SIPPICAN CORPORATION

1.0 INTRODUCTION:
Sippican Corporation a manufacturer of water purification equipment which are valves,
pumps, and ow controllers. Its recent monthly nancial results reveal the severe economic
impact from price cutting in pumps, one of its major product lines. The companys overall gross
margin is well below its targeted 35 percent level, sales in the latest month had fallen to about 5
percent. The poor nancial performance has occurred price increase in its new ow controller
product line, which met little sales resistance in the marketplace. Sippican operates with a simple
cost accounting system that directly charges each unit of product for its direct materials and labor
costs. Materials cost is based on the prices paid for components under annual purchasing
agreements.

1 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

2.0 ANALYSIS:
Based on the article, Sippican is spending more on overhead than on either direct material
or direct labor. The overhead increased significantly in recent years. Sippican has considerable
diversity in its product mix. Each product may contain different degree of spending on indirect or
supporting resources, and high variety on product and consumer characteristics. Activity-based
cost (ABC) system is considered to be a more accurate costing of present resource that will
enable Sippican to project its future resource demands more effectively. There are many
advantage using ABC system such as ABC system allocates indirect costs based on a products
cost driver, or the factor that creates the cost. As costs are allocated per product, a picture starts
to emerge of which business processes are performing well and which ones need to be improved.
ABC can be used to identify non-valued added activities and can help to better allocate resources
to efficient and profitable activities. The use of ABC can also add value to the continuous
improvement of business processes.
Sippican is a manufacturer company with multiple products, using simple cost accounting
system that directly allocate factory overhead to unit of product entirely through one single
allocation base. The company has only one producing department, which machines and
assembles components into nished products. Setup, receiving, production control, packaging,
shipping, and engineering are the cost system allocates factory overhead costs. In example, 185
% of production run direct labor cost in this case is although an inexpensive way while is
sometimes distort actual contribution of the product. As the level of diversity in output rises,
traditional costing becomes less reliable. Firms that have a lot of overhead expenses need a more
reliable method to allocate the overhead costs to different products. If Sippican uses incorrect
costing to allocate costs, it could price its products incorrectly. This might affect its competitive
position.

2 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

Then, calculating the practical capacity and the capacity cost rates for each Sippicans
resources production and setup employees, machines, receiving and production control
employees, shipping and packaging employees and engineers:
Capacity Cost Rates for Resources:
Employed
days/month

Monthly
cost ($)

Production workers

20

3,900

Paid
hours per
day
7.5

Productive
Hours per
hours per
month
day
6
120

Cost
per
hour ($)
32.5

Indirect workers

20

3,900

7.5

6.5

130

30

Engineers
Machines

20
20

9,750
5,400

7.5

6
12

120
240

81.25
22.5

Monthly Resource Cost and Utilization:

90
62
30

Monthly
cost ($)
/unit
3,900
5,300
3,900

3,900

15,600

480

431

89.79

8
30

9,750
3,900

78,000
117,000

960
3600

900
3,483

93.75
96.75

Units
Direct labor
Machines
Setup
Receiving &
production control
Engineers
Packing & shipping

Total cost
($)

Hour
available

*Hours
used

Capacity
used (%)

351,000
334,800
117,000

10800
14880
3600

10,700
14,600
3,400

99.07
98.12
94.44

*Hour used:
Production Volume
DL
Machine runs
Machine setups
Total machines
Setup labor
Reveicing &
Production control

Valves
7,500

Pumps
12,500

Controllers
4,000

Hours used
24,000

2,850
3,750
100

6,250
6,250
600

1,600
1,200
2,700

100

600

2,700

10,700
11,200
3,400
14,600
3,400

25

125

281

431

3 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

Engineers
Packaging &
shipping
*Calculation:

60

240

600

900

1,033

1,750

700

3,483

For valve

DL hours = 7,500 valves x 0.38 DL hours per valve = 2,850

Machine run hours = 7,500 valves x 0.5 machine hours per valve = 3,750
Machine setup hours and labor setup hours (from case) = 100 (5x20)
Receiving and production hours = 1.25 x 20 production runs = 25
Engineering hours = 60 (given from case)
Packaging and shipping hours = (40 shipments x 50/60) + (7,500 valves x 8/60) = 1,033

The total manufacturing overhead was $ 654 600. So, we are using the Activity Based Costing method to
find the differences. Below is the calculation that we are done in finding the rate for the cost driver for
overhead.

