Superior Manufacturing Company Case Project Questions

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Question Description

  1. For write-up: I will consider completeness, clarity of your logic and analysis. More weight will be put on your analysis and logic than getting a “correct” number. So, for computation questions, please write down the formula and all the necessary steps to get your answers. For questions requiring arguments, please flesh out your idea and clearly articulate your logic.
    Solve each question for the write up please. Questions:
    Superior Manufacturing Company
    1. 1) Based on Exhibits 1 and 2, prepare a contribution format of income statement. For sales and variable costs, show both total $ amount and per unit $ amount by product line. For fixed expenses, no need to split them into product lines. What is the company’s break-even point in dollar sales?
    2. 2) Do you agree with Waters’ decision to keep product 103? Why? Note that you may use your contribution format of income statement from exercise 1) to show your analysis.
    3. 3) If one could sell 100,000 units of any one of the three products, which product should be chosen? Why? A customer, whose use for the products is such that he gets the same utility per dollar from each of the three, has asked for $100,000 worth of any one of them. Which product should you sell to him? Why?
    4. 4) Should Superior lower as of January 1, 2006 its price of product 101 to $22.5? Why?
      Hint: what does Superior’s contribution margin look like if the price is $24.5? What does Superior’s contribution margin look like if lowering the price to $22.5?
    •  A typo: Note that in Exhibit 2 product 103, Direct Labor should be 6,877 (NOT 6,879).
    •  You can ignore Exhibit 4 of the case.

Unformatted Attachment Preview

For the exclusive use of M. Sahab, 2019. 9-105-010 REV: AUGUST 12, 2004 JAMES W. CULLITON DAVID F. HAWKINS JACOB COHEN Superior Manufacturing Company In February 2005, Herbert Waters was appointed general manager of the Superior Manufacturing Company by Paul Harvey, president. Waters, 56, had wide executive experience in manufacturing products similar to those of Superior. The appointment of Waters resulted from management problems arising from the death of Richard Harvey, founder and, until his death in early 2004, president of Superior. Paul Harvey had only four years’ experience with the company, and in early 2005 was 34 years old. His father had hoped to train him over a 10-year period, but his untimely death had cut this seasoning period short. The younger Harvey became president when his father died and had exercised full control until he hired Waters. New Management Paul Harvey knew that during 2004 he had made several poor decisions and noted that morale of the organization had suffered, apparently through lack of confidence in him. When he received the income statement for 2004 (see Exhibit 1) showing a net loss of $688,000 during a good business year, he knew he needed help. He attracted Waters from a competitor by offering a stock option incentive in addition to salary, knowing that Waters wanted to acquire a financial competence for his retirement. The two men came to a clear understanding that Waters, as general manager, had full authority to execute any changes he desired. In addition, Waters would explain the reasons for his decisions to Harvey and thereby train him for successful leadership upon Waters’s retirement. Upon taking office in February 2005, Waters decided against immediate major changes. Rather, he chose to analyze 2004 operations and to wait to see results for the first half of 2005. He instructed the accounting department to provide detailed expenses and earnings statements by products and departments for 2004 (see Exhibit 2). In addition, he requested an explanation of the nature of the company’s costs including their expected future behavior (see Exhibit 3). Company and Industry The Superior Manufacturing Company made only three industrial products: 101, 102, and 103. They were sold by the company’s sales force for use in the processes of other manufacturers. All of the sales force, on a salary basis, sold the three products but in varying proportions. Superior sold ________________________________________________________________________________________________________________ Professor James W. Culliton prepared the original version of this case, HBS No. 156-004. This version was prepared by Professor David F. Hawkins and Jacob Cohen, Affiliate Professor of Accounting and Control at INSEAD. HBS cases are developed solely as the basis for class discussion. The company mentioned in the case is fictional. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. For the exclusive use of M. Sahab, 2019. 