Destin Brass Case Study

DESTIN BRASS CASE STUDY

Aaron Johnson, Ian Ostenburg, Tucker Styrkowicz, Dilpesh Patel

Kansas State University

Advanced Industrial Management

IMSE 605

Dr. Ben-Arieh

November 2, 2015

Executive Summary        3

References        14

Appendix B: Unit cost and Profit margin comparison        16

Table of Contents

Executive Summary……………………………………………………………………………….3

Introduction………………………………………………………………………………………..4

Comparing product costing methods (traditional, revised and activity based costing method)        5

Figure 1:  Standard Unit Costs (Traditional method)        6

Figure 2:  Revised Unit Costs (Traditional / Hybrid method)        8

       Figure 3:  Revised Unit Costs (Activity based costing method)        9

   Figure 4:  Unit Cost Comparision        10

Strategic Implications        10

Net Income comparision between traditional and activity based costing method        11

       Figure 5: Profit margin (Traditional method)………………….……………………………12

Figure 6:  Profit margin (Activity based costing method)        12

Conclusion        13

References        15

Appendix A        16

Appendix B………………………………………………………………………………………17

Executive Summary

Historically Destin Brass has successfully met its target gross margin of 35%. However, Destin’s ability to meet this objective recently has been threatened by competitive pressure in the market for pumps, its primary product. Destin has cut prices in order to retain its sales volume but this has caused gross margin on pumps to fall to 22% (Appendix B), well below the required 35% (Appendix B). In the case, the cross-functional team seeks to identify the reason that competitors, but not Destin, have been able to cut prices on pumps. The team also wants to know why Destin has achieved a 42% (Appendix B) margin in the flow controller market without a competitive response from rivals. The team believes that Destin’s “traditional” accounting system is the problem. The firm used standard unit method to allocate the fixed costs among the three products using run labor hours. As the competition in the industry increased the management of the company was forced to look closely at the costing method. Peggy Alford, the controller, suggested the revised unit cost method whereby the fixed costs were apportioned on the basis of material cost and machine hours. However, John Scott the manufacturing Manager pointed out that according to this method, the valve seems costlier and flow controller seem more profitable than they actually are. He suggested activity-based costing to determine product cost. It is necessary to estimate the product costs under two alternative methods; a revised unit cost method and an activity method, and observe if these values differ significantly from the product costs estimated under standard unit costing. All methods need to be analyzed to deduce which is most appropriate and should be used for decision making. The product costs and profit margin using all methods are in appendix B.

Introduction

Destin Brass Products is a local specialized brass products manufacturer in Florida. Brass foundries are purchased from suppliers and are machined and assembled in the company’s three product line. Destin Brass Product produced brass equipment such as valve, pumps and flow controller. The same equipment and labor are used for all three product lines and runs are scheduled to match customer shipping requirements. Valves, Destin’s first product line, is having a stable share in a mature market due to the precise specifications requirement and an advanced manufacturing skills. Pumps, a product line generating 55% of the revenues has recently suffered from price cutting and profit has decrease due to competitive pressure. The pump market is large, and specifications are less precise than those for valves. Flow controllers is a product line with little competition and a potential for growing profitability. Flow controllers are generating 21% of revenues and Valves are generating 24% of company’s revenue. The company is currently using a traditional volume-based costing system with direct labor cost as the allocation base.

Problems and Issues:  The main problem faced by Destin Brass Products is the falling profitability of pumps due to competitive pressure. The competitors keep reducing price on pumps and Destin is forced to follow regardless of the high production costs. The key issue sits in the costing system. Destin is using a plant-wide rate to allocate all overhead with a base of direct labor dollars. However, each production line consumes resources differently and the direct labor dollars, materials cost or machine hours are not a proper measurement of the consumption for all the overhead in the cost pool. For example, in figure 2, machine hours is not a cost driver for engineering, packing and shipping costs, so it should not be used as a cost allocation base to them. It is the activity rather than production volume that causes costs. Therefore, activity based costing (ABC) system should be applied. Using the data in appendix A, unit costs and overhead allocation are recalculated in figure 3.