ByHariharasubramanian(68)AnandhaKrihshnan(06)Arya Mahadevan(02)Abudhaya(91)

TBM manufactures pump , valves and flow controllers

TBM ‘s Valves too expensive to compete in the non specialized valve market but none had tried to gain market share by cutting price .

TBM ‘s pump prices had been under pressure. It has no design advantage and sold at very lower price by their competitors.

TBM have no clue how can his competitors could be making profits at current prices

TBM was trying to understand the market for flow controllers better because it seems they have no competitors in the market and also recently raised price of the flow controller by 12.5% had no impact on the demand

Only short run variable cost is direct material

Material related overhead and allocated that to each product line based on the cost of material.

Set-up labor out of the total overhead and assigned it directly to each product line.

Machine hours better reflect the machines rather than labor dollars

Receiving and handling material , packing, shipping and engineering orders that caused overhead not the labor and machine hours.

Product that cause 3 % of the total transactions for receiving components would be allocated 3 % of the total receiving cost

FlowValves Pumps Controllers

Material $16.00 $20.00 $22.00Direct Labor 4.00 8.00 6.40Overhead 17.56 35.12 28.10

(439% of Direct Labor $) *Standard unit cost $37.56 $63.12 $56.50

*OverheadMachine depreciation $270,000Set-up labor 2,688Receiving 20,000Materials handling 200,000Engineering 100,000Packing and shipping 60,000Maintenance 30,000 Total overhead $682,688Total run labor = 9,725 hours $16 = $155,600. Overhead rate = $682,688 / 155,600 = 439%

FlowValves PumpsControllers

Revenue $57.78 $81.26 $97.07Variable Costs—Material only16.00 20.00 22.00Contribution 41.78 61.26 75.07 orAssume Labor is Variable (case says only direct material is short-run variable).

Run Labor 4.00 8.00 6.40Set-up Labor ~.02 ~.05 ~.48

4.02 8.05 6.88Contribution $37.76 $53.21 $68.19

FlowValves Pumps Controllers

Material $16.00 $20.00 $22.00Material Related Overhead (48%)* 7.68 9.60 10.56Set-up Labor .02 .05 .48Direct Labor 4.00 8.00 6.40Other overhead ($42.59 per machine hr)** 21.30 21.30 8.52Revised standard cost $49.00 $58.95 $47.96

*Material Related OverheadReceiving $ 20,000

Material Handling 200,000 Total $220,000

Overhead Allocation Rate on Materials Cost:$220,000 / $458,000 = 48% of materials cost**Other Overhead on Machine-Hour Basis

Machines Depreciation $270,000Engineering 100,000

Packing and Shipping 60,000Maintenance 30,000

Total $460,000Overhead Allocation Rate = $460,000 / 10,800 hours = $42.59 per machine hour

Valves Pumps Flow Controllers Total Month

Per Unit Total 7,500 Per Unit Total 12,500 Per Unit Total 4,000 24,000 unitsMaterial $16.00 $120,000. $20.00 $250,000. $22.00 $88,000. $458,000.Labor 4.00 30,000. 8.00 100,000. 6.40 25,600. 155,600.Overhead: . Set-up 0.02 128. 0.05 640. 0.48 1,920. 2,688. Receiving 0.08 600. 0.30 3,800. 3.90 15,600. 20,000. Mat’l. Handling 0.80 6,000. 3.04 38,000. 39.00 156,000. 200,000. Pack & Ship 0.32 2,400. 1.11 13,800. 10.95 43,800. 60,000. Engineering 2.66 20,000. 2.40 30,000. 12.50 50,000. 100,000. Maintenance 1.40 10,500. 1.39 17,400. 0.53 2,100. 30,000. Mach. Depr. 12.50 93,750. 12.50 156,250. 5.00 20,000. 270,000.Total Overhead $17.78 $133,378. $20.79 $259,890. $72.36 $289,420. $682,688.Total Cost $37.78 $283,378. $48.79 $609,890. $100.76 $403,020. $1,296,288.

