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Case #13
“Destin Brass Products Co.”
Harvard Business School Case #9-190-089 (Rev. April 24, 1997)
Academic instructors who are registered with the publisher’s
website (http://www.hbsp.harvard.edu) may download the Teaching
Note #5-191-029 (Rev. April 27, 1992) for this case free of
charge.
ABSTRACT
Management of Destin Brass Products Company is puzzled by
three observations: (a) competitors are reducing prices on Pumps,
forcing the company to match them; (b) no competition to the
TEACHING OBJECTIVES
The activity based costing (ABC) method is particularly
useful for companies incurring significant overhead costs (e.g.,
greater than 30 percent of the total product costs) and/or
SUGGESTED QUESTIONS FOR CLASSROOM DISCUSSION
1. Explain how costs are estimated in the three cost systems
delineated in the case: (a) the traditional cost system, (b) the
modified cost system, and (c) the activity based costing (ABC)
system. How do you determine which cost system is better suited
for a given company?
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ANALYSIS
1. Explain how costs are estimated in the three cost systems
delineated in the case: (a) the traditional cost system, (b) the
modified cost system, and (c) the activity based costing (ABC)
system. How do you determine which cost system is better suited
for a given company?
A. Traditional Cost System – In the traditional cost system, all
overhead expenses that include engineering, receiving, packaging/
shipping, maintenance and depreciation, and others incurred in a
given period (e.g., month) are added together. This sum is then
divided by the total direct labor cost incurred in the same
B. Modified Cost System – The modified cost system considered by
Destin involves the assignment of those overhead charges related
to material handling and receiving (e.g., $200,000 and $20,000,
C. Activity Based Costing System – ABC system is one in which
each of the overhead charges is first assigned to a cost pool
from which the charge is then allocated to the products using
Tracking costs by the activities involved should more logically
yield a true estimation of the product cost.
How do you determine which cost system is better suited for a
given company?
All cost systems are more or less acceptable, as long as they
obtain the correct total overhead charges incurred in a given
period so that the company’s gross profit is reported correctly.
2. Estimate the unit product costs for the three Destin products
using the ABC method.
Table C13-1 itemizes the direct and indirect costs for the
three products involved.
TABLE C13-1. UNIT COSTS BASED ON ABC
Valves Pumps Flow Controllers
Material Cost ($/unit) $16.00 $20.00 $22.00
Set Up labor $0.02 $0.05 $0.08
Depreciation $12.50 $12.50 $5.00
3. Compare the product costs that were determined using the ABC
method with those of the other two methods. Why are the results
different?
The difference in product cost estimated by the three methods
is primarily due to the allocation of the overhead charges
related to (1) receiving, (2) material handling, (3) packaging/
Table C13-2 presents the computation of gross margins for
these products using cost data from the three methods.
TABLE C13-2. GROSS MARGIN COMPUTATIONS
Comparison
Valves Pumps Flow Controllers
Selling Price per unit $58.00 $81.30 $96.17
Traditional Method $37.56 $63.12 $56.50
4. How accurate do the costs have to be in order to become
useful for managerial decision making?
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To be useful, a cost system need not be extremely precise as
its principal value lies in the correct reporting of the relative
magnitudes of itemized costs involved. However, it does need to
5. What are the strategic implications of the product costs
estimated using the ABC method?
As clearly pointed out by the ABC product costs, the other
two products are unintentionally subsidizing Flow Controllers.
Several management actions are called for:
A. Raise the price of Flow Controllers gradually to a level that
C. Because the labor contents of Flow Controllers are so
excessively high in comparison with that of the other two
products, the company must actively study the possibilities of
D. Strengthening the market position of Pumps is of critical
importance to the company, as Pumps contribute 55 percent of the
company business. Study the engineering expense for Pumps to work
off its product cost.
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Opportunities for profitability improvement are readily
evaluated by defining “unit costs” such as: (1) receiving labor
cost per unit component-run, (2) materials handling labor cost
per component-run, (3) materials cost per component in each
product, (4) cost for each change order, (5) labor cost for each
packaging/shipment, and (6) maintenance cost per machine hour.
6 How much higher or lower would the net income be that was
reported under the ABC method as compared with that reported
under the present traditional cost system, assuming that the
company is operating under otherwise similar conditions in the
months ahead? Why?
The net income of the company will stay the same, independent
of which cost system is used to report income (see Table C13-3).
TABLE C13-3. GROSS PROFIT OF THE COMPANY
Sales Revenue $4,35,000 $10,16,250 $3,84,680 $18,35,930
7. Attachment of Table C13-4.
TABLE C13-4. ABC MODEL FOR DUSTIN BRASS PRODUCTS
Valves Pumps Flow Controllers Monthly Total Notes
Production (Units) 7500 12,500 4000
Run (#) 1 5 10
Shipments (#) 1 7 22
Total Shipments (Units) 7500 12,500 4000
Manufacturing Overhead
Receiving $20,000
# Components handled for all runs 4 25 100 Run number
* Component number
Cost Pool $620.16 $3,875.97 $15,503.88
Receiving Per Unit $0.08 $0.31 $3.88
Packing/Shipping $60,000
# of shipments 1 7 22 Product shipments
Cost pool $2,000 $14,000 $44,000
Packaging/shipping per unit $0.27 $1.12 $11.00