Production Costs

Production Costs

Ben Parker

Enterprise Accounting and Finance

FBUS465-XA02

6/15/2015

Author’s Note:

Enterprise Accounting and Finance: Component 4: Phase 4

In any company it is important to figure out the selling cost before actually selling the product. This process can take place at the beginning, middle, or end of the product life cycle and it is important that a company always knows what goes into their product and how much they are selling it for. A company that has this knowledge will be price their products accurately, so they do not lose any money or price gouge a customer and drive them towards a competitor’s product.

In this case Specialty Tools is trying to secure business and is having to try to determine the selling price of their products to this customer. The sales manager has provided costs for both the A1 and B1 products and is asking that the prices be checked, so the company does not lose any money. Based on the information provided we can tell that the final cost of unit A1 after delivery and markup is $298.95 which is $36.05 lower than the suggested selling price of $335.00. Unit B1 is a different story as it has a selling cost after delivery and markup of $743.54 which is $18.54 higher than the suggested selling price of $725.00. This information shows what the actual target cost for products should be, A1 should be priced around $298.95 and B1 should be priced around $743.54 in order to meet the company’s normal markup and procedures.

The total product cost of each product based on the sales manager’s suggestion would be $8,877,500.00 for unit A1 and $13,412,500.00 for unit B1. These figures technically do not align with the company’s normal markups and procedures though, so to stay on track with normal procedures the total cost of units would need to be $7,922,175.00 for unit A1 and $13,755,433.75 for unit B1. The down side to this is that the company would actually be making less money than the sales manager’s suggestion since product A1 would no longer have a huge markup. This is a situation that would need to be carefully decided because it may be possible to obtain the order with the sales manager’s suggestion, but the other companies may put their costs on unit A1 more in line with the actual costs and cause Specialty Tools to miss out on the contract and revenue. If Specialty Tools decides to follow their normal procedures and markup than the customer would actually be paying less all together even though the per unit price of unit B1 is actually higher than the sales manager’s suggestion by $18.54 per unit. While Specialty Tools may be making less money this way over the sales manager’s suggestion, it would give the purchases a lower rate that may help to secure the business and still allow Specialty Tools to meet the normal markup price.

Based on the current market price Specialty Tools should go ahead and provide a quote to the customer. There is no point in producing this much product for an if and it would be a large if at that. A customer is always interested in price, but there are sometimes other motives that drives a customer to a different company. There could be brand loyalty, better products, or products that are better for that specific customer. Another possibility is that one of the other competitors underbid the project and actually ends up losing money or going out of business altogether. Even though Specialty Tools prices for unit A1 and B1 are very competitive with the average market price, it does not mean that Specialty Tools will get the job and therefore should wait before producing and losing $21,677,618.75 on a hunch.

The manufacturing data that was pulled to determine the selling price of unit A1 and unit B1 was based on the activity-based costing system. This can easily be recognized due to the breakdown of manufacturing, assembly, and machine hours. Activity-based costing is very important to have for any manufacture that produces more than one product as it provides more details about what actually goes into the product and what the cost should be. It will also help a company determine if there is a location that they can help try to save the company money (Bierman, 2010). If specialty tool was to use the conventional costing method than their prices per unit would be very different. The actually total selling price may not have changed; however, the price per unit would drastically change and could create confusion if the contract was secured and the product produced because one of the products would show losing money. The reason for this difference is because activity-based costing looks at all the details and costs of a production while conventional costing looks at the overall process and costs (Periasamy, 2010). For example, in the case of Specialty Tools instead of seeing that 6.8 machine hours went into unit A1 and 28.4 hours went into the making of unit B1 based on the activity-based costing system, we would only see that 35.2 machine hours went into the making of the products. This leads to a huge problem because Specialty Tools may know the total number of hours and the cost of each of those hours, but they do not know where those hours belong and cannot assign the machine hours appropriately to the correct unit. By not knowing which unit these hours belong to Specialty Tools will end up increasing the price of unit A1 as it does not have that many hours into it and lowering the price of unit B1 as it has majority of the machine hours in its production.

Many people have a tough time seeing the difference between activity-based costing and conventional costing because they are not familiar with the manufacturing world and get confused or scared at its mention, but activity-based costing is a very simple concept. The best way that this can be explained it to take a look at a bakery. That doughnut that is mass-produced in the morning may take ten minutes to prepare while that five tier wedding cake may take eight hours to prepare. If the bakery was to follow conventional costing methods than that doughnut may share some of the cost for that wedding cake and become very expensive. This concept is no different in the manufacturing world. A company needs to know what and how much time is going into the different products, so the company can accurately price them to avoid losing money or gouging the customer (Velmurugan, 2010).

Below is the link to the formulas and figures used to determine this information.

Accounting Final Formulas

Resources:

Bierman, H. (2010). Introduction to Accounting and Managerial Finance: A Merger of Equals. Retrieved from http://site.ebrary.com.ezproxy.bellevue.edu/lib/bellevue/reader.action?docID=10422258&ppg=268

Periasamy, P. (2010). Textbook of Financial Cost and Management Accounting. Retrieved from http://site.ebrary.com.ezproxy.bellevue.edu/lib/bellevue/detail.action?docID=10415439+

Velmurugan, M. (2010). The Success and Failure of Activity-Based Costing Systems. Retrieved from http://search.proquest.com.ezproxy.bellevue.edu/docview/856125540?accountid=28125

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