Sippican Case

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20229 Cost Management System


Executive Summary
 Company Overview
 Accounting method
 Production process  Activities performed

 Q1. Should Sippican use a contribution margin approach? Explanation  Q2. Capacity cost rates for resources

 Q3.
 a. Revised costs and profits  b. Product costs and profitability analysis with the new allocation method. Cause of the

shifts in values.
 Q4. What actions should the management take to improve Sippican’s profitability?


Company overview
• Sippican is a company manufacturing hydraulic control devices:

valves, pumps and flow controllers
• Recent trends (March 2006)  Valves: margin remained at standard 35%  Pumps: Sippican’s main business, gross margin fell to 5% (below expect. 35%)  Flow controllers: price increase by 10% with no effect on demand • Issue

Sippican had to react to competitors pumps price reductions to maintain volumes

Decline in profitability: pre tax margin to less than 2%


Competitive scenario
• High quality • Unique design • Loyal customer base • Major supplier • High volumes • Commodities • Major presence • Customized • Various types

Able to match Sippican’s quality, but no bids for market share with price cuts

Stable 35% gross margin



Price reduction

Price reduction & consequent decline in profitability More production runs and shipments to meet demand + 10% Price increase w/o affecting demand

Flow Controllers

Much variety of types in the industry


Accounting method
• Simple cost accounting system , full cost method:
 DM costs= price of components (annual agreement)  DL= 32.5$/h (fringe benefits are included); charged on std run times for each product  OH allocated as % of production-run DL cost (185% current OH rate)

• Variable costs are only DL and DM

Meeting to consider the possibility of adopting a contribution margin approach


Production process
Purchase Machine Assembly

 A unique product department  Same equipments and labor for all the

3 product lines
 Just in time

• 4 components
• Standardized • Large lots

• 5 components • Standardized • Products go to industrial distributors after assembly

Flow Controllers
• Varied&customized: more components, more labor , more products runs


Set up

2x 7.5h/d shifts; 20 days per month

• each time batch components is machined in a production run • 15 workers per shift (25% production workforce) • • • • • 62 machines Workers simultaneously at more machines 45 workers per shift (production&assembly workers) 5,400$/month operating expense Productivity: 6 per shift

Production run

Receiving and production control

• Orderind, processing, inspecting, moving batch componetnts to production runs • 75’ (regardless type of production run & components price) • 4 people over the 2 shifts • • • • 50’ per shipment 8’ bubble wrap and pack 14 workers per shift (tot28) 7.5h/d shift; 30’ training; 2x15’ breaks *Production& assembly workers: - 2x 15’ breaks 30’ training 30’ preventive mainteinance

Packaging and shipping

New product design and development

• 9750$/m compensation • 7.5h/d shift


Q1: Should executive adopt a contribution margin approach?
Costs-volumeprofits analysis

Variable costs:dm&dl
significant contribution to oh

Pricing decisions

No account of all costs related to products
Significant fixed costs

JIT: no need to incorporate inventories

NO: company cost structure

significant fixed overhead costs and significant activities influencing the values of the final products

* the whole analysis will based on the contribution margin approach. The results which will be obtained will be influenced by the use of Time-driven ABC, with the right cost driver allocation to cost pools. It will make the difference for...
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