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Destin Brass Products Co. has been established and grown to produce valves (24% of the company revenue), pumps (55% of the company revenue), and flow controllers (21% of the company revenue). This paper will illustrate the recommended solutions for the management of the company that are trying to evaluate the competitive trends of the market for the mentioned products, and trying to start new strategies to deal with these trends. Finance and accounting, as mentioned by Ambler (2008) are the essentials and basis to the short and long existence of any type of companies. The high competitiveness of market requires that all types of businesses have a comprehensive understanding to the costs and profits in much detail in order to facilitate decision making process.
In Destin Brass case, the company tried to establish a high brand name for producing the valves, but later as an expansion to the business, the company included two new product lines which are the pumps and the flow controllers keeping in mind the similarities of productions and the availability of the productions capacity. Destin Brass did not have a distinguished competitor in the valves market because of the high quality of the valves produced, but there is a massive competition in the pump and flow controllers market. This paper will capture a time of the company business where there is a high competition on the pumps’ prices and the solution of increasing the prices of the flow controllers did not change the market. The management is in need to reconsider its financial strategy in order to face competition.
The financial analysis
After evaluating the current financial situation of Destin Brass, The analysis hereby will collaborate to answer the management questions, and examples of the below solutions had been used by business and it proved to have an influence of decision making process regarding the company strategy. The solutions are as follows:
Product costs as per the ABC information
From the given information in the case study, there is a connection between the products costs and the costs incurred by the activities related to the productions of each product line. The answer to this issue is to prepare cost estimates for the three products by applying the essentials of the activity based costing, table 1 shows that the ABC costs of the valves is 37.8, the pumps is 48.82, and the flow controllers is $100.63. The ABC method tries to connect the indirect costs to the products, and consequently treat them as direct costs. Based on the case study financial information, the calculations in table 1 have been prepared by using the following: Creating a cost pool for the machine depreciation and maintenance cost, and allocate the products based on machine hours.
Creating a cost pool for receiving and material handling costs by calculating the number of transactions consumed for every product. Creating a cost pool for engineering costs by calculating how much engineering is consumed by each product. Comparing the ABC with the standard and the revised unit costs In this comparison, it will appear the cost of each product under the three types of costing calculation methods and the reason why they are different. Table 2 shows the comparison. The three costing methods treat direct costs which are run labour and material, in the same way. Moreover, financial experts support the idea that direct costs is not the actual problem as this can be tracked to the product, but the issue is that costing calculations gets complicated when trying to allocate the overheads (Indirect costs).
The allocation of overheads is where the differences in costs come under the three costing methods. In the standard cost accounting there is no effort made to track the overhead costs to the products. It is believed that indirect costs can not be related with the products that’s why they are summarised and then allocated to the products based on the given allocation factor (cost driver). In Destin Brass case, the overheads which include the receiving and materials handling, packing and shipping, and depreciation and maintenance for $680.000 per month, are allocated based on the run labour dollars. Consequently, every product is allocated a percentage of the overheads in the same ratio that the product consume of labour (valves 0.5 run hours per unit, pumps 0.5 run per unit, and flow controllers 0.4 run per unit). See table 3 for details. The revised cost accounting makes part of the indirect costs as direct.
The material and handling costs are treated in a separate way, but not the best cost driver had been chosen (direct material dollars), as it would be seen in the ABC. Moreover, setup labour is assigned directly based on the setup hours for which information is available. The remaining overheads are allocated on the basis of machine hours. As mentioned by Peggy Alford, this gives an idea why competitors are cutting prices on pumps. It is now clear that costs of the pumps is overstated using the standard costing method while the costs of the valves are understated. But, costing can be improved especially that the flow controllers’ price is not really explained that they are cheaper to produce than it was calculated by the standard costing method. The ABC method tracks as much as possible of the indirect expenses of the products and services.
So any expense incurred of a product is directly charged to that particular product rather than spreading the expense over all the products. When expenses incurred of a number of products, they are gathered and allocated based on a proper cost driver. In this way, the allocation will be done in proportion to the real costs consumption by all the products. Table 1 had shown the ABC costs calculations for the three products. Now, we can see that flow controllers have been subsidised by pumps and selling them for $97.07 is loss making (cost $100.63) rather than at 42% gross margin. But, subsidising flow controllers had made pumps less profitable while selling price of $81.26 corresponds to 43.37% gross margin. The costs of the valves are the same under both the standard and the ABC methods.
Strategic implications of the financial analysis
According to Bhimani et la (2008), highly competition business environment requires a comprehensive costs understanding, and a proper costing strategy is essential to facilitate decision making. In Destin Brass case, the management is facing a decision whether to go on in the pumps market in spite of the prices fall and decreasing profit margins or to cut this business line and concentrate only on the valves and the flow controller’s products which are profitable.
But, making a decision following the standard costing method would have caused disastrous consequences for the company as it would cut the profitable product and concentrate on products that are selling at a loss. Destin Brass is an ideal example of how vital is to have an accurate costing method to follow to provide strategic decision making. But, in spite of the importance of the financial and accounting information that the costing method will provide, the management vision should be supported by the information not only dictated by the accounting information.
The next month results
In the time where cost accounting does not matter for the cost allocation to determine the costs of the products, it does not affect the bottom line. Here, assuming that the quantities of the productions and the sales, inventory, selling prices stay the same, and the prices of material, labour, handling remains the same. The net profit would be the same as the net profit of the last month. The bottom line will be affected in case the results showing in the ABC method are considered and the selling prices are adjusted.
The costing methods used to identify the strengths and weakness of the business performance helps management to decide whether operations require any improvements. This indicates that the inaccurate costing allocation can lead to either over or under pricing. Consequently, this will prevent the management from leading the company to make higher profit, retain customers or lead the company to wrong strategic decisions.