Design, Manufacturing, and Distribution Processes

Whether lenses are simple or complex, Plastim follows this sequence of steps to design, produce, and distribute them:

• DESIGN PRODUCTS AND PROCESSES. Each year Giovanni Motors specifies details of the simple and complex lenses it needs for its new models of cars. Plastim’s design department designs the new molds and specifies the manufacturing process to make the lenses.
• MANUFACTURE LENSES. The lenses are molded, finished, cleaned, and inspected.
• DISTRIBUTE LENSES. Finished lenses are packed and sent to Giovanni Motors’ plants.

Plastim is operating at capacity and incurs very low marketing costs. Because of its high-­quality products, Plastim has minimal customer-service costs. Plastim competes with several other companies that also manufacture simple lenses. At a recent meeting, Giovanni’s purchasing manager informed Plastim’s sales manager that Bandix, which makes only simple lenses, is offering to supply the S3 lens to Giovanni at a price of $53, well below the $63 price that Plastim is currently projecting and budgeting for 2020. Unless Plastim can lower its selling price, it will lose the Giovanni business for the simple lens for the upcoming model year. Fortunately, the same competitive pressures do not exist for the complex lens, which Plastim currently sells to Giovanni at $137 per lens.

1. Plastim’s managers have two primary options:

• Give up the Giovanni business in simple lenses if selling them is unprofitable. Bandix makes only simple lenses and perhaps, therefore, uses simpler technology and processes than Plastim. The simpler operations may give Bandix a cost advantage that Plastim cannot match. If so, it is better for Plastim to not supply the S3 lens to Giovanni.
• Reduce the price of the simple lens and either accept a lower margin or aggressively seek to reduce costs.

To make these long-run strategic decisions, managers first need to understand the costs to design, make, and distribute the S3 and C5 lenses.

Bandix makes only simple lenses and can fairly accurately calculate the cost of a lens by dividing total costs by the number of simple lenses produced. Plastim’s costing environment is more challenging because the manufacturing overhead costs support the production of both simple and complex lenses. Plastim’s managers and management accountants need to find a way to allocate overhead costs to each type of lens.

In computing costs, Plastim assigns both variable costs and costs that are fixed in the short run to the S3 and C5 lenses. Managers cost products and services to guide long-run strategic decisions such as what mix of products and services to produce and sell and what prices to charge for them. In the long run, managers have the ability to influence all costs. The firm will only survive in the long run if revenues exceed total costs, regardless of whether these costs are variable or fixed in the short run.

To guide pricing and cost-management decisions, Plastim’s managers need to consider all costs and therefore assign both manufacturing and nonmanufacturing costs to the S3 and C5 lenses. If managers had wanted to calculate the cost of inventory, Plastim’s management accountants would have assigned only manufacturing costs to the lenses, as required by Generally Accepted Accounting Principles. Surveys of company practice across the globe indicate that the vast majority of companies use costing systems not just for inventory costing but also for strategic purposes, such as pricing and product-mix decisions and decisions about cost reduction, process improvement, design, and planning and budgeting. Managers of these companies assign all costs to products and services. Even merchandising-sector companies (for whom inventory costing is straightforward) and service-sector companies (who have no inventory) expend considerable resources in designing and operating their costing systems to allocate costs for strategic purposes.