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Case study
Costing System at Plastim Corporation

Introduction:
Plastim Corporation manufactures lenses for rear (tail) lamps of automobiles. The
lens, made from black, red, orange or white plastic, is the part of the lamp visible
from the outside. Lenses are made using injection molding. The molding operation
consists of injecting molten plastic into a mold to give the lamp its desired shape.
Under its contract with Giovanni Motors, a major automobile manufacturer,
Plastim makes two types of lenses a complex lens, CL15, and a simple lens, S3.
The complex lens is a large lens with special features such as multicolor molding
(where more than one color is injected into the mold) and complex shapes that
wrap around the side of the car.
The sequence of steps to design, produce, and distribute lenses, whether simple or
complex is as follows.
1. Design of products and processes. Design the molds from which the lenses
will be made and define the processes needed ( details of manufacturing
processes)
2. Manufacturing operations. The lenses are molded, finished, cleaned, and
inspected.
3. Shipping and distribution. Finished lenses are packed and sent to Giovanni
Motors.
Plastim is operating at capacity and incurs very low marketing costs. Because of its
high-quality products, Plastim has minimal customer-service costs. Plastims
business environment is very competitive with respect to simple lenses. At a recent
meeting, Giovannis purchasing manager indicated that a new competitor, who
makes only simple lenses, was offering to supply the S3 lens to Giovanni at a price
of around $53, well below Plastims price of $63. Unless Plastim lowered its
selling price, it would be in jeopardy of losing Giovannis business for the simple

lenses, similar to S3, for the upcoming model year. Plastims management was
very concerned about this development. The same competitive pressures did not
exist for the complex lens, which Plastim currently sells to Giovanni at a price of
$137 per lens.

Plastims management had various alternatives open to it:

1. Plastim could give up the Giovanni business in simple lenses if it were going
to be very unprofitable.
OR
2. It could reduce the price on the simple lens and either accept a lower margin
or aggressively seek to reduce costs.
But first management needed to understand what it costs to make and sell the S3
and CL5 lenses. To guide its pricing and cost management decisions, Plastims
managers assign all cost, both manufacturing and non manufacturing, to the S3 and
CL5 lenses. To cost products, Plastim currently uses indirect-cost-pool job costing
system. The steps are as follows.
1. Identify the chosen cost object: ( Simple 60,000 lenses and 15,000 complex
CL 5 lenses)
2. Identify the Direct costs of the lenses direct materials and direct
manufacturing labor
3. Plastim uses direct manufacturing labor-hours as the only allocation base to
allocate all indirect costs to S3 and CL 5. Most of the indirect costs consist
of salaries paid to supervisors, engineers, production support, and
maintenance staff that support direct manufacturing labor.

Product Costs at Plastims Inc. with existing Single Overhead Cost pool.
60,000 Simple lenses (S3)

15,000 Complex lenses (CL5)

Direct materials
Direct labor
Total direct costs
Indirect costs
allocated
Total costs

Total
$1,125,00
0
600,000
$1,725,00
0
1,800,000
$3,525,00
0

Per unit
$18.75

Total
$675,000

Per unit
$45.00

Total
$1,800,000

10.00
28.75

195,000
870,000

13.00
58.00

795,000
2,595,000

30.00

585,000

39.00

2,385,000

58.75 $1,455,000

$97.00

$4,980,000

Plastims management begins investigating why the S3 lens costs $58.75, well
above the $53 price quoted by Plastims competitor. Are Plastims technology and
processes inefficient in producing and distributing the simple S3 lens? Further
analysis indicates that this is not the reason. Plastim has years of experience in
manufacturing and distributing lenses like S3.Because Plastim often makes process
improvements, management is confident that Plastims technology and processes
for making lenses are not inferior to those of its competitor. Management is
pleasantly surprised to learn that Giovanni Motors considers the prices of CL5
lenses to be very competitive. Even more puzzling is that, even at these prices,
Plastim earns very large margins on the CL5 lenses.
60,000 Simple lenses (S3)

Revenue
Costs
Operating Income
Operating Income
Revenue

Total
$3,780,00
0
3,525,000
$255,000

15,000 Complex lenses (CL5)

