Question Manufacturing Company, a small manufacturing company in Toronto, manufa

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Question Manufacturing Company, a small manufacturing company in Toronto, manufactures 3 types of pumps used in a variety of applications. For many years the company has been profitable and has operated at capacity. However, in the last two years prices on all pumps were reduced and selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter results for the current year, which follow, typify recent experience. ABC MANUFACTURING COMPANY Income Statement 2nd quarter (in thousands) R-Pump F-Pump S-Pump Total Sales $4,800 $2,700 $2,700 $10,200 COGS 3,144 2,310 2,850 8,304 Gross Margin $1,656 $390 $(150) $1,896 Selling, Admin & other expenses 1,110 555 405 2,070 Income before the taxes $546 $(165) $(555) $(174) Robo, the company's president, is concerned about the results. After reviewing the second- quarter results she asked her management staff to consider the following 3 suggestions: 1)    Discontinue the S-Pump line immediately. S-Pump would not be returned to the product line unless the problems with the pump can be identified and resolved. 2)    Increase quarterly sales promotion by $300,000 on the R-Pump product line in order to increase sales volume by 15%. 3)    Cut production on the F-Pump line by 50%, and cut the traceable advertising and promotion for this line to $60,000 each quarter. Nobo, the controller, suggested a more careful study of the financial relationships to determine the possible effects on the company's operating results of the president's proposed course of action. The president agreed and assigned Sobo, the assistant controller, to prepare an analysis. Sobo has gathered the following information: -    The unit sales prices for the 3 pumps are as follows: R-Pump    $600 F-Pump    $270 S-Pump    $540 -    The company is manufacturing at capacity and is selling all the pumps it produces. -    All 3 pumps are manufactured with common equipment and facilities. -The selling, admin and other expense is allocated to the 3 pump lines based on average sales volume over the past 3 years. - Special (avoidable) selling expenses (primarily advertising, promotion, and shipping) are incurred for each pump as follows: Quarterly Advertising & Promotion    Shipping Expenses R-Pump $630,000 $30 per unit F-Pump $300,000 12 per unit S-Pump $120,000 30 per unit - The unit manufacturing costs for the 3 pumps are as follows: R-Pump F-Pump S-Pump DM $93 $51 $150 DL 120 60 180 Variable Manufacturing OH 135 90 180 Fixed Manufacturing OH 45 30 60 Total $393 $231 $570 Required: (i) Sobo says that ABC Manufacturing Company's product-line income statement for the 2nd quarter is not suitable for analyzing proposals and making decisions such as the ones suggested by Robo. a)    Explain why the product-line income statement as presented is not suitable for analysis and decision making.    b)    Describe and prepare an alternative income-statement format that would be more suitable for analysis and decision making, and explain why it is better. (7 marks) (ii) Use the operating data presented for Question Manufacturing Company and assume that the president's proposed course of action had been implemented at the beginning of the second quarter. Then evaluate the president's proposal by specifically responding to the following points: a)    Are each of the 3 suggestions cost-effective? Support your discussion with an analysis that shows that net impact on income before taxes for each of the 3 suggestions.    b)    Was the president correct in proposing that the S-Pump line be eliminated? Explain your answer. c)    Was the president correct in promoting the R-Pump line rather than the F-Pump line? Explain your answer. d)    Does the proposed course of action make effective use of the company's capacity? Explain your answer. Question Manufacturing Company, a small manufacturing company in Toronto, manufactures 3 types of pumps used in a variety of applications. For many years the company has been profitable and has operated at capacity. However, in the last two years prices on all pumps were reduced and selling expenses increased to meet competition and keep the plant operating at capacity. Second-quarter results for the current year, which follow, typify recent experience. ABC MANUFACTURING COMPANY Income Statement 2nd quarter (in thousands) R-Pump F-Pump S-Pump Total Sales $4,800 $2,700 $2,700 $10,200 COGS 3,144 2,310 2,850 8,304 Gross Margin $1,656 $390 $(150) $1,896 Selling, Admin & other expenses 1,110 555 405 2,070 Income before the taxes $546 $(165) $(555) $(174) Robo, the company's president, is concerned about the results. After reviewing the second- quarter results she asked her management staff to consider the following 3 suggestions: 1)    Discontinue the S-Pump line immediately. S-Pump would not be returned to the product line unless the problems with the pump can be identified and resolved. 2)    Increase quarterly sales promotion by $300,000 on the R-Pump product line in order to increase sales volume by 15%. 3)    Cut production on the F-Pump line by 50%, and cut the traceable advertising and promotion for this line to $60,000 each quarter. Nobo, the controller, suggested a more careful study of the financial relationships to determine the possible effects on the company's operating results of the president's proposed course of action. The president agreed and assigned Sobo, the assistant controller, to prepare an analysis. Sobo has gathered the following information: -    The unit sales prices for the 3 pumps are as follows: R-Pump    $600 F-Pump    $270 S-Pump    $540 -    The company is manufacturing at capacity and is selling all the pumps it produces. -    All 3 pumps are manufactured with common equipment and facilities. -The selling, admin and other expense is allocated to the 3 pump lines based on average sales volume over the past 3 years. - Special (avoidable) selling expenses (primarily advertising, promotion, and shipping) are incurred for each pump as follows: Quarterly Advertising & Promotion    Shipping Expenses R-Pump $630,000 $30 per unit F-Pump $300,000 12 per unit S-Pump $120,000 30 per unit - The unit manufacturing costs for the 3 pumps are as follows: R-Pump F-Pump S-Pump DM $93 $51 $150 DL 120 60 180 Variable Manufacturing OH 135 90 180 Fixed Manufacturing OH 45 30 60 Total $393 $231 $570 Required: (i) Sobo says that ABC Manufacturing Company's product-line income statement for the 2nd quarter is not suitable for analyzing proposals and making decisions such as the ones suggested by Robo. a)    Explain why the product-line income statement as presented is not suitable for analysis and decision making.    b)    Describe and prepare an alternative income-statement format that would be more suitable for analysis and decision making, and explain why it is better. (7 marks) (ii) Use the operating data presented for Question Manufacturing Company and assume that the president's proposed course of action had been implemented at the beginning of the second quarter. Then evaluate the president's proposal by specifically responding to the following points: a)    Are each of the 3 suggestions cost-effective? Support your discussion with an analysis that shows that net impact on income before taxes for each of the 3 suggestions.    b)    Was the president correct in proposing that the S-Pump line be eliminated? Explain your answer. c)    Was the president correct in promoting the R-Pump line rather than the F-Pump line? Explain your answer. d)    Does the proposed course of action make effective use of the company's capacity? Explain your answer.

