Lehigh Steel Harvard Case Solution & Analysis

Potential Benefit of Activity-Based Costing (ABC) for Lehigh

A diverse set of products with discreet operating activity for every product meant standard costing was not appropriate as costs were driven by different activities for each product. Complexity of processing was ever increasing with small niche products and ABC was more suitable to accurately identify drivers of costs for each product to better understand costs and profitability of each products. ABC could rectify distortions caused by standard costing truly reflecting resource consumption by products. Costs and profits for the five sample products under activity based costing are calculated in Exhibit A that reveal that all but one product is currently loss-making.

Differences in assumptions between the current standard costing system, ABC and TOC?

Standard costing assumes that all overhead costs are driven by a single factor such as weight of material. This costing system is appropriate where similar and standard product is produced with no variations. This system is not appropriate where overheads are significant and are driven by different activities. ABC on the other hand assumes that activities consume resources and products consume activities. This way costs are allocated to products based on activities that give rise to the costs thus ABC allocates costs to a diverse set of products on a much sound basis and is more appropriate for pricing and production decisions. Exhibit A shows that almost all of the products are in-fact loss-making and marketing teams’ favorite alloys have total operating loss of 15% and only product that is generating a modest profit is High Speed Machine Coil. Theory of Constraints (TOC) advocates active management of constraints and criticizes absorption costing for driving unprofitable decision making. Profit increase is achieved through maximizing throughout per unit of constrained resource. Product costs play no part in this system. Getting products through the manufacturing process and sold in least amount of time is a key concept.

RECOMMENDATION

Lehigh’s management should chose a product mix that reduces lead times and changeovers. Bigger order with long production runs should be pursued. Conversion of billet to roller wire for Lehigh’s parent company, Palmer should specially be performed in bigger batches reducing in number of orders and thus changeovers. An activity based costing system should be adopted and complemented with throughput analysis for better decision-making. Products that are profitable under activity based costing should be focused by the marketing activity. Currently high speed machine coil is the only profitable product so its sale and production should be prioritized..........................................

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