Sippican Corp free essay sample

Consider Sippican is a manufacturer company with multiple products, using simple cost accounting system that directly allocate factory overhead to unit of product entirely through one single allocation base (i. e. 185 % of production run direct labor cost in this case) is although an inexpensive way while is sometimes distort actual contribution of the product. To our understanding from reading the article, Sippican is spending more on overhead than on either direct material or direct labor. Further, Sippican has considerable diversity in its product mix. Each product may contain different degree of spending on indirect or supporting resources, and high variety on product and consumer characteristics. As such, activity-based cost system is considered to be a more accurate costing of present resource that will enable Sippican to project its future resource demands more effectively. 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. We will write a custom essay sample on Sippican Corp or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Answer: See the Q2 worksheet. 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? Answer: Currently, Sippican assigns overhead costs at a flat rate across all three products. While our analysis of cost and profitability reveals a dramatic difference between the cost to produce each product as reported using Sippican’s traditional costing structure and the detailed analysis using time driven activity based costing (see Q3 worksheet). Under the traditional costing structure, all three products are reported to have a positive gross profit margin. Pumps are reported to be the least profitable product with a 5% gross profit margin while flow controllers are reported to be the most profitable product with a gross margin of 38%. Our time based activity based costing analysis provides a clear picture of costs as they relate to the production of each specific product. Where flow controllers were thought to be the most profitable product, activity based costing reveals that flow controllers are actually produced at a negative margin. The shift in cost and profitability for flow controllers is found to be mostly related to the substantial costs to engineer the product and high cost of setup. 4. Based on the revised cost and profitability estimates, what actions should Sippican’s management team take to improve the company’s profitability? Answer: Recently, Sippican was forced to lower prices on pumps to compete in the marketplace. Our analysis reveals that Sippican could improve their situation by allocating unused capacity to pump production. The price of flow controllers was increased recently without any negative impact on demand. Sippican could improve the performance of their flow controller activities by further raising the price of flow controllers. Sippican Case - Sippican Corporation A manufacturer of hydraulic control devices – valves, pumps flow controllers. Currently the company is undergoing a severe economic impact from price cutting in pumps one of its major product lines. This has led to decline in its profits in this line of business – (as illustrated below) | Sales | 1847500 | | | | Variable Expenses | 809000 | | | | Contribution | 1038500 | 56. 21% | | | | | | | | Machine related expense | 334800 | | | | Setup Labour | 117000 | | | | Receiving production control | 15600 | | | | Engineering | 78000 | | | | Packaging Shipping | 109200 | | | | | | | | | Manufacturing Overhead | 654600 | 35. 43% | | | | | | | | Gross Margin | 383900 | 20. 78% | | | Other Expenses | 350000 | | | | Operating Income (pre-tax) ROS | 33900 | 1. 83% | | The company’s gross margin is expected to be 31% whereas as shown in the exhibit it is currently at 21%. Return on sales is 1. 8% which is far below the target of 15-20% that the company has been realising in the past. Sippican had recently raised the price of its flow controllers by more than 10% but yet failed to achieve any good financial results It operates at a simple cost accounting system that directly charges each unit of product for its direct labour and material cost (exhibit 3) * Material cost is based on the prices paid for components under annual purchasing agreement * Labour rates are charged at 32. 50 per hour and are charged to products on the basis of the standard run times for each product. The company has only one producing department which machines assembles components into finished goods. The cost system allocates the factory overhead cost to product as a percentage – this is currently at 185% (exhibit 2) Sippican’s controller Peggy Knight realized that overhead cost has been increasing significantly in the recent years particularly for setup labour, indirect labour for packaging and shipping process engineers. These increases were necessary to handle the small production runs many shipments now requested by customers and for developing the process routines used to build newly introduced flow controller models. The data collected by Knight from the manufacturing control system about the production run shipments and distribution of engineering personnel is shown in (exhibit 4) Following are the observations – * Average production run for valves is 375 units – 7500/20 (units /production run) * Average production run for flow controllers is 18 units – 4000/225 (units /production run) * Average valve shipment is 188 – 7500/40 (units/number of shipments) * Average flow controller is 8 units – 4000/200 (units/number of shipments) This shows that the flow controller is using indirect resources disproportionately from its shares of the company revenue and units sold. The company is spending more on overhead than on direct labour or material. The company has considerable diversity in its product mix. * Valves need little technical support are produced and shipped in large batch sizes * Flow controllers are produced and shipped in small batch sizes and require extensive technical support. This combination of high spending on indirect and support resources and high variety in product shows a heavily distorted cost. A time –driven ABC model for Sippican’s manufacturing operations is launched. This will quantify the impact of each product line’s use of indirect resources financially. The information collected on the points is mentioned in the case (5 points) Now the capacity cost rates for each major production process needs to be estimated – fabrication, assembly, setup, receiving and production control, packaging shipping and engineering. Illustrated below is the