105-010 Superior Manufacturing Company throughout New England and was one of eight companies with similar competitors were larger and manufactured a larger variety of products dominant company was the Samra Company, which operated a branch market area. Customarily, the Samra Company announced prices annually, followed suit. products. Several of its than did Superior. The plant in the company’s and the other producers Price cutting was rare, and the only variance from quoted selling prices took the form of cash discounts. In the past, attempts at price cutting had followed a consistent pattern: all competitors met the price reduction, and the industry as a whole sold about the same quantity but at the lower prices. This continued until the Samra Company, with its strong financial position, again stabilized the situation following a general recognition of the failure of price cutting. Furthermore, because sales were to industrial buyers and because the products of different manufacturers were very similar, Waters was convinced Superior could not individually raise prices without suffering substantial volume declines. During 2004, Superior’s share of industry sales was 12% for type 101, 8% for 102, and 10% for 103. The industrywide quoted selling prices were $24.50, $25.80, and $27.50 per 100 pounds of product, respectively. Manufacturing Strategy Superior’s manufacturing strategy was based on the “dedicated factory” concept. That is, each of the three products was produced in its own factory within the total factory complex. The three product factories were referred to as 101 Factory, 102 Factory, and 103 Factory. Each of these product factories was horizontally integrated beginning with receiving and extending through raw material storage, production-process facilities, finished-product inventory, and shipping. In addition, each product factory had a dedicated direct labor force, which for accounting purposes included hourly workers, shift managers, and other manufacturing-related personnel assigned to each product factory. Indirect labor “floated” between product factories as needed. Typically, the Superior manufacturing facilities operated below capacity. Cost System The Superior Manufacturing Company maintained a simple cost system. It was used for strategic planning, product-line decisions, identifying manufacturing process-improvement opportunities, profitability analysis, performance evaluation, cost control, and inventory valuation purposes. Management’s goal was to assign all of the company’s costs to each of the three products in a way that would lead to the most useful product costs for the cost system’s various managerial purposes. The cost system identified two categories of costs. The first category consisted of costs, such as material costs, that could be tied directly to the manufacture of specific products. All other costs were placed in the second category and referred to as indirect costs (see Exhibit 2). The cost system accumulated direct and indirect costs at the product-factory level before determining the individual product costs on a per unit basis. Since each of the three products was sold in 100-pound bags, per unit costs were expressed in terms of 100 pounds of finished product. The per unit cost was calculated by dividing the unit output into the respective product factory’s total 2 This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. For the exclusive use of M. Sahab, 2019. Superior Manufacturing Company 105-010 cost. Total cost was the sum of the product factory’s direct costs plus allocated indirect costs less an allocated other-income amount. Allocated indirect costs included the company’s interest cost related to bank loans. Costs designated as direct costs were assigned directly to the product factory in which they were incurred. For example, the cost of materials used to manufacture product 101 in 101 Factory was charged directly to the 101 Factory account. This material cost could be traced directly to 101 Factory through material purchase and requisition orders. Indirect costs were allocated to the product factories using a variety of allocation methods (see Exhibit 2). For example, the total company rent expense ($5,324,000) was allocated to each product factory based on its enclosed cubic space. Cubic space was selected as the allocation basis to capture the fact that the production process for each of the three products included enclosed scrubber towers that varied in height depending on the product produced. Using the cubic space as the allocation base, the total company rent was charged as shown in Figure A to each product factory. Figure A Total Company Rent ($5,324,000) Actual Rent Expense Allocation Basis (cubic space) Allocated Rent Source: 101 Factory ($1,872,000) 102 Factory ($1,570,000) 103 Factory ($1,882,000) Casewriter. The allocated per 100-pound rent cost of each product was derived by dividing the unit output of each product factory into the respective product factory’s allocated rent. A standard cost system was introduced in early 2005. It was used to value inventories, prepare budgets, and analyze performance (see Exhibit 4). Next year’s standard costs were last year’s actual per unit costs adjusted for anticipated cost changes. Since Superior’s three products were each sold in 100-pound bags, per unit standards were expressed in terms of 100 pounds of finished product. Drop 103? To familiarize Paul Harvey with his methods, Waters sent copies of Exhibits 2 and 3 to Harvey, and they discussed them. Harvey stated that he thought product 103 should be dropped immediately, as it would be impossible to lower expenses on product 103 as much as $2.16 per 100 pounds. In addition, he stressed the need for economies on product 102. 