Overhead
Machine-related expenses

Manufacturing overhead
$
334,800.00

Set-up labor

Receiving and Production Control

Engineering
Packaging and shipping
TOTAL

117,000.00
$
15,600.00
$
78,000.00
$
109,200.00
$
654,600.00

4 | H A RVA R D B U S I N E S S S C HO O L

Total Cost
Driver (hours)
11200
3400
345
900
340
16185

Rate of Cost Driver

$
29.89
$
34.41
$
45.22
$
86.67
$
321.18
$
517.37

SIPPICAN CORPORATION

Then, we were calculating the total costs for each product for Sippican Corporation. The highest
cost of product manufacturing overhead is Pumps which is $ 264,916.80. But, the cost per unit is higher is
Flow Controllers which is $ 98.80 because of less of production which is only 4000 unit. This might be
the quality of the product is high.

Overhead
Machine-related
expenses
Set-up labor
Receiving and
Production Control
Engineering
Packaging and shipping
TOTAL

Overhead
Manufacturing
Direct Material Costs
Direct Labour Costs
Total Costs
Total Costs/unit

Valves
Hours
Total Costs
$112,098.2
3750
1
100
$3,441.18
20
60
40
3970

$904.35
$5,200.00
$12,847.06
$134,490.8
0

Pumps
Hours
Total Costs

Flow Controllers
Hours
Total Costs

6250
600

$186,830.36
$20,647.06

1200
2700

$
$

35,871.43
92,911.76

100
240
100

$4,521.74
$20,800.00
$32,117.65

225
600
200

$
$
$

10,173.91
52,000.00
64,235.29

7290

$264,916.80

4925

255,192.40

Valves
$ 134,490.80
$ 120,000.00
$ 92,625.00
$ 347,115.80
$46.28

Pumps
$ 264,916.80
$ 250,000.00
$ 203,125.00
$ 718,041.80
$ 57.44

Flow Controllers
$ 255,192.40
$ 88,000.00
$ 52,000.00
$ 395,192.40
$ 98.80

Then, we were calculating the gross margin between the traditional method and the ABC method. The
highest differences is on Pumps product which is Sippican can gain 13% more profit if they are using
ABC method. For Valves, it also shows that Sippican can gain 6% of profit if they are using ABC method
in calculating the costs. The Flow Controllers show the loss about 42% if Sippican using the ABC
methods. This because of the engineering and setup costs is high .

Valves
Cost for traditional method
Cost for ABC method
Selling Price
Gross Margin (Traditional)

$ 51.20
$ 46.28
$ 79.00
35%

5 | H A RVA R D B U S I N E S S S C HO O L

Pumps
$ 66.31
$ 57.44
$70.00
5%

Flow Controllers
$ 59.05
$ 98.80
$ 95.00
38%

SIPPICAN CORPORATION
Gross Margin (ABC)
Differences of gross margin

41%
6%

18%
13%

-4%
-42%

The revised cost and profitability estimates, what actions should Sippicans management team
take to improve the companys profitability:
By using ABC method, we can see that for the pumps, the cost is actually lower and
the gross margin is actually higher. Therefore, to improve the companys profitability, Sippicans
management team should take action to continue produce the pumps since they would not give
up its place as a major pump supplier. As we can see that the gross margin is actually higher,
therefore the company can still gain profit from the production of pumps even though the price
for the pumps need to be reduce to compete in the marketplace. Sippican also can reduce
discounting for pumps, especially in small order sizes. It is because by not giving too much
discount, Sippican can maintain their profit of the pumps. Other than that, Sippican can allocate
unused capacity for pump production to reduce the production cost. So, Sippican can gain more
profit from the selling of pumps.
Besides that, to improve companys profitability, the management team should also
take action to focus on the production of valves. It is because from the ABC method, we can
analyse that the cost is much lower and the gross margin is really higher. The gross margin is
really higher. The gross margin is beyond the standard 35% and it is actually really good.
Therefore, the production of valves should be focus because it contributes a lot of profits for
Sippican. The company also can improve the profit of the valves from increase market share in
valves by offering discounts for large orders. So, it will attract more customers to order in a large
quantity. Therefore, Sippican will gain more profit.
In contrast, Sippicans management team should be aware about the production of
flow controller. It is because from the ABC method, we can see that the cost is actually higher
and the gross margin turns to negative margin. Therefore, it shows that Sippican not gain any
profit from the production of flow controller instead it make the company loss. The cost for the
production of flow controller become higher because of the engineering cost and set up cost.
Therefore, to gain profit from the production of flow controller, maybe the engineering hours and
set up hours could be reduce so that the engineering cost and set up cost can be reduce. Besides
6 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

that, aggressively raise prices for small orders of flow controllers is a good strategy that the
management team should do. By increase the price, it can cover the cost for the production and
also can gain some profit.

