Kanthal

Kanthal

1) President’s accomplishments

Basically, the president was trying to accomplish a move from a traditional cost accounting system to a new, ABC accounting system. This, in order to identify what are the true costs of each customer and each order, enabling the company to fully understand its cost structure thereby providing the base for better business choices (and higher profitability).

These are very sensible goals indeed. Even though the company is profitable, implementing a new, activity-based cost accounting system will allow the company to improve its margins and become even more focused and competitive in the future.

2) Drawbacks with the previous system

The old system was inadequate because of the following:

The system was designed for a more labor-intensive production process (i.e. 1 book-keeper for every 10 blacksmiths vs. 8 book-keepers for every 3 blacksmiths)

The system allocates overhead costs on an equal basis between customers and products, which creates discrepancies and hidden profits/costs.

Hidden profit and hidden cost customers are created when they are over or under-burdened by the unfair distribution of overhead costs. In extreme cases, these can make unprofitable orders look profitable, and vice versa.

For example, let us take a look at a sales account manager who spends 99% of his time one month negotiating an order from a new customer A that will earn a $3,000 profit. During the same month, he spends 1% of his time tending a re-order from an existing customer B for a $10,000. If his $5,000 monthly salary is allocated on an even basis, then customer A will be shown as making a $500 profit (instead of a $2,000 loss), while Customer B will be shown as a $5,000 profit only (even though the reality is double that figure).

3) New system working methodology

The new system eliminates financial accounting categories that are not meaningful. The system attempts to allocate costs on a per customer...