sea Part 2 Management decounting 1. Sippican Corporation: Operating Results (March 2006) EXHIBIT $1,847,500 10096 ore 351,000 : Direct Labor Expense pes pete Margin $1,038,500, 5696 i Manufacturing Overhead $334,800 z vestinesiant expenses 334800 Receiving and production control 15,600 Engineering bg Packaging and shipping 309,200 ‘ Total Manufacturing Overhead ay 35% es Gross Margin ee 3050 21% General, Selling & Administrative Expenses 350,000 . i Operating Income (pre-tax) Shave Cnewrer EXHIBIT 2 Product Profitability Analysis (March 2006) Direct labor cost® ‘Direct materia! cost Manufacturing overhead (@1859%) Souce: Ceswrter : “Dims abo conte wer chp at $2250 per Ihnut. The average daily compensation fr aye weed was 195 pt day ($3,000 noth Sided by 20 oe rite wos ezonty vide by 20 wortog das per mont). The holy rte was cleat by dividing 195 by ho as hours ay sgnin market share by cutting price, and gross margins had been maintained at a standard 35%, ‘The manufacturing process for pumps was practi- cally entice to tha for valves. Five components vere foe Spe verted imo the final produc. ‘The pumps were shipped to industrial gat utors after assembly, Recently, TeneoSippican Corporation (A)* The decline in our profits has become intolerable, The severe price cutting in that line has been implemented without losing any business. —Robert Parker, President of Sippican Corporation ‘Robert Parker was discussing operating results for the “Tatest month with Peggy Knight, his: controller, and ‘tinged with apprehension because competitors had been reducing prices on pumps, which were a major ‘product line. Since pumps were 2 product, Parker had seen no alternative but to match the reduced ‘tices to maintain volume. But the price i pti ‘teclinng company profits, especially in the pump line, ‘(Summary operating results for the previous month, ‘March 2006, are shown in Exhibits 1 and 2.) Sippican supplied products to manufacturers of purification equipment. The company had overt 3, Kaplan, Mt © President and Fellows of Harvard College. {Business School case 106-058. rai ee CHANT NB dona Aspe af Product Cotting Seen 5 ‘sions, such as regarding prices and production volumes)? Where the differences ard significant, explain why they exist. If there are no differences, or if the dif- ferences are not significant, explain why this is the se, ‘Do you thitik the cost system was a cause of the ro- Quests that Lourdes was receiving to discount ODDs back in 2001, when SMD was still a one~ Product, ODD-only company? Would it have made Sense to start implementing ABC at that time? . What should SMD management do regarding its cost system? (To the extent thatt they exist, discuss the advantages and disadvantages of each alterns- tive. Why did you recommend the alternative that you chose? Explain.) Started with a unique design for valves which allowed ito prodace to tolerances that were better than any in the industry. Parker quickly established a loyal cus- tomer base because of the high quality of his com> Pany’s manufactured valves. He and Scott realized that Sippican's existing labor skills and machining equip- ment could also be used to produce pumps and flow controllers, which their customers also. purchased, They soon established a major presence in: the high ‘Yolume pump product line and the mote customized flow controller line, Sippican’s production process started with the pur- chase of semifinished components from several sup- pliers. It machined these parts to the required toler ‘ances and assembled them in the company’s modern ‘manufacturing facility, The same equipment and labor were used for ail three product lines, and production runs were scheduled to match customer shipping requirements. Suppliers and customers had agneed to just-in-time deliveries, and products were packed and! shipped as completed, ‘Valves were produced by assembling four different machined components, Scott had designed machines that held components in fixtures so that they could tre ‘machined automatically. The valves were standard products and could be produced and shipped in lange Tots. Although Seott felt several competitors could now match Parker's quality in valves, none had tried'toiy 10 prepare factory payroll, this z Way to allocate overhead costs to Scomponents 10 campanents 302-56 4@S1 = $4 2@7— 14 5@ 2-10 — =e f= 8 $20 $22 ASOCL hours 0.40 DL hours Os 03 6 12 Exch component in a product required a separate Production run to machine the raw matetial ot pur hased part 10 the specifications for the product. Workers often operated several of the machines simultaneously once they had set up the machine, Because of the large number of setups, Sippican hhad dedicated about 25% of its production work- force to focus exclusively on setups. Some produc- tion workers did not operate any machines; they. Performed only manual assembly work. Theit as- ‘sembly time per product was included in the direct Fabor-hour estimates for each product, Sippican operated two 7% hour shifts each ‘weekday: Each shift employed 45 production and assembly workers, plus 15 setup workers, Workers Feceived two 15 minute breaks each day, They re- ‘Scived an average of 30 minutes per day for training and education activities, and all the workers— production, assembly, and setup—spent 30 minutes ‘each shift for preventive maintenance and minor te- pair of the machines. . The company had 62 machines for component pro- cessing. These machines were generally. avaitable for the six hours per shift that production workers were actively engaged in production or setup activ- ities on the machines. Sippican eased the ma- chines, Each machine's operating expenses were ‘about $5,400 per month, inchading lease payments, supplies, utes, and roaintenance and repairs. . The receiving and production control departments four people over the two shifts. These a gent prcsaed unravel wr ‘each batch of components for a production run. I took a total of 75 minutes for all the activities required to get one batch of components ordered,66 Part2 Management Accounting received, and moved to a machine for processing. ‘This time was independent of whether the components were for a long or a short production Tun, or whether the components were expensive or inexpensive. ‘The work in the packaging and shipping area had in- creased during the past coupie of years as Sippican increased the number of customers it served. Each shipment took 50 minutes to prepare the packages and labels, independent of the number or types of items in the shipment, plus eight mimutes per item to bubble wrap and pack in the carton, whether the ‘item was a valve, pump, or flow controller. The packaging and shipping area employed 14 people in each of the two shifts (28 in total). Like the employ- ees in production and assembly, employees in the Case 18-5 Sippican Corporation (B)* Sippican’s senior executive committee met to consider ‘the implications of its time-driven ABC model. Frankly, all had been shocked to learn that theit apparently highest-margin product line, flow controllers, could. actually be losing money because of its many. ship- ‘ments, short production runs, and heavy use of engi- neering time. The team contemplated action steps to ‘estore profitability. | “Professor Robert $. Kaplan, EXHIBIT 4 Monthly Production and Operating Statistics (March 2006) Teceiving, production control, packaging, and ship ping departments worked a 7/heur shift thit included two 15-minute breaks per day, and 30;nin- utes, on average, for training and education. Sippican employed eight engineers for and developing new product varieties, total compensation was $9,750 per month, Macho their time was spent modifying flow control ucts to conform to customer requests. Enginests: worked 7/4 hour shifts. After breaks, umining, edly cation, and professional activities, engineers sup- plied about 6 hours of productive work per shi, Knight's team had collected the data Exhibit 4 based on operations in March 2006. The! felt that this month was typical of ongoing oper ” anew strategy that involved Improve Revenue Quality: Menu-Based Pricing 4 + Focus om core products: valves! + ‘Thétense! market shane! counts for lange orders.