under revised cost method, the management only considered direct labor cost and machine hours as allocation bases. The ignorance of material handling cost, and packing and shipping cost caused...