The Sippican Corporation Case Study (A) Management Summary Sippican Corporation - a supplier of valves, pumps, and flow controllers to manufacturers of water purification equipment – faced concerns due to the fact that its competitors have been reducing the price of pumps, which was a major product line. According to Sippican’s cost accounting system further decrease in the price of pumps would not be acceptable as because of the past price reductions the margin on pumps have already declined from the planned 35% to 5%. Detailed and alternative analysis of the costs – such as Activity Based Cost analysis – reveals alternatives for the management to decide on pricing, efficiency measures, and product development.
Sippican Corporation uses a simple cost accounting system for performance evaluation of the different products produced in order to be able to make future decision. Indications that it is not working properly are that even though the 3 products require different effort from overhead Sippican still assigns overhead costs at a flat rate across all products using a production-run direct labor cost allocation ratio assuming that there is a direct relationship between overhead and the output quantity based on this ratio. The disadvantage of it is that a huge amount of cost is determined based on a single driver. The case indicates that Sippican is extending its relations creating more complex and segmented orders for which the simple accounting system is too superficial.
Total manufacturing overhead of Sippican accounts for 35% of the sales revenue. The later detailed ABC analysis illustrates that significant differences arise in the cost to produce the different products. A more detailed cost analysis (vs. simple or contribution margin methods) provides a clear understanding of the costs and profitability of each product to support proper managements decisions or even avoid a financial/profitability crisis. Based on the above pros and cons Sippican should not abandon assigning overhead costs.
To calculate the overhead cost rates the total cost in the specified pools and the assigned driver and their amounts have been used. Exhibit 1 and 4 provide the appropriate figures keeping in mind that the amount of the driver is usage. Overhead rate equals the total cost in the pool divided by the total amount of driver (2/4).
Pool/activity Machine-related expenses Set-up labor Receiving and production control Engineering Packaging and shipping
Cost in pool $334 800 $117 000 $15 600 $78 000 $109 200
Cost driver Machine hours Set-up hours Runs Engineering hours Shipments
Total amount Overhead of driver Rate (2/4) 11 200 3 400 345 900 340 $29.89 $34.41 $45.22 $86.67 $321.18
With the overhead rate available the cost per unit for each of the 3 products can be calculated using the following equation: (overhead rate of driver * total amount of driver used) / number of units produced. 1 Cost element OH Rate 2 3 Valve =(1*2)/3 2 3 Pumps =(1*2)/3 2 3 =(1*2)/3 Flow controllers
Total Produced amount of # of units driver
Direct Labor cost Direct material cost Machine-related expenses $29.89 Set-up labor $34.41 Receiving and production control $45.22 Engineering $86.67 Packaging and shipping $321.18 Total cost per unit: Actual selling price of a unit: Gross margin Gross margin (%) Gross margin (%) of original method Delta
3750 100 20 60 40
7500 7500 7500 7500 7500
Total Total Cost per Produced Cost per Produced Cost per amount of amount of unit # of units unit # of units unit driver driver $12.35 $16.25 $13.00 $16.00 $20.00 $22.00 $14.95 6250 12500 $14.95 1200 4000 $8.97 $0.46 600 12500 $1.65 2700 4000 $23.23 $0.12 100 12500 $0.36 225 4000 $2.54 $0.69 240 12500 $1.66 600 4000 $13.00 $1.71 100 12500 $2.57 200 4000 $16.06 $46.28 $57.44 $98.80 $79.00 $70.00 $95.00 $32.72 $12.56 -$3.80 41% 18% -4% 35% 5% 38% 6% 13% -42%
The ABC analysis of cost and profitability shows major...
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