Superior Manufacturing Co. Case Analysis

Q1. Based on the 2004 statement of profit and loss data (Exhibits 1 and 2), do you agree with Water’s decision to keep product 103? In order to support an opinion on the side we decided to analyze all the probable scenarios. If the company management decided that it is better to stop the production of product 103, they could do this in one of the following manners: 1.

Stop production and any business related to product 103. 2. Stop production but outsource it to another company and continue the distribution. 3. Stop production and use the available production capacity in order to produce product 101 or 102.If the company management decided that it is better to continue the production of product 103, they could do this in one of the following manners: 1.

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Maintain the same volume of production. 2. Increase the volume of production. 3. Lower the volume of production.

4. Substitute 102 production capacity with 103 if the 103 facility has not sufficient capacity to exploit economies of scale Analysis of the P statement of 31 December 2004 If we have a look at the P statement for the 2004 it is obvious that product 103 is bringing substantial losses.The calculations show that there is a loss of 2. 16$ per unit sold which overall totals for the amount sold to at about 2. 209 million $.

525,00| |Supplies(v) | $ 1. 360,00 |Property Insurance(non v) | $ 1. 463,00| |Repairs(v) | $ 438,00 |Indirect Labor | $ 8. 846,00| |Compensation Insurance(v) | $ 1. 296,05 |Light & Heat(almost non v,fuel dep. | $ | | | | |394,00 | |Power(v) | $ 773,00 |Building Sevice(non v) | $ | | | | |266,00 | | | |Compensation Insurance(non v.

| $ | | | | |442,30 | |Total: |46996,05 |Total: | $ 18. 60,30 | | | | | | | | | | | |Percentage of the total cost: |72% |28% | | |Total Cost | | $ | | | | |65. 256,35 | | | | | | | The size of the indirect non variable costs is quite high. It amounts for 28% of all the costs.If we keep in mind this information and reason on the statement of the management that the production facility is normally working under its full capacity we could suggest that there is a possibility of benefitting from economies of scale. If we assume this possibility and plot the change in price related to the change in production volume we get the following: |Compen Ins(v) |Direct Labor(v) |Power(v) | | $ 51,00 | $ 5.

423,44 | $ 10. 681,00 | |volume |unit price |Sales |Profit(Loss) p. unit |Profit(Loss) total | |600 | $ | $ 16. 212,90 | $ | $ -7. 40,11 | | |39,76 | |-12,73 | | |650 | $ | $ 17. 563,98 | $ | $ -6.

939,00 | | |37,70 | |-10,68 | | |700 | $ | $ 18. 915,05 | $ | $ -6. 237,88 | | |35,93 | |-8,91 | | |750 | $ | $ 20. 266,13 | $ | $ -5. 36,77 | | |34,40 | |-7,38 | | |800 | $ | $ 21.

617,20 | $ | $ -4. 835,66 | | |33,07 | |-6,04 | | |850 | $ | $ 22. 968,28 | $ | $ -4. 134,55 | | |31,89 | |-4,86 | | |900 | $ | $ 24. 319,35 | $ | $ -3. 33,44 | | |30,84 | |-3,81 | | |950 | $ | $ 25.

670,43 | $ | $ -2. 732,33 | | |29,90 | |-2,88 | | |1000 | $ | $ 27. 021,50 | $ | $ -2. 031,22 | | |29,05 | |-2,03 | | |1050 | $ | $ 28. 372,58 | $ | $ -1. 30,11 | | |28,29 | |-1,27 | | |1100 | $ | $ 29.

723,65 | $ | $ -629,00 | | |27,59 | |-0,57 | | |1150 | $ | $ 31. 074,73 | $ | $ | | |26,96 | |0,06 |72,11 | |1200 | $ | $ 32. 25,80 | $ | $ 773,23| | |26,38 | |0,64 | | |1250 | $ | $ 33. 776,88 | $ | $ 1. 474,34 | | |25,84 | |1,18 | | |1300 | $ | $ 35.

