INTRODUCTION

Established in 1984, Destin Brass Products Co. had grown to become a significant player in
the industry of manufacturing water purification equipment. By identifying a market for
water purification valves, Destin Brass quickly built brand awareness and a customer base.
Destin Brass developed propriety manufacturing techniques and had a deep understanding
of working with brass. This competitive advantage led Destin Brass to add pumps and flow
controllers to its product range. Valves, Pumps and Flow Controllers represented 24%,
55% and 21% of company revenues respectively with each having a planned gross margin
of 35%. In recent times, manufacturers of pumps had entered into a price war forcing
prices down and consequently Destin Brass saw its gross margin on pump sales drop to
22%. At the same time, Destin Brass had found that the price elasticity of demand for Flow
Controllers was relatively inelastic, when it increased prices by 12.5% with no effect on
demand. Confused by competitor moves in the price cutting of pumps, the managers at
Destin Brass considered if competitors simply didnt know what they manufacturing costs
were, but it was more likely that problems may lie within Destin Brasss cost accounting
system. Destin Brass currently had a traditional cost accounting system in place. The
system took into account direct and indirect costs based on production and sales activity.
Each produced unit was charged for material cost based on component costs and labor
costs based on production run labor times. Overheads were then allocated in a two-stage
process and yielded standard unit cost of $37.6, $63.1 and $56.5 for valves, pumps and flow
controllers respectively. An alternative to the traditional approach would be to forego
overhead cost allocation altogether. Material and set-up labor cost overheads would be

allocated to each product line and machine hours would be changed for labor dollars as the
basis for allocating the remaining factory overhead. This revised approach reduced pumps
and flow controller unit costs to $58.9 and $47.9 but increased valve unit costs to $49. A
final approach involved more accurately distributing engineering costs and the idea that
activity, rather than production volume, drove costs. This activity based costing (ABC)
system would be allocated on the basis of transactions. ABC yielded a standard unit cost of
$47.2, $51.6 and $74.2 for valves, pumps and flow controllers respectively. The ABC system
suggested that Destin Brass could reduce pump prices dramatically whilst still maintaining
healthy margins and at the same time increase flow controller prices to maximize profits.
The case illustrates that misused cost accounting systems can have serious strategic
implications for a business.

BACKGROUND
Destin Brass Products Company was founded by Guidry, Scott, and Steve Abbott, the
current sales and marketing manager. After a conversation with the president of a large
water purification equipment manufacturer, Abbott discovered an opportunity to produce
high quality brass valves since the manufacturer was dissatisfied with the quality of brass
valves currently available. Scott was known for his ability to create high-quality brass boat
fittings for the fishing industry. Guidry was a veteran with a history of successful ventures,
and Alford had manufacturing accounting experience. Thus, Abbotts vision came to
fruition when the group purchased a commercial machine shop in 1984.

Scott noted the mistakes of existing valve makers and decided that a skilled labor force,

expensive machinery, or both, were required to maintain the necessary tight tolerances.
Before long, Destin became the sole supplier of valves to its customer. Individual
components were bought from foundries, with a just-in-time delivery agreement. After
delivery, the pieces were precisely machined and assembled.

Yet, two Destin founders had bigger dreams than solely manufacturing valves. A market for
brass pumps and flow controllers existed, which required the same skills and machinery as
the valves. Thus, a newly created engineering department designed the two new product
lines and the same skilled work force and machinery was utilized. Destin hoped to gain a
competitive advantage due to Scotts brass experience and an expanded product line.

VALVES
Consisting of four brass components, the valves were automatically machined; therefore, a
single machinist could operate two machines and assemble the valves simultaneously. The
high expense of precise machining made the specialty valves noncompetitive in the regular
valve market. Therefore, all monthly production was done at once and shipped directly to
the companys single customer. Valves accounted for 24% of Destins revenues and gross
margins maintained a standard of 35%.

PUMPS

The manufacturing process for pumps almost mirrored that of valves, but five components
were required rather than four. Five monthly production runs met the demands of seven

industrial distributors, as long as prices remained competitive. Destin felt the strain of
lowering their pump prices in order to remain in the market; thus, resulting in a 22% gross
margins in the last month, far below the planned gross margin of 35%, but 55% of their
revenues.

FLOW CONTROLLERS

Flow Controllers require more components, and more labor hours, but the physical
manufacturing process is similar to the valves. In recent months, ten production runs
resulted in 22 shipments to distributors and other customers. Unlike the pump market,
price competition for the flow controller is mild. Destin Brass was able to raise prices by 12
% with no obvious affect on demand. Flow controllers make up 21% of the companys
revenues.

After the latest months reports were completed, the group of four met to discuss the
results. With higher quality manufacturing capabilities than many competitors, the group
could not grasp how the competition could lower prices on pumps and still remain
profitable, yet have no price competition in the flow controller arena. A round table
accounting discussion finalized with Guidry directing Scott and Alford to propose a new
method of reporting production costs and to answer some key questions.