Cost-benefit Analysis and Capacity Cost Rates

This is an introductory case, and yet it introduces a powerful new approach for building an ABC model. Considerable theory is illustrated in how we build the Sippican time-driven ABC (TDABC) model. Also, the (B) case introduces an important link, previously recognized but not exploited, in how to embed an ABC model into the budgeting process, replacing line-item budgeting with an integrated, analytic approach. The case discussion provides insight and confidence about the feasibility of building a TDABC model, especially in the face of resistance from finance people who claim that ABC is too complex to implement.

1. Given some of the apparent problems with Sippican’s cost system, should executives

abandon overhead assignment to products entirely and adopt a contribution margin

approach in which manufacturing overhead is treated as a period expense? Why or why

not?

2. Calculate the practical capacity and the capacity cost rates for each of Sippican’s

resources: production and setup employees, machines, receiving and production control

employees, shipping and packaging employees, and engineers.

3. Use these capacity cost rates and the production data in Exhibits 3 and 4 to calculate

revised costs and profits for Sippican’s three product lines. What difference does your

cost assignment have on reported product costs and profitability? What causes the shifts

in cost and profitability?

4. Based on the revised cost and profitability estimates, what actions should Sippican’s

management team take to improve the company’s profitability?

|Traditional Cost Analysis |Valves |Pumps |Flow Controllers |

|Selling price |$79.00 |$70.00 |$95.00 |

| | | | |

|Direct labor cost |$12.35 |$16.25 |$13.00 |

|Direct material cost |16.00 |20.00 |22.00 |

|Manufacturing overhead at 185% of DL cost |22.85 |30.06 |24.05 |

|Standard unit costs |$51.20 |$66.31 |$59.05 |

| | | | |

|Gross margin |$27.80 |$3.69 |$35.95 |

|Gross