1. CH’NG CHIA YEE219648 CHUA YI MEI219663 NEW SZE YEE219791 ONG WEI LING220125 KOK KHAR HOW221246

2.  Founded in 1948, manufactures and markets - air treatment components and control products  products fall into two major categories:  compressed air filters, regulators and lubricators (FRLs)  complete family of compressor room products  production process is driven by "demand flow“  Price cuts in the pump - affected the company’s margins (below 20% vs. 35% estimated)  Flow controllers performing well (41% vs. 35% estimated)  Investigate its costing mechanisms & identify the proper mix of its product line

3. Valve Product differentiation (short) Cost leader (long) Pump Cost leader Flow controller Product differentiation

4. Original product line Maintained 35% gross margin Valves Matched competitor price reductions Pumps Recent 10% price increase did not affect demand Flow Controllers

5. Purchase materials and semi-finished components from suppliers Machine components to order Ship product to customer (Just-In-Time Shipping)

6.  Volume-based costing  Product cost by way of allocating : direct cost to the product and indirect cost related to the units produced.  Direct cost : Direct Material and Labor Cost  Indirect Cost : Overhead

7. PRODUCTVALVESPUMPSFLOW CONTROLLERS TOTAL # of Units7,50012,5004,00024,000 Direct Labor Cost per unit$ 10.00$ 12.50$ 10.00 Direct Material Cost per unit$ 16.00$ 20.00$ 22.00 Overhead Cost (@300%)$ 30.00$ 37.50$ 30.00 Direct Labor Cost$ 75,000$ 156,250$ 40,000$ 271,250 Direct Material Cost$ 120,000$ 250,000$ 88,000$ 458,000 Total Direct Costs$ 195,000$ 406,250$ 128,000$ 729,250 Overhead Costs (300% of DL)$ 225,000$ 468,750$ 120,000$ 813,750 Total Cost Allocation$ 420,000$ 875,000$ 248,000$ 1,543,000

8. What cost system should the company use ?Do the company pricing correctly ?How should the company increase profitability ?

9. Activity-Based Costing Traditional Volume-Based Costing VS

10. Activity-based costing is a method that designed to provide managers with cost information for strategic and other decisions that potentially affect capacity, fixed and variable cost. ABC is the costing system based on cost drivers that link activities performed to products and allocate overhead activity costs directly to products using cost drivers 1.Non-manufacturing as well as manufacturing costs may be assigned to product but only on a cause-and-effect basis. 2.Some manufacturing cost may be excluded from product costs. 3.Numerous overhead cost pools are used, each of the cost is allocated to product and other cost objects using its own unique measure of activity.

11. Manufacturing costs Nonmanufacturing costs ABC assigns both types of costs to products. Traditional product costing ABC product costing ABC does not assign all manufacturing costs to products. All Most, but not all Some ABC uses more cost pools and allocation bases.

14. COMPARISON OF PROFIT PROBABILITY OF VOLUME-BASED COSTING AND ACTIVITY-BASED COSTING ValvesPumpsFlow Controllers Actual selling price $ 86.00 $ 87.00 $ 105.00 Volume-based costing: Unit product costs $ 56.00 $ 70.00 $ 62.00 Actual gross margin (%)34.88%19.54%40.95% Activity-based costing: Unit product costs $ 46.17 $ 58.20 $ 115.38 Actual gross margin (%)46.32%33.10%-9.88%

15. Inappropriate method that leads to wrong assumptions when analyzing profitability and Leads to wrong pricing decisions and ineffective cost management. Activity based costing helps to find the real relationship between the volume of production of a product and the overhead Identified and help in setting profitable selling price for different products

16. Gross margin of Flow Controllers (according to cost allocated in ABC) $$ Sales (105 x 4,000)420,000.00 Direct Labor Expense (10 x 4,000)40,000.00 Direct Materials Expense (22 x 4,000)88,000.00 Manufacturing overhead -Machine related expenses (9 x 4,000) -Setup Labor (6.25 x 4,000) -Receiving and production control (28.13 x 4,000) -Engineering (12.50 x 4,000) -Packaging and shipping (27.50 x 4,000) 36,000.00 25,000.00 112,520.00 50,000.00 110,000.00333,520.00 Gross loss(41,520.00) PROBLEM 3 – HOW TO INCREASE PROFITABILITY OF THE COMPANY? The problems arise as a result of: 1.Loss arising from sales of flow controller 2.High manufacturing overhead faced by the company Analysis of Flow Controller production line

