Cost management systems and organizational effectiveness

¶ … Management Systems

With the implementation of the 25% mark-on limit, the producer has decided to cease the manufacturing of product A, coming to only produce B, C and D. The question that is being imposed at this stage refers to whether there are any more products that would be dropped according to the same rule. In order to answer this question, one has to recalculate the mark-on percentages for products B, C and D. This first requires the calculation of the standard costs in accordance with the adjusted allocation rate. The results indicate an 89.09% mark-on for product B, a 6.10% mark-on for product C. And a 37.18% mark-on for product D, leading to the conclusion that product C. would be eliminated from the production line. The resources used in its production would be transferred to the manufacturing of product D.

2.

Once a product is dropped, it is necessary to recalculate the allocation rate. This allocation rate per hour considering the manufacturing of only products B. And D. is of 12.50%. At this stage, it is required to adjust the mark-on rates for these two products based on the new allocation rate. The recalculated standard costs are $32.5 for product B. And $35 for product D. And the new mark-on percentages are 18.46% for product B. And 40% for product D. under the specification of products with a mark-on under 25% being dropped, the management at Premier Products would cease the manufacturing of product B. The trend observed is that of renouncing the products that require large amounts of time to be manufactured. Product A for instance, the first item to be dropped, took 6 hours per unit. The final product left standing seems to break this pattern, but its combination of labor and costs is more efficient, meaning that the model and the 25% mark-on strive to support operational development and financial gains by increasing the efficiency.

3.

Organizational managers employ a wide series of techniques to identify the profitability of each individual product. A relevant example of such a technique is given by the calculation of the contribution margin. It can be measured by subtracting the variable costs per unit from the selling price (Dynamic Business Plan, 2009), or in percentage form by dividing this result by the selling price and multiplying the outcome by 100 (Investopedia, 2009). Considering that the firm includes the costs of materials, labor force and variable overhead in its calculation of the unit variable cost, the contribution margin of its four products are as follows: $38 product A, $21 product B, $29.5 product C. And $26.5 product D.

In a situation in which Premier Products only considers labor force costs in its variable costs structures, the values of the contribution margins would suffer modifications. However, their ranks would remain the same. More specifically, the new contribution margins would be as follows: $68 for product A, $33.5 for product B, $44.5 for product C. And finally, $39 for product D. The company's productivity would significantly increase with a growth in the manufacturing volumes of product A. Despite the fact that, based on the 25% mark-on, product A was the first to be dropped, the item maintains the highest contribution rate due to its increased retail price.

4.

If the company wants to trace all variable costs to its product accurately, the allocation methodology that uses labor hours could be used. This type of estimate will come up with a dollar rate per labor hour and then the average variable cost per unit can be evaluated, depending on the number of labor hours used to manufacture the product. In this case, for example, for each of the products A through D. there is a certain number of hours that is used to manufacture the product (6, 1, 3 and 2 respectively). The overhead cost per hour is calculated by dividing the variable overhead by the total number of hours. The variable cost per unit according to this method is calculated by multiplying this constant by the total number of hours per product to arrive at a variable cost per unit.

Using the same methodology to calculate the fixed overhead per unit would significantly lower this, since the variable cost has been calculated in the method previously presented. With this, there is only a $3.75 per unit, significantly lower than previously. With the new method, the final results show that all four products will be profitable. According to the new methodology, there are several conclusions worth mentioning: (1) the mark on is closer to a 20-25% value rather than previously and (2) two products that were formerly very profitable are now below the 25% threshold (products B. And D).

5. According to the calculations in the Excel (last lines), dividing the costs into two different pools would mean that products A and B. would have an allocation rate of 6.07 and that products C. And D. would have an allocation rate of 7.5.

6. The main condition for direct labor hours to accurately allocate Premier's indirect costs to its four products would be for the employees to be using all the respective utilities associated with fixed costs during the analyzed period and for the product portfolio. At the same time, this would probably not work for large bulks of standardized products where it is more difficult to differentiate accurately the cost allocation between different products.