There will be no difference. Each month reflects two different methods of assigning the same actual costs to the three products. The total results for the company will be identical.

FlowValves Pumps

ControllersActual Selling Price $57.78 $81.26 $97.07

Standard Cost 37.56 63.12 56.50Gross Margin 20.22 18.14 40.57Gross Margin % 35% 22% 42%

Revised Cost 49.00 58.95 47.96Gross Margin 8.78 22.31 49.11Gross Margin % 15% 27% 51%

ABC Cost 37.78 48.79 100.76Gross Margin 20.00 32.47 (3.69)Gross Margin % 35% 40% (4%)

The total reported results are the same for the company under the three methods.

The accounting allocations for individual product lines change the gross margins significantly.

Product line profitability changes most significantly for flow controllers under ABC, dropping from the highest gross margin product to a loser.

By ABC method we are allocating to resource consumption rather than cost allocations such as engineering and maintenance

Receiving and inbound handling is $140,000 ($20,000 + .6 x $200,000).Under a "just-in-case" or JIC practice where all components for a month's Flow Controller production will be purchased together, the total receiving and material handling costs will be only $14,000 (1/10 the cost). Some assumptions will be necessary for calculating an inventory storage and carrying cost charge. The total cost of flow controller components purchased each month is $88,000. Assume uniform production during the month so that the average inventory cost is $44,000 (50% x $88,000). Assume carry costs are 100% per year, including a capital charge for space, space costs (maintenance, etc.), handling costs (labor, etc.), carrying costs (insurance, taxes, etc.), and cost of funds. Applying a monthly carrying cost rate of 8.5% (100% / 12 months), the monthly storage and carrying cost is $3,740 (.085 x $44,000).

Drop Flow Controllers? If flow controllers were dropped, how much cost savings could be realized? This question cannot be answered by ABC which is not based on a variable cost and fixed cost dichotomy. For example, one half the engineering costs are subjectively assigned to flow controllers. Will $50,000 of engineering cost be avoided if flow controllers were dropped?

This does not change the conclusion that on a fully allocated basis, flow controllers have a negative gross margin, let alone providing any bottom line profit.

Can raise Selling Price:

Given the “no-competition” market for flow controllers, perhaps the selling price could be increased gradually, but who knows. If any uncertainty expressed by management in this market, there seems to be little harm in this pricing strategy, assuming management wishes to keep the product line after seeing the ABC results. But, one must note that the higher the selling price, the more likely TBM will see some competition and reduced demand.

On Pumps :

The selling price for flow controllers increased more than 12% this past month while the selling price for pumps decreased more than 16%.

The ABC analysis indicates that pumps still have the highest gross margin (40%) at the actual selling price. The gross margin would be 35% at a price of $75.06, which would allow still further price cuts of $6.20 per unit. .

Cost Reduction for Pumps :

There is a lot of buyer power in this market, so TBM must undertake cost reduction and re-engineering programs to be the low cost producer.

The case says pumps require less precision manufacturing than valves. Pumps involve only on more component than valves. this could be also a area of cost reduction e

Perhaps less skilled machinists could be used on the pumps (and flow controllers)? Although automation is touted by management, direct labor represents 12% of the total manufacturing costs. some cost savings may be possible.

Setup time can be reduced

On Valves : Apparently, the one valve customer is pleased with our quality and competitive price. Competitors are not attempting price cuts. The case implies that automation and efficient production processes are helping control costs and efficiency. But is it good strategy for TBM to be dependent on a single customer for valves? The ABC gross margin is 35% for valves so no action seems necessary to raise or lower prices. A question for management: Is there no growth in this market? Evidently, the company makes pumps and flow controllers to fill out the production capacity. Can we really continue long-run with 24% of sales in a no-growth market with a single customer?