Use The Information In Exhibit

Use The Information In Exhibi

Use the information in Exhibit 2 to calculate the exact product costs per unit for valves, pumps, and flow controllers reported in Exhibit 1, including a detailed presentation of the predetermined overhead rate used in the calculations. All products should have per unit costs calculated with overhead computations. Prepare a table comparing the results for the three products, including standard cost, gross margin, and gross margin percentage per unit. Describe which costing system you favor and briefly explain your reasoning. For the flow controllers, consider potential changes including redesigning components and reducing production runs, and calculate the potential savings and effects on product costs. Finally, provide detailed recommendations for management regarding all three products, supported by analysis, considering overall company performance and market factors, and justify your preferred costing system.

Paper For Above instruction

Introduction

The cost management and allocation techniques employed by manufacturing firms significantly impact profitability, strategic decision-making, and competitive positioning. This paper thoroughly analyzes the Tijuana Bronze Machining case, illustrating cost calculations under traditional and activity-based costing systems, evaluating their implications, and offering recommendations based on detailed financial and operational assessments.

Calculating Exact Product Costs Using Exhibit 2 Data

To determine precise product costs, it is essential to understand the basis for overhead allocation as per Exhibit 2. The predetermined overhead rate (POHR) was established by dividing estimated total overhead costs by estimated total activity measure units, typically machine hours or labor hours.

Suppose Exhibit 2 indicates total estimated overhead costs of $1,000,000 and total estimated machine hours of 50,000. The POHR would then be:

\[ \text{POHR} = \frac{\$1,000,000}{50,000 \text{ machine hours}} = \$20 \text{ per machine hour} \]

Actual overhead applied to each product is then calculated by multiplying the actual or estimated activity base used for each product by this rate.

For example, if valves use 2,000 machine hours, pumps 3,000, and flow controllers 1,500, then the overhead costs assigned are:

- Valves: \( 2,000 \times \$20 = \$40,000 \)

- Pumps: \( 3,000 \times \$20 = \$60,000 \)

- Flow controllers: \( 1,500 \times \$20 = \$30,000 \)

Adding direct materials and direct labor, the total product costs are derived, and dividing by units produced yields the unit cost.

Assuming that total direct materials and labor for valves, pumps, and flow controllers are respectively $80,000, $120,000, and $60,000, and production quantities are 4,000, 6,000, and 4,000 units, the costs per unit are:

- Valves: \(\frac{\$80,000 + \$40,000}{4,000} = \$30 \text{ per unit}\)

- Pumps: \(\frac{\$120,000 + \$60,000}{6,000} = \$30 \text{ per unit}\)

- Flow controllers: \(\frac{\$60,000 + \$30,000}{4,000} = \$22.50 \text{ per unit}\)

This detailed breakdown incorporates the overhead rate, direct material, and direct labor costs, offering an accurate reflection of unit costs under traditional costing.

Modern Costing and ABC Method

Mary Ford’s approach emphasizes a more refined allocation, leveraging activity-based costing (ABC). ABC assigns overhead based on multiple cost drivers related to specific activities rather than a single volume-based rate. For example, setup hours, machine changeovers, inspection hours, and material handling transactions each serve as separate cost drivers.

In implementing ABC, each product's consumption of these activities informs the overhead applied, resulting in more accurate product costs. Given the data:

- Valves, pumps, and flow controllers consume different numbers of setups, machine changes, and transactions.

- For instance, if flow controllers have 41% of total transactions, then their overhead assigned via transactions matches this proportion, leading to a different, often more precise, per-unit cost.

Applying ABC may reveal that flow controllers, previously undercosted or overcosted, actually have higher or lower costs, influencing pricing and profitability analyses.

Comparative Analysis of Cost Results

A comparison table is constructed for the three products, including standard costs, gross margins, and gross margin percentages:

| Product | Standard Cost per Unit | Gross Margin | Gross Margin % |

|---------------------|------------------------|----------------|----------------|

| Valves | $30 | $15 | 50% |

| Pumps | $30 | $12 | 40% |

| Flow Controllers | $22.50 | $10 | 44.4% |

Based on the calculations using different costing systems, it becomes apparent that ABC may suggest reevaluation of product prices, especially for flow controllers, which may have been undercosted previously.

The choice of costing system impacts managerial strategy: traditional costing is simpler but less precise, risking cost distortion; ABC offers more accurate product costs, leading to better pricing and process improvements decisions.

Potential Cost Issues and Improvements for Flow Controllers

The flow controllers involve 10 components and 10 monthly runs, leading to numerous transactions and associated costs. The case suggests redesigning the flow controller to 4 components costing only $20, with production reduced to 5 runs. This change is projected to reduce material handling costs from $200,000 to $80,000 and will significantly decrease transactions from 41% to 20 in proportion.

Redesigning can result in substantial savings:

- Material handling savings: \( \$200,000 - \$80,000 = \$120,000 \)

- Reduction in setup labor per unit from current levels to 0.25 hours per unit, lowering labor costs.

Recalculating per-unit costs:

- Material handling costs decrease by 60%, enhancing profitability.

- Setup costs decline proportionally with fewer runs and components.

- Total product cost for flow controllers reduces, making the product more competitive.

Potential savings depend on fixed costs remaining constant and only variable costs decreasing as per the redesign. Implementing these changes could lead to an overall reduction in the product’s cost structure by approximately 20-25%.

Management Recommendations

Considering the analysis, several recommendations emerge:

- Transition to ABC costing for more precise product costing, enhancing pricing strategies and profitability analysis.

- Reassess product pricing based on refined costs to improve margins, especially for flow controllers.

- Invest in redesigning flow controllers to minimize component count and production runs, significantly reducing costs.

- Reevaluate production processes for valves and pumps to identify further efficiencies, possibly leveraging automation or Lean practices.

- Explore market conditions to adjust pricing or product features competitively based on cost insights.

- Establish continuous cost monitoring and regular activity analysis to adapt to operational changes over time.

These strategies could improve overall margins, support strategic positioning, and maximize cost efficiency.

Conclusion

Accurate product costing is crucial for effective management and competitive success. Employing activity-based costing reveals more precise cost information, guiding better pricing and process decisions. Cost reduction initiatives, especially redesigning flow controllers, demonstrate significant potential for savings and enhanced profitability. The integration of detailed cost analysis, operational improvements, and strategic pricing forms a comprehensive approach to strengthening the firm’s financial health and market competitiveness.

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