Explanation / Answer

Answer:a) The suggested discontinuance of the S-pumps would be cost effective, but the suggestions relating to F-pumps and R-pumps would not be cost effective. These conclusions are based on the following quarterly analysis.

Answer:b) Yes, the managing director was correct in eliminating the S-pumps. The S-pump sales price covers only its variable cost and does not contribute anything to manufacturing overhead or promotion costs. Thus, the S-pump has a zero contribution margin.

Answer:c) Yes, the managing director was correct in promoting the R-pump line rather than the F-pump line, because the unit contribution margin and contribution per labour dollar is greater for the R-pump line as follows:                                                                                           R-Pump      F-Pump

Unit contribution ............................................................................. $222.00           $57.00

Contribution per direct-labour dollar .............................................       1.85               0.95

However, the managing director's decisions regarding promotion expense do not seem well conceived. The decreased promotion on the F-pump line and the increased promotion on the R- pump line do not produce sufficient contribution to offset the promotional costs.

Answer:d) No. The proposed course of action does not make effective use of capacity. The 15 per cent increase in production volume on the R-pump line will not require all of the capacity that has been released by discontinuing the S-pump line or reducing the F-pump line by 50 per cent.

Particulars R-Pump F-Pump S-Pump Unit selling price 600 270 540 Unit variable cost: Raw material 93 51 150 Direct labor 120 60 180 Variable manufacturing overhead 135 90 180 Shipping expenses 30 12 30 Total 378 213 540 Unit contribution margin 222 57 0 Proposed changes: Increase (decrease in units) R-Pump 1200 F-Pump -5000 S-Pump -5000 Changes in total contribution margin 266400 -285000 0

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