A Mid-Sized Forging Company
ABC Industries was a mid-sized, closed-die forging company located in Southeastern Michigan. Its annual sales of $25 million generated earnings before income taxes of $500 thousand.
After receiving steel bars, the company would cut them to the appropriate length, sand blast them and then perform one to three forging operations on presses of varying tonnage until the steel was forged into the required shape. Although some parts were complete at that point, many were finished in the company’s machine shop. When all manufacturing processes were complete, all parts went through a sorting process before being packaged and shipped.
ABC had been developing its cost information using traditional costing methods. It determined its product costs using a plant-wide, direct labor-based overhead rate calculated using the previous year’s actual results.
In creating a managerial costing model that more closely reflected the operation of the business, manufacturing activities – both value adding and non-value adding – were segregated into groups with similar cost structures:
Expenses and activities supporting production labor (payroll taxes, health insurance, human resource support. etc.) were segregated from those supporting non-labor production resources (depreciation, utilities, maintenance, etc.). These production labor-support costs were the only costs included in a labor hour-based rate used to assign direct labor costs to products.
Expenses and activities involved in the pre-production set up of forging presses – including the cost of lost capacity due to equipment downtime during set up – were segregated and incorporated into a “cost per set up” that was used to assign set up costs to products based on their production batch size.
Forging presses were divided into three groups based on their tonnage and machining operations were separated from forging activities. Non-labor related production expenses and activities (occupancy, depreciation, utilities, maintenance, etc.) were assigned to these four activity centers based on consumption metrics or estimates of knowledgeable individuals and these costs included in equipment hour-based rates used to assign indirect manufacturing costs to products.
Expenses and activities involved in sorting and packing parts were segregated and included in a direct labor hour-based rate used to assign sort and pack costs to products.
Expenses and activities involved in the in-process movement and storage of parts were segregated and included in a “cost per move” that was used to assign this direct – but non-value-adding – cost to products.