SEGMENTED INCOME STATEMENTS, KEEP OR DROP DECISION, SPECIAL ORDER DECISION, JIT AND ACTIVITYBASED COSTING, STRATEGIC CONSIDERATIONS
Emery Company, a manufacturer of motors for washing machines, has installed a JIT purchasing and manufacturing system. After several years of operation, Emery has succeeded in reducing inventories to insignificant levels. During the coming year, Emery expects to produce 200,000 motors: 150,000 of the Regular Model and 50,000 of the Heavy Duty Model. The motors are produced in manufacturing cells. The expected output represents 80 percent of the capacity for the Regular Model cell and 100 percent of capacity for the Heavy Duty Model cell. (This capacity includes time for cell workers to perform maintenance and materials handling.) The selling price for the Regular Model is $60; for the Heavy Duty Model, $70.
The relevant data for next year’s expected production are as follows:
|
|
Regular Cell |
Heavy Duty Cell |
|
Direct materials |
$3,500,000 |
$1,000,000 |
|
Labor |
$900,000 |
$315,000 |
|
Power |
$250,000 |
$100,000 |
|
Depreciation |
$800,000 |
$300,000 |
|
Number of runs |
100 |
100 |
|
Number of cell workers |
20 |
5 |
|
Square footage |
20,000 |
10,000 |
The following overhead costs are common to each cell:
|
Plant depreciation |
$900,000 |
|
Production scheduling |
300,000 |
|
Cafeteria |
100,000 |
|
Personnel |
150,000 |
These costs are assigned to the cells using cost drivers selected from the cell activity data given above.
In addition to the overhead costs, the company expects the following nonmanufacturing costs:
|
Commissions (2% of sales) |
$250,000 |
|
Advertising: |
|
|
Regular Model |
400,000 |
|
Heavy Duty Model |
200,000 |
|
Administration (all fixed) |
500,000 |
Keith Golding, president of Emery Company, is concerned about the profit performance of each model. He wants to know the effect on the company’s profitability if the Heavy Duty Model is dropped. At the same time this request was made, the company was approached by a customer in a market not normally served by the company. This customer offered to buy 30,000 units of the Regular Model at $30 per unit. The order was requested on a direct contact basis, and no commissions will be paid. Keith was inclined to reject the offer, since it was half the model’s normal selling price. However, before making the decision, he wanted to know the effect of accepting the offer on the company’s profits.
To help decide on the two issues, the following additional data have been made available:
|
Activity |
Cost Driver |
Supply |
Usage |
Lumpy Quantity |
Fixed Rate |
|
Scheduling |
Runs |
250 |
200 |
25 |
$1,200 |
|
Cafeteria |
Cell workers |
45 |
25 |
15 |
1,800 |
|
Personnel |
Cell workers |
40 |
25 |
20 |
3,750 |
Of the three activities, the cafeteria activity is the only one with a variable activity rate. This rate is $760 per cell worker.
Required:
1. Prepare an ABC segmented income statement for Emery Company using products as segments. Can the unused activity be exploited to increase overall profits? Explain.
2. By how much will profits be affected if the Heavy Duty Model is dropped?
3. Prepare an analysis that shows what the effect on company profitability will be if the special order is accepted. Was the president correct in his feelings concerning the special order?
4. Now, assume that the models are regularly sold to companies that produce medium to high quality washing machines. The special order customer will use the motors in a low end washing machine and plans to advertise the fact that the low end washing machine can be purchased at a lower price with the same quality as a so called higher quality brand. Given this information and the results of Requirement 2, should the order be accepted? Explain.