Lehigh Steel is a specialty steel producer that fell from high profits to equally high losses within the span of three short years, led by the incapability to differentiate between lucrative and loss-making business. The intensity and development of service facilities and accumulation of overhead costs in a largely customized product line hints that activity-based costing (ABC) could lead to potential profitability. However, the high fixed-cost framework also hints towards the fact that the theory of constraints (TOC) may also prove to be significant. Lehigh must decide how to calculate profitability to prioritize its products.
Activity Based Costing
Alloy: Condition Round, Coversion: Roller Wire, Die Steel: Chipper Knife, Die Steel: Round Bar, High Speed: Machine Coil
1. Using the information in Exhibit 4, 5 and 6, do a revised operating profit work up (like Exhibit 5) on an ABC Basis.
2. Based on the current production levels, costs and revenues determine the priorities of the five products (or processes) should have for allocating CRM capacity, using the following cost concepts; Full standard cost, Full ABC cost, Extreme TOC cost and any other cost concepts that you believe are appropriate.
3. Calculate the apparent change in profits Lehigh would experience by shifting production capacity from lowest to the highest priority product for each of the above.
4. Explain why the method of setting one set of priorities is superior to the others.
5. If Lehigh uses your methodology to allocate production priorities, what will you expect to happen, besides an increase in profits?
6. Are there any apparent limitations to the above methodology for allocating scarce capacity?