By

Hariharasubramanian(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
 Flow
Valves Pumps Controllers
Material $16.00 $20.00 $22.00
Direct Labor 4.00 8.00 6.40
Overhead 17.56 35.12 28.10
(439% of Direct Labor $) *
Standard unit cost $37.56 $63.12 $56.50
*Overhead
Machine depreciation $270,000
Set-up labor 2,688
Receiving 20,000
Materials handling 200,000
Engineering 100,000
Packing and shipping 60,000
Maintenance 30,000
Total overhead $682,688
Total run labor = 9,725 hours  $16 = $155,600.
Overhead rate = $682,688 / 155,600 = 439%
 Flow
Valves Pumps Controllers
Revenue $57.78 $81.26 $97.07
Variable Costs—Material only 16.00 20.00 22.00
Contribution 41.78 61.26 75.07
or
Assume Labor is Variable (case says only direct material is short-run
variable).
Run Labor 4.00 8.00 6.40
Set-up Labor ~.02 ~.05 ~.48
4.02 8.05 6.88
Contribution $37.76 $53.21 $68.19
 Flow
Valves Pumps Controllers
Material $16.00 $20.00 $22.00
Material Related Overhead
(48%)* 7.68 9.60 10.56
Set-up Labor .02 .05 .48
Direct Labor 4.00 8.00 6.40
Other overhead
($42.59 per machine hr)** 21.30 21.30 8.52
Revised standard cost $49.00 $58.95 $47.96
*Material Related Overhead
Receiving $ 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 $270,000
Engineering 100,000
Packing and Shipping 60,000
Maintenance 30,000
Total $460,000
Overhead 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 units
Material $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.
 Flow
Valves Pumps
Controllers
Actual Selling Price $57.78 $81.26 $97.07

Standard Cost 37.56 63.12 56.50

Gross Margin 20.22 18.14 40.57
Gross Margin % 35% 22% 42%

Revised Cost 49.00 58.95 47.96

Gross Margin 8.78 22.31 49.11
Gross Margin % 15% 27% 51%

ABC Cost 37.78 48.79 100.76

Gross 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?