Destin Brass Products Co., was facing competition in brass pumps market due to low prices set by competitors. The company started in 1984 used to manufacture only valves initially but started brass pumps and flow controllers because they required the same manufacturing skills.
Valves represented 24% of the total revenue of the company and had a gross margin of 35%. Destin was manufacturing 7500 units per month
Pumps (55% of the revenues) also required the same setup. The targeted margin was also 35%. But recently the competitors the competitors have started reducing prices which has forced Destin Brass Products Co. to reduce their price also. This has resulted in reduced gross margin of 22% which is also expected to go down in the future. The production for pumps was 12500 units per month.
Flow controllers contributed to rest 21% of the revenues. Destined manufactured 4000 units in the previous month. In this segment they did not face any competition and had recently increased their prices by 122% with no apparent effect on demand.
The competitors may be using a different method of accounting whereas Destin is using the standard method of accounting. This might have resulted in the lower cost of pumps for the competitors.
Following economics concepts have been used in the case
The process by which overheads are finally included in the cost of production of product.
2. Absorption costing:
The process of costing in which overheads are absorbed in product cost using some suitable method.
The process of charging overheads that are wholly associated with a particular cost centre to that centre.
The process by which shared overheads are divided between related cost centres on an equitable basis.
5. Activity based costing:
The method of costing in which every cost is traced by appropriate cost driver which is based on the level of activity.
6. Direct cost
Cost related to particular cost object and that can be traced to it.
7. Indirect cost
Cost related to particular cost object but cannot be traced to it.
8. Unit cost
Cost associated with one unit of production.
PROBLEMS FACED BY MANAGERS
▪ Competitors in the pumps market were continuously reducing their prices. In order to compete in the market destin had to reduce their prices. This has resulted in shrinking of the gross margin which has come down from 35% to 22% in the recent. But as the competition is high, further price cut is again expected. So should destin reduce its price of not?
▪ Competitors are using the new accounting method whereas Destin Brass Products Co. is still using the older one. This might be there reason that the cost of pumps are higher than the competitors. Should destin adopt the new accounting method or not?
Range of possible solutions
Various possible solutions for managers are:
1. Continuing with existing costing method
In this method the overhead costs are allotted on the basis of direct labour charges.
2. Revised standard unit costs
As given in Exhibit 4, material overhead are allotted on the basis of material used.
3. Activity based costing(ABC) method
As given in exhibit 5, costs can be allotted on the basis of the activities performed.
Selection of a solution
The best solution would be to choose activity based costing because this seems to be the method which competitors are also choosing. Also this method gives an explanation to reduce the price of the pumps.
Use the Overhead Cost Activity Analysis and other data on manufacturing costs to estimate product costs for valves, pumps, and flow controllers (Activity...