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Preferred Costing Method For A Manufacturer

What is the preferred costing method for a plastic injection molding manufacturing company?

The company manufactures plastic products to customer orders; most of the time the specifications of products ordered by each customer are relatively fixed; the products are identical (e.g. plastic containers) and manufactured by batch. I was asked to help set up the costing system for the company. I know it has to be process costing, but then which sub-type - FIFO, Weighted Average or Standard Costing? I am inclined to FIFO or Weighted Average, but not 100% certain. Would appreciate if you could share with me your thoughts. Thanks a lot. Jenny

Answers

Len Green
Title: Performance Improvement Consultant and E..
Company: Haygarth Consulting LLC
LinkedIn Profile
(Performance Improvement Consultant and ERP Strategist, Haygarth Consulting LLC) |

Hi Jenny
Some thoughts to consider:

0. What is important to the company to measure? Go ask the execs.
1. Track trend in actual cost of production over time/order size?
2. Do materials prices fluctuate wildly and frequently? Sometimes it helps to use average costing because the cost of the materials consumed in any production order cannot/do not need to be segregated to that order.
3. Managing to a standard cost (i.e. using variances to highlight production variances) and a standard sales price (i.e. to highlight margin variances due to selling practices). I like this approach because I can then tell the CEO, COO and CSO where we are making/losing money...in making the product or in selling it.
4. Finally, what functionality does your ERP system support?

Good luck!

Jenny Hu
Title: Consultant
Company: Accounting & Finance Consulting
(Consultant, Accounting & Finance Consulting) |

Hi Len,

Thank you very much for your insightful advice! If I may, I'd like to see if you could help me to explore a bit further:

The company needs to see accurate product cost information, so that they could determine product profitability and customer account profitability. Right now at product / item level, only direct materials are accounted for (in product unit cost) but not direct labor and manufacturing overhead. Their operating capacity is being maxed up, a clear picture of product profitability and account profitability help them to allocate operating capacity more efficiently.

Currently majority of the company's customers agree to purchase price adjustments based on the price fluctuation of resin (main ingredient for plastic manufacturing) - in this case, wouldn't standard costing in fact skew the product or customer account profitability?

By the way - It is a small business, owner-managed, 20+ products. They don't have an ERP system yet - if you could recommend one, which one would you recommend?

Thanks so much!

Jenny

Jerry Novotny
Title: Principal
Company: Jerome L Novotny, CPA
LinkedIn Profile
(Principal, Jerome L Novotny, CPA) |

Jenny, Len makes some great points.

Furthermore, are the shop floor people and supervisors willing and able to commit to the discipline needed to set up an ERP system and then to consistently use it in the production process? Sometimes people's attitudes can be a critical consideration to any change in procedures or ERP systems.

Another question is are there additional services or price breaks that are being provided to customers that actually lead to losing money on specific customers, especially considered as "too big to lose"? Such factors might be:

1. Providing R&D services that are not charged to certain customers?
2. Are more favorable payments terms provided to certain customers?
3. Is your company required to maintain minimum levels of raw materials or even WIP or finished goods for customers?
4. Is your company required to provide free tooling or molds for certain parts?
5..If so, can sales contracts be renegotiated to include some sort of cost sharing relative to the above?

On the raw material side, can any scrap material be returned for credit to your material vendors?

Perhaps, a walk-through of a sales order or a major raw material purchase with the above concepts in mind will surface other areas of savings or enhanced pricing power can be identified. This might be done a lot quicker and cheaply than the huge time and cost commitment for a ERP system.

As I like to say, just some random thoughts!

Robin Gomm
Title: Managing Director
Company: Capri Consultants Ltd
LinkedIn Profile
(Managing Director, Capri Consultants Ltd) |

Hi Jenny

Given the relatively small size of the operation and, as Jerry cautions, the probability that shop floor staff will not apply the the disciplines implicit in the operation of an ERP system. my advice is KISS.

One of the low cost accounting packages is more than adequate.

As regards the costing method I'd go for Activity Based Costing and the use of standard costs provided these are linked back to actual costs and revenues, with relevant month end variance analyses

I suggest you take a peek at www.wincapri.com

Regards

Robin

Anonymous
(CFO) |

Jenny:

This posting is related to you question about resin actual cost. You can use standard cost to establish the 'base' price of resin, and I assume the company uses that price for its customer pricing. You can use PPV to monitor actual resin cost increase or decrease from the base. So standard cost should work well for you in this case.

Rick

Leonard Brown
Title: Analyst, Coach
Company: Profit Analytics Limited
(Analyst, Coach, Profit Analytics Limited) |

Hi Jenny

You’ve already received some sound advice. So rather than adding to that – I’m going to offer a few thoughts for your project - perhaps from a slightly different angle.

If I understand correctly, the first problem the business is trying to resolve is how to allocate its operating capacity more profitably: “its operating capacity is ‘maxed-out’”- but the business is not as profitable as it should be/need be. Is that correct?

You say the business is “small” (but not how small) and you don’t mention the size or capability of its Finance team.

However, I suggest you consider…
1) Starting the project as simply as possible with information the managers within the business can readily understand and relate to - by using a small but truly representative sample to generate interest and support for the work that will be involved,
2) Target initial daily/weekly output (information) being available within six weeks from starting the project – albeit that it will be a first ‘rough cut’ and will need a number of iterations to improve its accuracy.

Only once the business is satisfied with the relative accuracy of this contribution based activity reporting, I suggest you move-on to trying to build-up a total cost-to-serve and product/customer cost. And, there again, from experience, I’d limit the depth/detail of analysis - and concentrate on identifying the ‘DNA’ of profitable-v-unprofitable orders, customers, etc.

If this makes any sense to you – and you want to talk-it-through in a little more depth, let me know.

Leonard

Anonymous
(Controller) |

One last bit of advice. If you are truly maxed out on capacity, then you should start looking at your business as the sale of production hours. Look at raw material cost, direct labor cost and any overhead that is identifiably different by item (perhaps a more expensive machine, special supplies, etc). Don't worry about fixed overhead for supervisors and management. With only 20 items, you don't need an ERP system to track stuff. They shop floor people can manage that on a cocktail napkin without worrying about BOMs and routings, etc.

Jenny Hu
Title: Consultant
Company: Accounting & Finance Consulting
(Consultant, Accounting & Finance Consulting) |

Wow,

Thank you so much for all the wonderful advice! They are very insightful. This is really a very supportive community - I am completely amazed. Thank you all!

Jenny

Alones A
Title: Finance Executive
Company: Withheld
(Finance Executive, Withheld) |

Great discussion - wondering if some one can share some practical format for costing products? A practical guidance would also suffice.

Thanks

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