As we mentioned In our presentation, we often found ourselves pairing the model years 1987 and 1 988 gather and the years 1989 and 1990 together, as the two pairs seemed to compare very well (the first pair obviously falling before the outsourcing of the two product lines and the second pair falling after the outsourcing). Based on this Idea, we made the assumption that the growth rate In sales, direct materials, direct labor, and overhead costs from 1989 to 1990 would be good estimates of the growth rate from 1 990 to 1991, and therefore we used those growth rates to estimate our 1991 numbers on the estimated model year budget.
Based upon our assumptions and the numbers they resulted in, our estimated edged for the 1991 model year if the manifolds product line was not outsourced yielded a factory profit of $69,656. This profit is $6,1 55 higher than the recorded factory profit in 1990, an increase of 9. 7%. Our estimated 1991 model year budget also resulted In the overhead allocation rate dropping from 563% In 1990 to 549% In 1 991, a decrease of 14%. When we estimated the budget without manifolds (AKA assuming it was outsourced), the factory profit was $16,501.
While it is hard to compare that profit to the prior years’ due to the fact that the manifolds product line accounted for $93,000 In sales In 1990, the overhead allocation rates can still be compared. Our surnamed budget had an overhead allocation rate of over one thousand percent (1 in 1 991 if the manifolds product line is outsourced. This would be a direct result of losing such a high amount of sales dollars while not getting rid of any significant amount of costs due to the fact that Bridgetown current costing system Is based on direct labor dollars and not product line or process.
Since the current costing system’s allocation rate for overhead can be found by placing overhead costs over erect labor dollars, essentially what you are doing when outsourcing manifold Is significantly reducing the denominator while hardly touching the numerator, thus the overhead rate shoots up. Based on the aforementioned estimated numbers, as well as the pending possibility of emission standards changing which would heavily favor our manifolds and would likely result In Increased demand and selling price for them, we would not suggest discontinuing the production of manifolds and outsourcing the product line.
The increased overhead rate would reflect poorly on the company, and would intention the downward trend that the company is currently in, which would move them one step closer to failure. The high sales numbers as well as the bright future that manifolds seem to have on the marketplace are enough to convince us not to outsource the product line. OFF know for sure which of the company’s overhead accounts are predominantly fixed and predominantly variable (not based on assumptions), and what percentage of those overhead accounts that are variable are related to manifolds (again, eliminating the uncertainty involved in assuming), we would be able to quickly and accurately determine Just how profitable the manifold product line really is, which would make the decision on whether or not to outsource it, for all intents and purposes, a no-brainier.
Essentially, we feel that the main problem with Bridgetown is the way they allocate their overhead costs. Although assumptions can be made based on the overhead account descriptions to determine whether or not they are predominantly fixed or variable, we simply do not feel comfortable making those assumptions. Take for example account 2000. The description reads, “Production supplies such as gloves, safety goggles, and packing material.
While this appears to be an account containing predominantly variable costs, we do not feel as though taking a dollar amount from account 2000 and multiplying it by the percentage of direct labor dollars that are devoted to manifolds would provide an accurate number, because who’s to say that the process used to manufacture manifolds doesn’t use significantly fewer gloves and safety goggles than the process used to manufacture doors?
For this reason, we would strongly suggest that, if the company is able to afford it, activity-based costing is put into effect. While we realize that activity-based costing systems can be costly to implement, the amount of trouble that it would save the company is overwhelming. Under an BBC system, Bridgetown would know exactly how much overhead is used by each activity, and decisions on outsourcing would be made simple.
As it is the company is left cleaning up the mess from decisions that may have been made prematurely based upon the suggestions of an outside company who are not inclined to look out for Bridgetown best interests. If this company is to remain competitive in the fierce automobile manufacturing market, something needs to be done about the current costing system.