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Sippican

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Individual Paper: Activity-Based Costing

Matija Karaula

Individual Paper: Activity-Based Costing
Sippican Corporation

Course: B2B Pricing: Negotiation, Calculation, and Strategy

Matija Karaula
B2B Pricing: Negotiation, Calculation, and Strategy

Individual Paper: Activity-Based Costing

1) Defining the problem
The main problem of a Sippican corporation was a low pre-tax operating income (1.8%). To solve that problem, a cause had to be found. Sippican reported gross margins of 35% on valves,
5% on pumps and 38% on flow controllers. After looking at a gross margins of the three product lines, one would think that pumps were an issue to work on, and a main cause for a low operating income, because the pump sales accounted for 47,36% of a total sales in March with just 5% operating margin. However, the method of measuring the product profitability had to be questioned. To be more accurate, the method of assigning the overhead costs to each product line was the reason for inaccurate gross margins of the Sippican´s product lines.
Exhibit 1 – Result of a wrong overhead cost assignment
Wrong assignment of overhead costs Innacurate product profitability Inappropriate product pricing strategy

Lower operating income

The method of calculating the manufacturing overhead used by Sippican would be accurate if every of their three product lines was of the same or similar complexity. More complex products require more indirect work so one cannot simply assign the overhead costs to the products proportionally to direct labor working hours on each of them. However, that was exactly what Sippican was doing and what resulted in overvaluing the flow controllers (the most complex product line of Sippican), and undervaluing the pumps and valves. Moreover, that created the wrong image of Sippican´s product profitability which led to an...

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