Then, estimated resources demand are as follows:

Valves
Production units

10,000

Total DL hours
Total machine run hours
Machine setup hours

3,800
5,000
160

Flow
Controllers
12,000
2,500
Time in Hours
6,000
1,000
6,000
750
192
480

Total machine hours

5,160

6,192

1,230

12,582

160

192

480

832

50
60
1,367

50
240
1,658

62.5
400
417

162.5
700
3,442

Labor setup hours

Receiving and production control
Engineering hours
Packaging and shipping

Pumps

Total
24,500
10,800
11,750
832

The calculation for receiving and production control and packaging and shipping as follows:
Receiving and Production Control calculation:
Valves: 1.25 40 = 50 hours
Pumps: 1.25 40 = 50 hours
Flow Controllers: 1.25 50 = 62.5 hours

Packaging and Shipping Time calculation:

Valves: [(40 50) + (10,000 8)]/60 = 1,367 hours
Pumps: [(70 50) + (12,000 8)]/60 = 1,658 hours
Flow Controllers: [(100 50) +(2,500 8)]/60 = 417 hours

7 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

The unit of resources needed to meet the demand:

Resources Needed

Hours Needed

Hours
available/unit

Direct labor
Setup labor
Machines
Receiving and production control
Packaging and shipping
Engineers

10,800
832
12,582
163
3,442
700

120
120
240
130
130
120

Full Time
Equivalent Unit
Needed
90.00
6.93
52.43
1.25
26.48
5.83

Actual
90
7
53
2
27
6

Income
statement
new product
line of
Sipican
Corporation
B:
PRO FORMA FOR
SIPICAN (B)

Valves

Flow
Controllers

Pumps

Unused

Charged

Actual

Capacity
Sales (units)
Sales revenue

10,000
$

Sales percentage

750,000.00

12,000
$ 960,000.00

38%

2,500
$

48%

275,000.00

$ 1,985,000.00

$ 1,985,000.00

14%

DL expenses

123,500.00

$ 195,000.00

32,500.00

$ 351,000.00

351,000.00

Material expenses

160,000.00

$ 240,000.00

55,000.00

$ 455,000.00

455,000.00

Contribution margin($)

466,500.00

$ 525,000.00

187,500.00

$ 1,179,000.00

$ 1,179,000.00

Contribution margin(%)
Machine run-time
expense
Machine set-up expense

62%
$

112,500.00

Setup labor
Receiving and
production control
Engineering
Package & ship
Manufacturing
overhead
Total costs
Gross margin
Gross margin %

55%

68%

59%

$ 135,000.00

16,875.00

$ 264,375.00

3,600.00

4,320.00

10,800.00

18,720.00

5,200.00

6,240.00

15,600.00

1,500.00

1,500.00

1,875.00

4,875.00

19,500.00

41,010.00

49,740.00

168,685.00

$
$

59%
$

3,105.00

267,480.00

27,040.00

260.00

27,300.00

4,875.00

2,925.00

7,800.00

32,500.00

56,875.00

1,625.00

58,500.00

12,510.00

$ 103,260.00

2,040.00

105,300.00

$ 216,300.00

90,160.00

$ 475,145.00

9,955.00

466,380.00

452,185.00

$ 651,300.00

177,660.00

$ 1,281,145.00

9,955.00

$ 1,272,380.00

297,815.00

$ 308,700.00

97,340.00

$ 703,855.00

(9,955.00)

40%

32%

8 | H A RVA R D B U S I N E S S S C HO O L

35%

35%

712,620.00
36%

SIPPICAN CORPORATION
S&A

350,000.00

Operating profit

362,620.00

Return on sales

Resources
Direct Labor (Production and
Assembly)
Machines (Runs and Setup)
Setup Labor
Receiving and Production Control
Engineers
Packaging and Shipping

