Superior Manufacturing

Topics: Expense, Cost, Income statement Pages: 11 (1241 words) Published: December 2, 2013
Superior Manufacturing Company

The new president of Superior Manufacturing Company (SMC) has appointed Herbert Waters as general manager after the net loss of 2004 of $688,000. Water's first task was to decide whether to keep Product 103 or not. His decision to keep Product 103 based exclusively on the information in Exhibit 1 and Exhibit 2 seems to be a poor decision at first glance. This is due to the fact that almost all of the profits reported in Exhibit 2 for Product 101 are negated by Product 103. However, looking at Exhibit 1 makes us question whether Exhibit 2 is a fair representation of product performance since manufacturing profit is larger than operating expenses excluding interest. Water's experience has probably also given him insight into the fact that not all costs allocated to a product can be avoided by eliminating that product. There are a large number of costs that will not be able to be avoided such as the lease on the building that still has another 12 years of contract remaining.

Upon evaluating the possibility that Exhibit 2 has shed that certain costs are directly tied to the products and other costs are allocated based on volume sales, we have determined a new format to determine product shortcomings. In this format, direct costs are assigned for direct labor, power, and compensation expense at 5 % of direct labor, materials, supplies, and repairs. All of these direct costs are assigned because they are variable based on usage of the products and can be avoided if the products were eliminated. The remaining costs are considered indirect and cannot be avoided due to contracts, leases, or other circumstances that keeps the costs at a constant on a small range. 2004 product performance is as follows under this new format:

Profit and Loss forecast per product for January 1 to June 30, 2004  
 
 

 
 
Product 101
Product 102
Product 103
Total
Sales
$51,672
$25,996
$26,670
$104,338
Direct Labor
$12,937
$6,107
$6,879
$25,921
Compensation Insurance(Direct)
$647
$305
$344
$1,294
Power
$220
$251
$302
$773
Materials
$7,641
$4,716
$4,851
$17,208
Supplies
$525
$485
$350
$1,360
Repairs
$184
$150
$104
$438
Segmented Margin
$29,518
$13,982
$13,840
$57,344
Segmented Margin Percentage
57%
54%
52%
55%
Common Indirect Overhead:

 
Rent

$5,324
Property Taxes

$1,525
Property Insurance

$1,463
Compensation Insurance(Indirect)

$439
Indirect Labor

$8,846
Light and Heat

$394
Building Services

$266
Selling Expense

$18,383
General Admin

$6,534
Depreciation

$13,591
Interest

$1,472
Total Indirect Costs

$58,237
 

 
Less: Other Income

$205
Profit (Loss)
 
 
 
-$688

Under this new format, we can see that each product is contributing a fair percentage of the contribution margin, between 52% for Product 103 to 57% for Product 101. We can now understand why Water's decided not to eliminate Product 103 since eliminating that product would result in worse loses than have already been reported in 2004.

One of SMC's competitors is reducing the price of Product 101 from $24.50 to $22.50 at the beginning of 2006. The calculated contribution margin of expected sales of 750,000 units at the continued price of $24.50 and expected sales of 1,000,000 at the reduced price of $22.50 follows.  

750,000 units
 
Selling Price
$24.50
$18,375
Direct Labor
$6.06
$4,545
Power
$0.11
$83
Compensation Expense(Direct)
$0.30
$227
Materials
$3.41
$2,558
Supplies
$0.24
$178
Repairs
$0.08
$60
Contribution Margin
$14.30
$10,724
 

 
 
1,000,000 units
 
Selling Price
$22.50
$22,500
Direct Labor
$6.06
$6,060
Power
$0.11
$110
Compensation Expense(Direct)
$0.30
$303
Materials
$3.41
$3,411
Supplies
$0.24
$238
Repairs
$0.08
$80
Contribution Margin
$12.30
$12,299
SMC should follow suit of competition...
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