Why have selling administrative costs not traditionally been traced to individual products and customers?
Under the old costs system, Kanthal management felt that selling and administration costs were fixed costs, and as a result they could not be changed, manipulated, or utilized to influence growth or profitability. Traditionally, Kanthal had considered S"E expenditures to be period costs and were expensed in that manner rather than allocating them to the various product lines and customers. Under the old system, management failed to realize that some of their customers placed heavy demands on the organization while others did not. Therefore, no attempts were made to allocate S"A costs to the customers or product lines. As a result, costs were spread evenly and the focus of the sales force was on volume rather than the percent profit margin or the true bottom line contribution of each order to the company.
Evaluate the approach taken at Kanthal to compute the profit of individual orderliness, including assigning S"A costs to each customer order. How were the costs of customer orders and the costs of producing non-stocked items estimated?
The company re-invented a way to approach their cost allocations. Instead of treating S"A expenditures as period costs, the company derived a methodology for allocating these costs where they were applicable. The financial managers solicited information from the various departments in the organization about the nature of the activities in each department. A new cost allocation method was constructed based on the information received.
The new costs system allowed for management to capture the costs either as work that was either order related or volume related. These were the primary cost drivers for the S"A and manufacturing expenditures. After discussing everything with the different department heads, the company would then determine how much of each departments' expenditures related to sales volume and production and how much related to handling individual production and sales orders. Four categories for cost allocation were later established:
1)Manufacturing volume related costs
2)Manufacturing order related costs
3)S"A volume related costs
4)S"A order related costs
Although this system was much more rigorous, it made a good faith effort to assign the various production and S"A expenditures to customers and products lines. The departments captured in this system were comprehensive and were also generally identified as to who would have responsibilities for manufacturing costs.
Computing order and volume costs was a four-step process. First, S"A order costs were computed by dividing the total number of orders into total S"A costs (refer to Exhibit 4 in the case). Second, the manufacturing order costs for non-stocked items was calculated by dividing total manufacturing order costs for non-stocked items by the number of orders for non-stocked products. Non-stocked products have additional costs associated with processing orders that went above and beyond the costs associated with a stocked product. The third step involved determining what the S"A allocation factor would be for calculating the S"A volume related costs. This allocation factor would then be applied to manufacturing COGS. The fourth and final step involved the calculation of the operating profit based on backing out volume related costs from sales revenues followed by deducting S"A and manufacturing order costs from the resulting gross margin to arrive at a operating profit.
Consider a product line with 50% gross margins (after subtracting volume-related expenses from prices). The cost for handling an individual customer order is SEK 750, and the extra cost to handle a production order for a non-stocked item is SEK 2,250.
a). Compare the operating profits and profit margins of two small orders, both for SEK