Per unit
$63.00

Total
$2055,000

Per unit
$137.00

Total
$5,835,000

58.75

1,455,000

97.00

4,980,000

4.25
6.75%

600,000

40.00
29.20%

855,000

Plastims managers are surprised that the margins are low on S3 product where it
has strong capabilities, while the margins are quite high on the newer, less
established CL5 products. Since they were not deliberating charging a low price

for S3, they wonder if the cost system over costs the simple S3 and under costs the
complex CL5 lens.
Refining a cost system
A refined costing system results in a better measure of the non uniformity in the
use of an organizations resources by jobs, products and services. Increased
competition and advances in information technology have accelerated these
refinements. Three guidelines for refining a costing system are:
1. Direct-cost tracing. Classify as direct costs as many of the total costs as is
economically feasible.
2. Indirect-cost pools: Expand the number of indirect-cost pools until each of
these pools is homogeneous. In a homogeneous cost pool, all costs in the
cost pool have the same or similar cause-and-effect relationship.
3. Cost-allocation base. Identify the preferred cost-allocation base for each
indirect-cost pool.

Activity-Based Costing Systems

ABC systems calculate the costs of individual activities and assign costs to cost
objects such as products and services on the basis of the activities undertaken to
each product or service.
Plastims team identifies seven major activities.
1. Design products and processes
2. Set up molding machine to ensure mold is properly held in place and parts
are properly aligned before manufacturing starts.
3. Operate machines to manufacture lenses.
4. Maintain and clean the mold after lenses are manufactured.
5. Set up batches of finished lenses for shipment
6. Distribute lenses to customer sites.
7. Administer and manage all processes at Plastim

ABC systems emphasize on individual activities by focusing on the set up

activity. Setups frequently entail trial runs fine tuning, and adjustment. The
resources needed to set up the machines depend on the complexity of the
manufacturing operation. Complex lenses require more set ups resources
than do simple lenses. Furthermore, complex lenses can be produced only in
small batches because the mold needs to be cleaned more often.
Set up data for the simple S3 lens and the complex CL5 lens are as follows:

1
2
3
4
5

Quantity of lens produced

Number of lens produced per batch
Number of batches = (1) (2)
Set up time per batch
Total set up hours = (3)(4)

Simple
S3
60,000
240
250
2 hours
500 hours

Complex
CL5
15,000
50
300
5 hours
1,500 hours

Total

2,000 hours

Plastim identifies the total setups (consisting mainly of allocated costs of process
engineers, supervisors, and setup equipment) as $300,000. The following table
shows how setup costs are allocated to the simple and complex lenses using direct
manufacturing labor-hours and setup-hours respectively as the allocation bases.
Cost allocation bases

Simple S3 lens

Complex CL5 lens

Total

Direct labor hour

$226,415*

$ 73,585

$300,000

Set up hours

$ 75,000!

$225,000

$300,000

*$7.54717 30,000, $7.54717 9,750

!$ 150 500, $ 150 1,500

Some costs can be directly identified with a particular activity. For example,
salaries paid to design engineers are directly identifies with the design activity.
Other costs need to be allocated across activities. However, the allocation base
chosen are as follows.

Activity
(1)

Cost Category
(2)

Total
costs
(3)

Design

Productsustaining

$450,000

Set up

Batch

$300,000

Manufacturing
operations
Shipment set
up
Distribution

Output units

$637,500

Batch

$81,000

Output units

$391,500

Administration

Facility
sustaining

$255,000

Allocation base
(4)

Allocation
rate
(5) =
(3) (4)
100 parts times
$4,500 per
square-meter area
part times
square-meter
area of mold
2,000 setup hours
$150 per
setup-hour
12,750 molding$50 per
machine hours
machine hour
200 shipments
$ 405 per
shipment
$67,500 cubic
$5.80 per
meters
cubic meter
39,750 direct labor $6.4151 per
hour
direct labor
hour

The key point here is that all costs do not fit nicely into activity categories. Often
costs may need to be first allocated to activities before the costs of the activities
can be allocated to products.