17. Divest flow controller production line Adjustment to the price of flow controller Invest in overall cost reductions of the company

18. Comparative income statement CurrentAfter dropping the production line Sales2,152,5001,732,500 Direct Labor(271,250)(231,250) Direct Materials(458,000)(370,000) Manufacturing overhead -Machine related expenses -Setup Labor -Receiving and production control -Engineering -Packaging and shipping 336,000 40,000 180,000 100,000 150,000(806,000) 300,000 15,000 67,480 50,000 40,000(472,480) Gross Margin617,250658,770 General, selling & admin expenses(559,650) Operating income (pre-tax)57,60099,120 Margin2.68%5.72% OPTION 1 – DIVEST FLOW CONTROLLER PRODUCTION LINE

19. Advantages: 1. The profit and profit margin of the company will increase after dropping the production line; 2. If the excess capacity utilized by other product, the company will be more profitable. Disadvantages: 1. Potential losing customers of other product, who also buy flow controller from the company; 2. Company not operating at its maximum capacity because dropping the excess capacity did not utilized by other production line; 3. The product has room to improve since it is price inelastic, there is still a potential to increase profit by increasing the price. OPTION 1 – DIVEST FLOW CONTROLLER PRODUCTION LINE

20. Suggestion: Increasing the price of the flow controller by 20% Flow Controllers ( After increase selling price) New selling price$ 105 x 120% = $ 126 Unit product cost (Activity Based Costing) $ 115.38 New Gross Margin$ 10.62 (8.4%) OPTION 2 – ADJUSTMENT IN PRICE OF FLOW CONTROLLER

21. Effect on income statement Comparative income statement CurrentAfter adjustment to the price Sales2,152,5002,236,500 Direct Labor(271,250) Direct Materials(458,000) Manufacturing overhead -Machine related expenses -Setup Labor -Receiving and production control -Engineering -Packaging and shipping 336,000 40,000 180,000 100,000 150,000(806,000) 336,000 40,000 180,000 100,000 150,000(806,000) Gross Margin617,250701,250 General, selling & admin expenses(559,650) Operating income (pre-tax)57,600141,600 Margin2.68%6.33%

22. Advantages: 1.Since the product is price inelastic, it will not have too much effect on the product’s market share; 2.It will increase margin of the company. Disadvantages: 1.Since company has, recently, increase price of the product, it may affect the reputation of the company if it increase the price again; 2.There is still risk that the company will lose customers as a result of increasing price; 3.Competitors might take opportunity to attack the market. OPTION 2 – ADJUSTMENT IN PRICE OF FLOW CONTROLLER

23. COST REDUCTION To reduce cost without sacrificing the product’s performance, quality, and safety etc. To find alternative materials or method which less expensive than existing but providing same functions for all 3 products. Reduce cost by redesigning the workflows and business process of the company. To eliminate non-value added activities in order for company to perform more effectively & efficiently. To reduce cost of a products in the product’s Research, development & engineering stage. Should be used by the company when designing a new product because about 80~85% of a product’s total life cycle cost are committed by decision made in RD & E stage. For existing product & new product For new product

24. Advantages: 1.For long term benefits of the company, to achieve competitive advantage; 2.It will reduce the cost of the company and increase profitability; 3.Increase efficiency and effectiveness of the company’s business process. Disadvantages: 1.It required longer times in order to have effects towards the company; 2.It required larger investments to be committed by the company for research to be done towards all its products and business process. OPTION 3 – INVEST IN COST REDUCTIONS

25. Recommendation Option 2 – Adjusting price of flow controller Option 3 – Invest in overall cost reductions -For immediate effect on the company’s profit; -A more correct pricing, without having to manufacture & sell a product at loss; -For short term, discount can be given to customers in future through discounts for bulk purchase or early clearance of credits etc. -For long term benefits of the company; -Allow company to gain competitive advantage through its manufacturing & business process; -Be prepare for switching of strategies, such as from “differentiation” to “cost leadership” if competitors start pricing wars to gain market shares. Increase profitability & achieve company’s goal to maximize profit