SWIRLCOOL- An ABC Analysis

Sudhir Pawar, President of Swirlcool Company, was discussing operating results in the latest month with
Arjun Veer Singh, his controller and Suraj Chaudhary, his manufacturing manager. The meeting among
the three was taking place in an atmosphere tinged with apprehension because the competitors had
been reducing prices on Part A, Swirlcool’s major product line. Since it was a commodity product, Pawar
had seen no alternative but to match the reduced prices to maintain volume.

Swirlcool supplied products to manufacturers of washing machine equipment. The company had started
with a unique design for part A that it could produce to tolerances that were better than any in the
industry. Pawar quickly established a loyal customer base because of the high quality of its
manufactured part A. He and Chaudhary realized that Swirlcool’s existing labor skills and machining
equipment’s could also be used to produce Part B and Part C, products that were also purchased by its
customers.

Swirlcool’s production process started with the purchase of semi-finished components from several
suppliers. It machined these parts to the required tolerances and assembled them in the company's
modern manufacturing facility. The same equipment and labor were used for all three product lines, and
production runs were scheduled to match customer shipping requirements. Suppliers and customers
had agreed to just-in-time deliveries, and products were packed and shipped as completed.

The manufacturing process for part A was practically identical to that for part B and part C. The details of
the three parts material and labor costs along with the annual unit sales and unit price are provided in
Exhibit 1. These components were machined and then assembled into the final product. The parts were
shipped to industrial product distributors after assembly. Swirlcool had matched the lower prices so that
it would not give up its place as a major part A supplier. Gross margins on parts sales in the latest month
had fallen below 20%, well below the company's planned gross margin of 35%.

The financial year 2015-16 was coming to an end and Sudhir Pawar was concerned about the recent
financial trends in operating results. Arjun Veer Singh was also reflecting on the changed environment at
Swirlcool. They seemed to be spending a lot more time on purchasing and scheduling activities and just
keeping track of where they stood on existing, backlogged and future orders. They were concerned as
he did not have any more capability to handle additional confusion and complexity in the operations.

Sudhir Pawar asked Suraj Chaudhary to give him a report of the cost accounting process for the fiscal
year 2015-16.

Activity-Based Costing
Suraj Chaudhary had recently attended a seminar of her professional organization in which a professor
had talked about a new concept, called Activity-based costing (ABC). This concept seemed to address
many of the problems he had been seeing at Swirlcool. The speaker had even used an example that
seemed to capture Swirlcool’s situation exactly.

The professor had argued that overhead should not be viewed as a cost or a burden to be allocated on
top of direct labor. Rather, the organization should focus on activities performed by the indirect and
support resource of the organization and try to link the cost of performing these activities directly to the
products for which they were performed.

Suraj Chaudhary obtained several books and articles on the subject and soon tried to put into practice
the message he had heard and read about.

Activity Based Cost Analysis

Chaudhary first identified categories of support expenses that were currently being allocated to parts
production. The details of the expenses are provided in Exhibit 2. Chaudhary interviewed department
heads in charge of indirect labor and found that five main activities accounted for their work. The details
of the same are mentioned below in Table 1.

Table 1

Chaudhary also collected information on potential activity cost drivers for Swirlcool activities and the
distribution of cost drivers for each of the activities and parts. The details of the same are given in Table
2 and that of parts is given in Exhibit 3.

Table 2

Chaudhary believed he now had the information to estimate an activity based cost model for Swirlcool.
Exhibits