EXECTUIVE SUMMARY
Ronald Guidry, Steve Abbott and John Scott established the Destin Brass Products Co. in 1984, Destin, Florida. Later, Peggy Alford joins the team as an accountant. The company manufacturing three water purification equipments such as valves, pumps and flow controllers*. Out of three Destin's products, pumps profit margin is decreasing with time because of competitive pump market and tedious design.
The company's 55% revenue comes from sales of pumps. The company's profit slipped again lower than last month, a meeting was held to postmodern for better understand the competitive trends and to develop new appropriate strategies. Mr. Alford, an accountant of the Destin company explained during the meeting that the company is currently practicing the traditional cost accounting system where all overheads costs applied to production costs as well as the overhead costs is applied to product using the direct labor costs. The advantage of using the system it is very simple to do the calculations and all the data meets for preparing financial reports and tax returns. So the standard unit cost of valves $37.56, Pumps $63.12 and Flow/co* $ 56.50, while the planned gross margin are 35% for each products as mentioned above but the actual gross margin of last month are as follows 35% for valves, 22% for pumps and 42% for Flow/co (Exhibit 3 of assignment note).
Alford further explained that the company has also calculated using of more modern or revised cost accounting system unit cost excluding the material related overhead (receiving and materials handling) from other (manufacturing) overhead cost. Received unit costs of valves $ 49.00, pumps 58.95 and flow controls 47.96 (Exhibit 4 of Destin assignment note). If the company uses ABC+ (ABC= Activity Based Costing)+ accounting system to view of the proper way to allocate Activity based costs using this system; in first stage, the costs are trace to activities and then these costs are trace in second stage to the products that used the activities. The ABC of valves $37.50, pumps $ 48.79 and flow controls 100.91.
Overview of the profit margin comparing the above three accounting system. i.e. Traditional accounting system profit margin of valves 35%, pumps 22% Flow/co. 42%.
Revised profit margin of valves 15%, pumps 27% Flow/co. 51%. Activity Based Costing profit margin of valves 35%, pumps 40% Flow C. -4%. Therefore, if the company will use ABC accounting system the pumps profit margin will improve as well an indication to increase price of Flow/co further as Steve has recently raised flow/co price to 12%, even does not affect the demand. The advantage of using ABC in Destin because of multi-product company where lager overhead exists and ABC is more accurate to trace costs to activities performed the products. ABC system will allow strategic evaluation of products design, manufacturing technology, pricing designs and product line designs.
Case Analysis
The Destin Brass Production Co. manufacturing water purification equipment and it grew speedily due to demands and soon become sole supplier of valves to its customers. The company extends products line and started production of pumps and flow controllers. Destin's quality of the valve is good and because of high demand, the company maintaining 35% profit margin and 24% of company revenues comes from valves.
Flow controls planned gross margin kept as 35%, later 121/2 % profit margin increased but the demand does not affect because Destin had almost no competition. Even further reasonable increase profit margin also support the product, and 21% company revenue comes from flow controllers.
The pump market was large and 55% company revenue comes from pump. Initially, company planned gross margin was 35% but due to highly competitive market pressure the profit margin slipped to 22% even though continues pressure to decrease the price further to sustain in the market.
The founders has getting tens to see the sales report of the pump and decided to look inside the company's pricing system and make strategies to stay competitive in the market reducing further price while making reasonable price.
Traditional Cost Accounting
The company is currently practicing the traditional cost accounting system where all overheads costs applied to production costs as well as the overhead costs is applied to product using the direct labor costs. Where the cost per unit of the valves to be $37.56, pumps $63.12 and flow controllers $56.50, results, overhead unit cost of pump and valve are the same amount, while lass overhead unit cost to flow/co. Planned and actual gross margin of valves is same where for flow/co actual gross margin increases from planned gross margin and finally, pumps actual gross margin decreased from planned gross margin. After investigation of actual production process, it was noticeable that the no of transactions required to manufacturing flow/co is 78% higher in handling materials while actually 7% machine hour used (Exhibit 5 of assignment note).
The advantage of using the system it is very simple to do the calculations and all the data meets for preparing financial reports and tax returns.
Limitations of the system is that it does not give manufacturing details and the result manufacturing per unit cost of pumps increases while adding the overhead cost applies similar to all products. Without knowing the actual manufacturing cost, it is difficult to keep the competitive price of the pump.
Result, the company may assume that they are not making profit manufacturing and selling of the pumps, they might stop production of pumps. This is just because of using traditional cost accounting system. So the company has to thing using other accounting system where they can get the details reports of manufacturing costs and overhead costs.
Revised Unit Costs
The more modern or revised cost accounting system gives more details information of the production cost of the products as comparison of traditional accounting system. In this system, the material related overhead cost and other overhead costs separated (Exhibit 4 of assignment note). Material related overhead cost applicable instead of direct labor cost and not even labor cost of production run. The revised standard cost of valves $49, pumps $58.95 and flow/co is 47.96. If we compare traditional vs revised accounting system for Destin Co, it would be noticeable that the profit margin of pumps will increase by 5% from 22% to 27% where the valves profit margin slipped and for flow/co. increases by 9%. I think 5% profit margin increased is not so significant so using of Revised accounting system of Destin Co is not so profitable (please see Exhabit-1 for the comparison of traditional Vs revised cost accounting).
The advantage of the system is still simple and have the details information needs to do the financial/ tax reporting.
Account Based Costing (ABC)
Exhabit-1
Bibliography:
Books
McLaney, E., Atrill P., Accounting, An Introduction, 4 Ed, Prentice Hall Europe.(2008)
Horngren, C.T., Sundem, G.L., Stratton, W.O., Introduction to Management Accounting, 12 Ed., Pearson Education Inc. (2002)
Brigham, E. F., Ehrhardt, M.C., Financial Management, Text and Cases. Cengage Learning (I) Pvt. Ltd (2008)
McKoen, P., Gough, L., The Financial Manual for Non-Financial Managers. PearsonEducationLimited (2000)