3 This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. For the exclusive use of M. Sahab, 2019. 105-010 Superior Manufacturing Company Waters relied on the authority arrangement Harvey had agreed to earlier and continued production of the three products. Midyear Results In the first week of July 2005, Waters received from the accounting department the six months’ statement of cumulative standard costs including variances of total company actual costs from standard (see Exhibit 4). It showed that the first half of 2005 had been a successful period. In order to expedite the availability of interim-period results, Superior did not determine actual product-line revenues, costs, and profits. Rather, product-line data was prepared using standard per unit data and actual unit sales. Reduce 101 Price? During the latter half of 2005, the sales of the entire industry weakened. Even though Superior retained its share of the market, its profit for the last six months was expected to be small. In November 2005, the Samra Company announced a price reduction as of January 1, 2006 on product 101 from $24.50 to $22.50 per 100 pounds. This created a pricing problem for all its competitors. Waters forecast that if Superior held to the $24.50 price during the first six months of 2006, the company’s unit sales would be 750,000. He felt that if it dropped its price to $22.50, the six months’ unit volume would be 1 million. Waters knew that competing managements anticipated a further decline in activity. He thought a general decline in prices of all products was quite probable. The accounting department reported that the standard costs in use would probably apply during 2006, with two exceptions: materials and supplies would be about 5% below the 2005 standard. Waters and Harvey discussed the pricing problem. Harvey observed that even with the anticipated decline in material and supply costs, a sales price of $22.50 would be below cost. Harvey therefore wanted the $24.50 price to be continued, since he felt the company could not be profitable while selling a key product below cost. Questions 1. Based on the 2004 statement of profit and loss data (Exhibits 1 and 2), do you agree with Waters’s decision to keep product 103? 2. Should Superior lower as of January 1, 2006 its price of product 101? To what price? 3. Why did Superior improve profitability during the period January 1 to June 30, 2005? How useful was the data in Exhibit 4 for the purpose of this analysis? 4. Why is it important that Superior has an effective cost system? What is your overall appraisal of the company’s cost system and its use in reports to management? List the strengths and weaknesses of this system and its related reports for the purposes management uses the system’s output. What recommendations, if any, would you make to Waters regarding the company’s cost accounting system and its related reports? 4 This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. For the exclusive use of M. Sahab, 2019. Superior Manufacturing Company Exhibit 1 105-010 Profit and Loss Statement for Year Ending December 31, 2004 (000) Gross Sales Cash Discount $105,905 1,567 Net Sales Cost of Manufacturing $104,338 65,251 Manufacturing Profit Less: Selling Expense General Administration Depreciation $ 39,087 $18,383 6,534 13,591 38,508 Operating Profit Other Income $ 579 205 Net Profit before Interest Less: Interest $ 784 1,472 Net Loss $ 688 Source: Casewriter. 5 This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. For the exclusive use of M. Sahab, 2019. 105-010 Exhibit 2 Analysis of Profit and Loss by Products and Departments—Year Ended December 31, 2004 (thousands $ except per 100 lbs.) Product 101 per 100 lbs. Rent Product 102 per 100 lbs. Product 103 per 100 lbs. Total Classification Direct Indirect Allocation Basis $ 1,872 $ .88 $ 1,570 $1.53 $ 1,882 $ 1.90 $ 5,324 X Cubic space Property Taxes 621 .29 503 .49 401 .40 1,525 X Area Property Insurance 524 .25 405 .39 534 .53 1,463 X Value of equipment Compensation Insurance 836 .39 439 .42 458 .46 1,733 X Direct labor ($) 12,937 6.06 6,107 5.92 6,879 6.97 25,921 4,413 2.07 2,124 2.06 2,309 2.33 8,846 X Direct labor ($) Direct Labor Indirect Labor 6877 X Power 220 .11 251 .24 302 .31 773 X Machine horsepower Light & Heat 158 .07 130 .12 106 .10 394 X Area X Area Building Service 109 .05 82 .08 75 .08 266 Materials 7,641 3.59 4,716 4.58 4,851 4.91 17,208 Supplies 525 .25 485 .46 350 .36 1,360 X Repairs 184 .08 150 .15 104 .10 438 X Total X $30,040 $14.09 $16,962 $16.44 $18,249 $18.45 $ 65,251 Selling Expense 9,100 4.27 4,582 4.44 4,701 4.76 18,383 X $ value of sales General Administrative 3,451 1.62 1,300 1.26 1,783 1.80 6,534 X $ value of sales Depreciation 5,659 2.65 4,274 4.16 3,658 3.70 13,591 X Value of equipment X Value of equipment X $ value of sales Interest Total Cost Less: Other Income 524 .25 409 .39 539 .53 1,472 $48,774 $22.88 $27,527 $26.69 $28,930 $29.24 $105,231 101 .04 53 .05 51 .05 205 $48,673 $22.84 $27,474 $26.64 $28,879 $29.19 $105,026 Sales (Net) 51,672 24.24 25,996 25.23 26,670 27.03 104,338 Profit (Loss) $ 2,999 $ 1.40 ($ 1,478) ($ 1.41) ($2,209) ($ 2.16) Unit Sales (100 lbs.) Quoted Selling Price Per Unit Cash Discount Taken (% of selling price) Source: Note: 2,132,191 1,029,654 986,974 $24.50 $25.80 $27.50 1.08% 2.14% 1.74% ($ 688) 1.48% Casewriter. Figures may not add exactly because of rounding. This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. -6- For the exclusive use of M. Sahab, 2019. Superior Manufacturing Company Exhibit 3 105-010 Accounting Department’s Commentary on Costs Direct Labor: Variable. Union shop at going community rates. No abnormal demands foreseen. It may be assumed that direct labor dollars are an adequate measure of capacity utilization. Compensation Insurance: Variable. Five percent of direct and indirect labor is an accurate estimate. Materials: Variable. Exhibit 2 figures are accurate. Includes waste allowances. Purchases are at market prices. Power: Variable. Rates are fixed. Use varies with activity. Averages per Exhibit 2 are accurate. Supplies: Variable. Exhibit 2 figures are accurate. Supplies bought at market prices. Repairs: Variable. Varies as volume changes within normal operation range. Lower and upper limits are fixed. General Administrative, Selling Expense, Indirect Labor, Interest, and Other Income: These items are almost nonvariable. They can be changed, of course, by management decision. Cash Discount: Almost nonvariable. Average cash discounts taken are consistent from year to year. Percentages in Exhibit 2 are accurate. Light and Heat: Almost nonvariable. Heat varies slightly with fuel cost changes. Light a fixed item regardless of level of production. Property Taxes: Almost nonvariable. Under the lease terms Superior pays the taxes; assessed valuations have been constant; the rate has risen slowly. Any change in the near future will be small and independent of production volume. Rent: Nonvariable. Lease has 12 years to run. Building Service: Nonvariable. At normal business level, variances are small. Property Insurance: Nonvariable. Three-year policy with fixed premium. Depreciation: Nonvariable. Fixed dollar total. Source: Casewriter. 7 This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. $14,034 $14.09 Total Cost Casewriter. 996,859 $ 1,407 712,102 ($ 1.41) 25.23 $ 26.64 .05 $ 26.69 .39 4.16 1.26 4.44 $ 16.44 .15 .46 4.58 .08 .12 .24 2.06 5.92 .42 .39 .49 $ 1.53 ($1,010) 17,961 $ 18,971 36 $ 19,007 278 2,962 897 3,162 $ 11,708 107 328 3,261 57 85 171 1,467 4,216 299 278 349 $ 1,090 Product 102 Standard Total at per 100 lbs. Standard 501,276 ($ 2.16) 27.03 $29.19 .05 $29.24 .53 3.70 1.80 4.76 $18.45 .10 .36 4.91 .08 .10 .31 2.33 6.97 .46 .53 .40 $ 1.90 ($1,082) 13,550 $14,632 25 $14,657 266 1,855 902 2,386 $ 9,248 50 180 2,461 40 50 155 1,168 3,496 231 266 201 $ 952 Product 103 Standard Total at per 100 lbs. Standard ($ 685) 55,675 $56,360 101 $56,461 793 7,459 3,414 9,805 $34,990 236 747 9,301 147 205 435 4,698 13,751 919 793 839 $ 2,919 Total Standard $ 713 55,675 $54,962 110 $55,072 730 6,817 3,289 9,830 $34,406 251 750 9,282 107 200 432 4,485 13,820 917 732 770 $ 2,660 Total Actual +1,398 +1,398 +9 +1,389 +63 +642 +125 -25 +584 -15 -3 +19 +40 +5 +3 +213 -69 +2 +61 +69 +259 Variances + = Favorable - = Unfavorable This document is authorized for use only by Mohamad Sahab in Superior Manufacturing Co Project taught by LIANG TAN, George Washington University from Mar 2019 to Sep 2019. aActual unit sales times standard net revenue per unit. Source: Unit Sales (100 lbs.) $ 1.40 Profit (Loss) 24,164 $22,757 $22.84 24.24 40 $22,797 .04 $22.88 Actual Sales (net)a Less: Other Income 1,615 2,642 249 Depreciation 4,257 .25 1.62 2.65 General Administrative Interest 4.27 Selling Expense Total 79 .08 239 .25 Repairs 50 3,579 Supplies .05 3.59 Building Service 70 109 2,063 6,041 389 249 289 $ 877 Materials .11 .07 Light & Heat 2.07 Power 6.06 Compensation Insurance Indirect Labor .25 .39 Property Insurance Direct Labor .29 $ .88 Property Tax Rent Item Product 101 Standard Total at per 100 lbs. Standard Exhibit 4 Profit and Loss by Products and Departments at Standard an ...
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Question 1
Contribution Margin Income Statement

Direct Labor
Property Tax
Indirect Labor
Light and Heat
Other Income
















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