Given some of the problems with Sippican’s cost system, should executives abandon overhead assignment to product entirely and adopt a contribution margin approach? Why or why not?
The overhead spending is greater than the direct labour costs or the direct material costs for all three product lines- Valves, Pumps and Flow Controllers (Exhibit 2). Overheads are simply charged at 185% constant for three diverse products. The fact that there is huge variance in the number of units produced per production run- it is 375 for valves and 18 for flow controllers per production run. This shows the reason for high overheads cost too. Hence it calls for checking the cost allocation system of the company. Since Sippican produces three different products which comprise of different components, processes for all three need to be customised and refined to bring in any kind of standards. Variations in batch size owing to the machining constraints etc. are brought in by a disparity in the time required for production runs of all three products. Even on increasing the price of the flow controllers the demand for the product did not go down, this gives an indication of the faulty pricing system. Because of these reasons it seems that we should check the cost allocation system of the company.
Calculate the practical capacity and the capacity cost for each of the Sippican’s resources: production and setup employees, machines, receiving and production control employees, shipping and packaging employees, and engineers.
The first thing to do here is to find the actual capacity thats being used in each and every resource. For this purpose teh total number of units is first defined. Thereafter the total number of hours are found out which is available with the company as the number of days working and teh number of hours per day is available. Once that’s done teh actual is divided by the maximum hours to find out teh capacity. That gives us the capacity utilisation.
For the capacity cost, the paid hours per day is defined, te number of productive hours is defined as there are break times which need to be subtracted. There after the no. of days an employee work is used to arrive at the cost per hour. RESOURCES
Capacity Cost Rate
Paid Hours per day
Productive Hours per Day
Cost Per hour
No. Of days Employees Work Production Workers
Use the capacity cost rates and the production data in Exhibits 3 and 4 to calculate revised cost and profits for Sippican’s three product lines. What difference does your cost assignment have on reported product cost and profitability? What causes the shifts in cost and profitability?
The method that should be used here is Time based activity Based costing. The reason for that are:
The overheads divided into different categories based on the type of work it is utilised in, for example: setup costs, production run etc. Now the case shows that if each and every product was examined separately with regards to the time they were taking for each activity, it could be seen that the timing were considerably different for each product. 2.
The standard method in which the company used 185% of DL was not the correct way to allocate the OH costs.
The difference that can be seen due to the change in method is as follows: Costs and Profits (Time Based ABC Method)
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