Kanthal

1. Major Issues and General Scenario

General Scenario:

Kanthal is a successful and profitable company that is a worldwide market leader in many of the products that it produces. Nevertheless, its new president feels that the company needs a new strategy that will provide it with a way to further increase profits but without increasing costs.

The new president believes that the key to the new strategy is to be able to understand the true nature (i.e. costs) of customers and orders. He feels that if the company is able to tie costs o customers in an accurate manner, it will enable the company to better focus on higher profitability.

Major Issues:

Understand the cost structure of the company.

Allocate costs on a per customer and per order basis.

Implement a new cost system that will support the new cost allocation methodology.

Improve decision making on customers and sales orders based on the information provided by the new system.

2. Case Questions

2.1. What was the president trying to accomplish?

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.

2.2. Why was the old system inadequate?

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).

2.3. How does the new system work?

The new system works by doing the following:

Eliminate financial accounting categories that are not meaningful

As much as possible, allocating costs on a per-customer/per-order basis.

As much as possible, allocating costs on a production volume basis.

The features of the new system include:

Reporting the cost structure (and profitability) on a per sales order basis

Reporting the cost structure (and profitability) on a per customer basis

The new system's effectiveness is limited by the following:

It does not focus and highlight inefficiencies in inventory