127,95 | $ | $ 2. 175,45 | | |25,35 | |1,67 | | [pic] It is obvious that for volumes higher than 1 150 000 product 103 is actually profitable.These calculations are made without taking into consideration the expected 5% diminishment of the prices of materials and supplies in 2006. (did not take into consideration the change of price of sales, admin, indirect labor…) Sensitivity analysis In order to make recommendations for a possible strategic course of actions we need to take in consideration the variance of some key indicators. These are: 1. The operating capacity of the facility and the level at which it operates now.

2. Possible changes on the market volume and company’s market share(expected reactions from the competitors) 3. Potential savings 4. Inventory costs Strategic scenariosHaving in mind the analysis of the current situation we could offer some scenarios for strategic actions to the management of Superior Manufacturing. Referring back to the first paragraph we can explore the following options: Stop the production of product 103: 1. Stop production and any business related to product 103.

2. Stop production but outsource it to another company and continue the distribution. 3. Stop production and use the available production capacity in order to produce product 101 or 102. 1.

Stopping the production of product 103 in the current situation would mean that the company will no longer produce a non profitable product. This will bring to avoiding a possible potential loss of at about 2. 2 million $ assuming expected sales of 1million units.On the other hand it will bring as a loss all the non variable, fixed expenses, missed sales profit, restructure of the workforce etc. To calculate these we assume that in short term, i. e.

for the next operating cycle (year 2005) the company will: a. continue to pay all the fixed expenses b. not sell the machinery c. totally reduce the directly occupied working force d. still need at about 10% of the indirectly occupied workforce and general administration in order to secure and maintain the operations still related to the rented and possessed property.

|Rent(non v) | $ 1. 882,00 | $ 1. 882,00 | |Property Taxes(almost non v. | $ 401,00 | $ 401,00 | |Property Insurance(non v) | $ 534,00 | $ 534,00 | |Compensation Insurance(v) | $ 45,80 | $ 458,00 | |Direct Labor(v) | $ | $ 6. 879,00 | | |- | | |Indirect Labor | $ 230,90 | $ 2. 09,00 | |Power(v) | $ | $ 302,00 | | |- | | |Light & Heat(almost non v,fuel dep.

) | $ | $ 106,00 | | |- | | |Building Sevice(non v) | $ | $ 75,00 | | |- | | |Materials(v) | $ | $ 4. 51,00 | | |- | | |Supplies(v) | $ | $ 350,00 | | |- | | |Repairs(v) | $ | $ 104,00 | | |- | | |Total | $ 3. 093,70 | $ 18. 249,00 | |Selling expenses(non v,changeable) | $ | $ 4. 01,00 | | |- | | |General Administrative(non v,changeable) | $ 178,30 | $ 1. 783,00 | |Depreciation(non v,changeable) | $ 3.

658,00 | $ 3. 658,00 | |Intereset(non v,changeable) | $ 539,00 | $ 539,00 | |Total Cost | $ 7. 469,00 | $ 28. 30,00 | |Less:Other Income(non v,changeable) | $ | $ 51,00 | | |- | | | | | $ 28. 879,00 | |Sales (Net) | $ | $ 26.

670,00 | | |- | | |Total loss | $ 7. 469,00 | $ 2. 209,00 |It is obvious that at least in short and mid-term period stopping the production would bring much bigger losses than continuing it. Therefore we can’t recommend this as a good solution of the situation 2. Knowing the current state and especially how specific is the industry it is highly unlikely that outsourcing can be an option.

3. Using the existing production capacity in order to produce one of the other products that are known to make money for the company (product 101) or at least not such big losses (product 102) is also not a solution. We know that the market is very rigid and it is pretty much impossible to double the market share without any substantial price changes.Taking into consideration all of the above said continuing the production of product 103 is the viable option. When exploring however this option we need to take into consideration the production capacity of the facility and the level to which it is exploited. For instance in the document it is mentioned that the factory is working under capacity, but this could mean that it is working as well as on 40% of capacity as well as on 90%.

Another consideration would be the financial health of the organization. This is necessary as any of the scenarios would require a period of losses or increased expenses. We need to know how much of these the company could support financially from a strategic point of view. 1.Lowering the volume of production is obviously not the worst solution but it is a bad solution. Strategically it could serve as to soften the period of transition towards stopping the product 103.

