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COPYRIGHT 2005 Institute of Management Accountants
EXECUTIVE SUMMARY A company's customer choice or decision to bid for a job can have a significant effect on company profit. A detailed case study demonstrates how a firm that analyzes its conversion process can make a better-informed decision regarding what job orders or bids it should pursue. The detailed scenario explains job complexity caused by product variety and a lack of a customer strategy. Because the company accepted jobs without understanding their impact on overall costs, it went into a "death spiral." This outcome could have been avoided if management had understood the impact of its customer decisions on costs and, thereby, on profits.
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A variety of factors come into play when a company is faced with a decision to take on a job. The process involves cost estimates for bidding purposes as well as a review of current and planned workload for scheduling purposes. One problem many companies face is that their cost systems may be out of date or may not be managed such that product costs are accurate. Substantial documentation shows that an activity-based approach to cost reporting can help overcome this problem by aiding cost comprehension and, therefore, enabling better management.
This article presents a description of a complex workplace where costs are beginning to outweigh revenues. The complexity is driving costs in a fashion that can only be understood if the processes are broken down into activities and each activity is costed. This is a classic situation in which an activity approach enables a better understanding of costs, thereby creating the possibility for improved management of costs.
CUSTOM PAINT SHOP
Custom Paint Shop is a privately held custom coater (painter) of automotive components to original equipment manufacturers (OEMs) and tier 1 and 2 suppliers. Raw metal parts are received on consignment from the customer, finished with the desired application(s) of paint, and shipped back to the same customer. Coating services include electrodeposition, powder, and electrostatic spray topcoat applications. The company has annual revenues of $65 million, with $20 million in sales coming from the plant that specializes in spray topcoat applications, which is the focus of the example. The basic processes, from receipt of the raw stock to shipment of the completed product to the customer, are illustrated in Figure 1.
[FIGURE 1 OMITTED]
Custom Paint Shop is a service company in that the customer is also the supplier. Raw stock (raw material inputs) from the customer is delivered, processed, and then returned to the customer as a completed product (finished good outputs). The customer may then choose to further fabricate the part and/or send it forward to the next customer in the automotive supply chain. Most firms that are required to have their components coated in accordance with various OEM paint specifications do not possess the expertise, start-up capital, or desire to face the business and financial risks associated with "tooling up" to perform the painting function. Custom Paint Shop markets itself to this clientele as a "headache relief" option.
Historically, Custom Paint Shop accepted most of the work assignments offered. Prices were based on cost-plus basis, where cost was a form of standard costing, including an annually calculated burden rate (see Appendix A for details of the calculations). This approach omitted some costs, such as the costs of painting small parts and finessing painted parts. Recently, demand increased significantly, especially for higher-grade coatings. As volume increased, however, profits decreased. Consequently, activity analysis was introduced.
PRODUCT LINES
Custom Paint Shop's basic product is a series of coatings that it applies to various automobile parts. Because the coatings vary by nature, color, and the level of gloss, the product line is composed of a large number of combinations of the various types of coating, color, and paint finishes. In Table 1, the combinations are shown in 17 groups according to the type of coating--enamel topcoat, high or low gloss, base coat, and clear coat--and the relative cost per gallon of the paint (high, medium, or low). Most products receive some form of high-gloss finish. Products are further differentiated by whether a primer is or is not added at the beginning of the paint process. Paint costs vary over quite a range, which also differentiates the products. Table 2 shows selected summary measures of the colors within each finish type, the gallons used (excluding those wasted during setup), and the cost per gallon. The various parts to which the coatings are applied are, specifically, bumpers, luggage racks, window sashes, tailgates, hoods, and body moldings.
Several distinctions between the high- and low-gloss finishes...
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