In 1983, Dr. Franklin Carton, a Northwestern University electrical engineering profes-
sor, and his sister, Dr. Allison Carton, a surgeon, patented an electronic medical mon-
itoring device. That same year they formed Carton Medical Devices (CMD) in Mount
Prospect, 15 miles west of Evanston, Illinois, and hired their sister as president. The
device gradually gained wide acceptance at leading hospitals throughout the world.
Over the years, CMD hired a team of engineers and scientists who developed addi-
tional medical devices; by 1995 sales exceeded $150 million.
CMD bought parts and electronic components from leading U.S. and Asian suppliers.
However, for proprietary reasons, CMD produced complex mechanical components
and assembled circuit boards and finished devices in its Mount Prospect plants. In
2006, when revenues were at a record high $475 million, CMD suffered its first operating
loss. In response, CMD hired Talton Consulting Group to evaluate its operations. In late
2007, key Talton consultants met with the Cartons to discuss their findings.
Talton believed CMD’s manufacturing processes and production control systems
were well designed and appropriate for its products and the markets they served.
However, CMD had never developed a cost system linked to its production control
records. Instead, it used two fundamentally different cost systems; neither Talton nor
the Cartons had faith in either system. Talton believed that some products were prob-
ably priced too low to earn a profit and others were priced so high as to invite com-
petition. Talton’s consultants believed the cost numbers were too inaccurate to make
reasonable pricing decisions or to control costs.
Cost Systems, Overview
For financial and tax reporting, CMD used a simple half-standard cost system to com-
pute costs for the inventory value in its financial statements and tax returns (book
inventory). CMD’s accountants added actual material, labor, and overhead costs to
inventory. They reduced inventory by estimated standard product costs when goods
were sold. Each year, CMD’s independent auditors conducted a physical inventory
count and then valued the physical inventory using the same standard costs CMD
used to compute cost of goods sold. Typically, the auditors’ inventory value was less
than CMD’s book inventory by 10–15%, although on occasion the physical inventory
value was higher. The Cartons worried that the discrepancies might be from high
scrap or theft, but their audit partner believed it was a result of poor recordkeeping.
For pricing, CMD used an activity-based cost system (ABC). CMD implemented
that system in 1996 by asking employees in each department to estimate the cost of
production processes in their respective departments. Each year Carton’s account-
ing department resurveyed employees in several departments to update their cost
estimates, but CMD executives worried that some departments overestimated costs
to obtain higher budgets and others underestimated costs to impress management.
Even if a department tried to be accurate, the estimates could be inaccurate because
there was no way to verify the cost estimates.