From table xxx and yyyy(to number the tables and graphics) is obvious that lowering the production level to less than 700 000 units is economically a worse decision than stopping the production immediately 2. Maintaining the same level of production can be again a good mid-term approach serving as a transitional period towards increasing the level of production. We say this because as we know the market is quite rigid. This means that it will take quite some time for the company to increase its market share.Probably this could happen if some of the other players on the market vanish or the company takes an aggressive price policy. In this case increasing the production volume would bring to building of inventory in the amount of 200 000 to 500 000 or more units.

For the scale of the company this is a huge inventory. That is why as a short or even mid-term solution it would be better to maintain the same volume of production. This of course requires calculating and comparing the current losses of sales to the expenses for inventory or a very aggressive pricing policy. Another key factor needs to be taken into consideration here as well. This is the production capacity of the factory.We know that the factory is working under capacity but if this means that it is currently exploiting 85% or 90% of it, then the factory’s production capacity is not higher than 1, 1.

1 million units. In this case obviously the best long-term solution is maintaining the pretty much same level of production as it will spare us from incurring a loss of 7 million $. 3. Increasing the production volume is obviously the best solution. This is possible only if the factory is working on a grave under capacity regime. For example if it is exploiting only 40%-50% of the machine productivity.

In this case the full economies of scale potential could be exploited.A good prediction could be that producing 1,4 or eventually even 1,5 million units annually could give the company the price flexibility in order to take aggressive price positions and eventually gain an additional 5%-6% market share. With this market positions it will sell all of its production and be making at about 2-2. 5 million of profit from product 103. Q2. Should Superior lower as of January 1, 2006 its price of product 101? To what price? Analyzing the future scenario of the company and of the whole market on the basis of the price variations applied by the competitors on the product 101, Waters made two forecasts of the company sales of first semester 2006.

The first one was done maintaining the original price of 24,5 $ while the second one was realised lowering the price to 22,5 $ as the competitors planned to do.Maintaining the previous price Waters forecasted to reach 750. 000 units sales, while reducing the price as Samra has planned to do, he forecasted 1. 000. 000 units sales. First of all the forecasted balance sheet for the first semester 2006 has been calculated reallocating the costs using the given allocation basis, starting from the total costs to the total department costs, then to the unitary costs.

The assumptions made in order to calculate the budget for the first semester of the year 2006 were: • The amount of unit sales of products 102 and 103 will remain the same unless the decreasing trend of the market described in the case, thanks to the company cash discounts which will remain the same. The unitary costs of direct labour and repairs will remain the same. • The unitary cost of materials and supplies will be lowered of 5% as described in the case. • The total non variable costs having a fixed allocation basis will remain the same (rent, property taxes, property insurance, power, light and heat, building service, depreciation, interests). • The total non variable costs depending on a variable allocation basis have been recalculated and reallocated (compensation insurance, indirect labour, selling expense, general administrative, other income).

|std. per 100 lbs. |total std. |std. per 100 lbs.

|total std. | | |std. per |total std. | | |100 lbs. | | |$24,50 |750 |-$2.

207 | |$24,40 |772 |-$1. 972 | |$24,30 |793 |-$1. 755 | |$24,20 |813 |-$1. 557 | |$24,10 |832 |-$1. 376 | |$24,00 |850 |-$1.

213 | |$23,90 |867 |-$1. 066 | |$23,80 |883 |-$937 | $23,70 |898 |-$824 | |$23,60 |912 |-$727 | |$23,50 |925 |-$674 | |$23,40 |937 |-$581 | |$23,30 |948 |-$532 | |$23,20 |958 |-$497 | |$23,10 |967 |-$477 | |$23,00 |975 |-$471 | |$22,90 |982 |-$480 | |$22,80 |988 |-$502 | |$22,70 |993 |-$538 | |$22,60 |997 |-$587 | |$22,50 |1000 |-$649 | The best solution found with the assumption of non linear trend in order to maximize the profit is a 23,00 $ price with a demand of 975. 00 units; the result of this alternative is a loss of 471 $. Q3. 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? We are convinced that the costing system Superior Manufacturing used to register the results of the first semester of 2005 was very imprecise further than useless to check the performances of the different units. To demonstrate this we are going to compare it with the system we suggest, showing how the first semester was really quite profitable even if it would have been followed by a worst second semester that would bring at the end of the year losses comparable to those of 2004.