Implementation of Activity-Based Costing at Plastim

The three guide lines for refining costing system are
1. Increasing direct cost tracing
2. Creating homogeneous in-direct cost pool
3. Identifying cost allocation basis (That have cause-and-effect relationship
with costs in the cost pool)

Product Costs under Activity-Based Cost Systems

60,000

15,000

Simple Lenses (S3)

Total
Direct Costs
Direct materials
Direct labor
Direct
maintenance
Total direct costs
Indirect Costs
Design costs
Setup costs
Manufacturing
operations costs
Shipping set up
costs
Distribution
activity
Administration

Complex Lenses (CL5)

Per
Unit

Total

Per
Unit

Total

$1,125,00
0
600,000
120,000

$18.75

$675,000

$45.00

$1,800,000

10.00
2.00

195,000
150,000

13.00
10.00

795,000
270,000

1,845,000

30.75

1,020,000

68.00

2,865,000

135,000
75,000
450,000

2.25
1.25
7.50

315,000
225,000
187,500

21.00
15.00
12.50

450,000
300,000
637,500

40,500

0.67

40,500

2.70

81,000

261,000

4.35

130,500

8.70

391,500

192,453

3.21

62,547

4.17

255,000

activity
Total indirect
costs
Total costs

1,153,953

19.23

$2,998,95
49.98
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Comparing Alternative Costing systems

961,047

64.07

2,115,000

$1,981,047

$132.0
7

$4,980,000

1. Existing Single Indirect-Cost Pool System

60,000 Simple lenses (S3)

Revenue
Costs
Operating Income
Operating Income
Revenue

Total
$3,780,00
0
3,525,000
$255,000

15,000 Complex lenses (CL5)

Per unit
$63.00

Total
$2055,000

Per unit
$137.00

Total
$5,835,000

58.75

1,455,000

97.00

4,980,000

4.25
6.75%

600,000

40.00
29.20%

855,000

2. ABC System

60,000 Simple lenses (S3)

Revenue
Costs
Operating Income
Operating Income
Revenue

Total
$3,780,00
0
2,998,953
$255,000

15,000 Complex lenses (CL5)

Per unit
$63.00

Total
$2055,000

Per unit
$137.00

Total
$5,835,000

49.98

1,981,047

132.07

4,980,000

13.02
20.66%

600,000

5.07
3.70%

855,000

Activity Based Management

1. Product and pricing Management

The ABC system gives insight into the cost management structures for making and
selling diverse products. As a result, management can make better product and
pricing decisions. For example, the ABC system indicates that Plastim can reduce
the price of S3 to the $53 range and still make a profit, because the ABC cost of S3
is $49.98. Without the ABC information, Plastim management may have
erroneously concluded that it would incur an operating loss on the S3 lens at the
$53 price. This incorrect conclusion may have caused Plastim to reduce its
business in simple lenses and focus on complex lenses, where its existing singleindirect pool system indicates it is very profitable.

2. Cost reduction decisions

Manufacturing and distribution personnel use ABC systems to focus on cost
reduction efforts. Managers set cost-reduction targets in terms of reducing the cost
per unit of the cost-allocation base in different activity areas. For example, the
supervisor of the distribution activity area at Plastim could have a performance
target of decreasing the distribution cost per cubic meter from $5.80 to$5.40 by
reducing distribution labor and warehouse rental costs.

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3. Process Decisions
Creating a map of the cost of important activities (activity cost pools) and the
factors that cause these costs to be incurred (cost drivers and cost-allocation bases)
opens many opportunities for improving efficiency. Management can evaluate
whether particular activities can be reduced or eliminated by improving process.

4. Design decisions:
Management can identify and evaluate new designs to improve performance by
evaluating the product and process designs impact activities and costs.
5. Planning and managing activities.
As was the case with Plastim, most companies implementing ABC systems for the
first time analyze actual costs to identify activity-cost pools and activity cost rates.
Many companies then use ABC systems for planning and managing activities.

Reference:
Activity-Based Costing and Activity based Management
Cost Accounting (A managerial emphasis) by Charles T. Horngren, George Foster,
Srikant M, Datar and Howard D.Teall