18.27%

Available for
Used Hours

Cost/Hours

Cost of
Unused Capacity

100

32.50

3,250.00

280
200
88.75
60
156.67

$
$
$
$
$

22.50
32.50
30.00
81.25
30.00

$
$
$
$
$

6,300.00
6,500.00
2,662.50
4,875.00
4,700.10

9 | H A RVA R D B U S I N E S S S C HO O L

SIPPICAN CORPORATION

3.0 RECOMMENDATION:

From the overall analysis, we can recommend that Sippican Corporation should consider
implement a time-driven activity-based costing system. This system provides more accurate cost
and gross margin for each product. It use more cost pools to assign overhead costs. ABC method
also provides clearer insight about where direct labour and machine hours are really going. So it
is easily for Sippican Corporation to make adjustment on machine and labour time for each
product. It is really good by using ABC method because the labour and machine hours are
allocate separately. So, the costs can be determines accurately. By using ABC method, it
enhances control over overhead costs and help for better management decisions.
Sippican Corporation able to improves the companys profitability by using ABC
method. They know the real cost and gross margin of each product. The management team can
adjust the overhead costs so that the company able to gain the maximum profit. By refer to the
gross margin for each product on the ABC method, Sippican Corporation able to decide the
actually quantity and price for each product that contribute to the maximum profit for their
company. Besides that, the company able to decide the discount rate that they should offer to
their customer in order for not making loss and still gain the maximum profit.

10 | H A R V A R D B U S I N E S S S C H O O L

SIPPICAN CORPORATION

4.0 REFERENCES:

Langfield-Smith. (2013). Management Accounting. Mc Graw Hill Education.

Stephen A. Ross, R. W. (2015). Corporate Finance. Mc Graw Hill Education.

11 | H A R V A R D B U S I N E S S S C H O O L

SIPPICAN CORPORATION

5.0 APPENDIX:

Minute Meeting CIMA (Group 7) 1

DATE

: 17/3/2016

VENUE

: Faculty of Management

TIME

: 2.00 pm

ATTENDANCE:
1. MUHAMMAD ZULKEFLI BIN ABDULLAH
2. NURUL NADIAH BINTI HARUN
3. NOR LIYANA BINTI HASHIM
4. AIN SYAMSULIYANA BINTI SAHMSOL AZMAN
5. FARRA NABILA BINTI SHAHROM
NO
1.
2.
3.
4.

5.

DETAILS
Everyone read the case study and gain their understanding
about the case study.
Everyone briefly explain what they understand regarding the
case study.
Everyone was assigned their numbers of question on the case
study and also other part of the report.
This is the summary of tasks that has been divided:
Nadiah- Question 1,introduction and minutes meeting
Farah Nabila Question 4 and recommendation
Nor Liyana- Question 5 and 6
Ain- Question 3 and submit hardcopy and softcopy to
Dr. Saudah
Zul- Question 2 and compile
The meeting was delay to next meeting for discussion for the
answers at 3.00pm.

12 | H A R V A R D B U S I N E S S S C H O O L

NOTES
Everyone

SIPPICAN CORPORATION

Minute Meeting CIMA (Group 7) 2

DATE

: 21/3/2016

VENUE

: College 9-10

TIME

: 8.00 pm

ATTENDANCE:
1. MUHAMMAD ZULKEFLI BIN ABDULLAH
2. NURUL NADIAH BINTI HARUN
3. AIN SYAMSULIYANA BINTI SAHMSOL AZMAN
4. FARRA NABILA BINTI SHAHROM
ABSENT WITH REASON:
1. NOR LIYANA BINTI HASHIM ( CLUB MEETING)
DETAILS
NOTES
1. Everyone has prepared their answers to be presented to
others members of the group.
2. Everyone had explained one by one about their answer
and give justification for the answers.
3. We also had discussed about the issues and solution to Everyone
solve the question that been asked by others.
4. Ain had reminded us to send the report on the day of
the presentation and dont be late as what Dr. Saudah
told.
5. Everyone had noted to make changes for their part
regarding the misunderstanding.
6. Zul remind others to submit by 12.00am for easy her
for compiling purposes.
7. The meeting dismisses at 8.5 0pm.

13 | H A R V A R D B U S I N E S S S C H O O L