In fact, without making any calculations it seemed so strange that with the same period costs (that are in large part non-variable or fixed), the same direct costs for products, the same annual sold quantities, and the same prices, the company was able to significantly improve its performances. So from the beginning we looked with suspicion at the results of the first semester, immediately finding out that if product 101 and product 102 sold respectively the 46,75% and the 50,79% of the annual quantity, it is almost clear how non balanced are the sales of product 102; after only 6 months the 69,26% of 102 sales were already registered. In the following paragraphs we are going to make some hypotheses, trying to explain the reasons for all the significant variances we found. Since it is a problem of profitability, we first look at revenues and costs nature and then we show where the data reported in exhibit 4 are misleading. RevenuesFrom an only superficial external analysis, that’s to say how was it allowed by the small number of data we have, in 2005 the market was not growing; so the good results in term of quantity sold seem to show a very good semester for sales but this is probably due to the natural cyclic proceeding of the sales of an industrial good, such as the percentage showed before confirms; probably owing to economies in the reordering process and the issues related to the dimensions of lots of delivery impacting on logistics costs, customers are likely to buy a larger amount of product 102 at the beginning of a new year, while at the end they try to minimize values of finished goods and components stocks.

This is a common way of behaving in B2B markets, with different solutions that fit different goals, like the minimization of inventory value or the lowering of net profit to avoid a huge expense in taxes.Larger quantities of products already sold at the end of June mean fixed costs spread on a larger number of products and so an improvement in profitability; however this appreciable gain is only temporary, because it will be balanced by results of the second semester and that’s why Waters expects a new worsening of the situation (that is in reality physiological, such as we will show later differently allocating the period costs). Even if we have no data about the actual sales of the second semester of 2005, since the market is expected to be stable or even decreasing, larger quantities in the first semester should correspond to very low sales in the second one, with product 102 that will have to cover the fixed expenses of the second semester of its factory with only the 30,84% of the total annual sales. Interesting would be to know something more about stock values that at the beginning of the year should have been very high values, since customers buy larger quantities in the first semester.If the way to account the stock is the same of finished goods, stock can account for a considerable amount of money. Costs We already anticipated the main reason that stands behind the large part of positive variances that the exhibit 4 shows between actual and expected results.

What is evident is that variable direct costs (Direct Labor, Materials, Supplies, Repairs) were allocated by Superior in a correct way, calculating the unitary costs and then multiplying it times the actual sales. No variances are reported on the cost of components or raw materials, so that we can retain as reliable the actual costing system, that, we have to remember it, uses the unitary costs of the previous year.However exactly this feature of the costing system lets happen some things: fixed or non-variable costs are allocated on the basis of the past years results but also on a period shorter than the annual time horizon. This means for example that if this year the company produces more than in the past, it will spend more for the rent than the same contracted cost: this is an absurd because it is a fixed cost for the following 12 years. In the 2005 first semester documents we can see lots of these “deviations”, all the time that a cost fixed on the annual time horizon is allocated on a semester sold quantity.

We can say that the principle of competence cost is totally violated. And this is the reason by which actual registered costs are, for all those kind of costs but two voices, so lower: • Rent (fixed – allocated on cubic space)which is lower of 259 k$ Property taxes (almost non-variable – allocated on the area): -69 k$ • Property insurance (non-variable – allocated on the value of equipment): -61 k$ • Indirect labor (almost non-variable – allocated on the direct labor): -213 k$ • Building services (non-variable – allocated on the area): -40 k$ • General administrative (almost non-variable – allocated on the value of sales): -125 k$ • Depreciation (non-variable – allocated on the value of equipment): -642 k$ • Interests (almost non variable – value of equipment): -63 only to semester All these costs were expected to be higher because the unitary costs of the previous year were multiplied times the actual sales but they don’t depend on the quantity sold.A different explication has to be made for the other voices: the compensation insurance remains practically indifferent because direct costs increased (owing to increased quantities) while indirect ones are better distributed on the increased quantities (obviously not according to the costing system used by Superior). Power (variable cost, allocated on the machine horsepower and thus on the level of activity) doesn’t significantly change because on 4148819 units totally produced in 2004, the 2210237 units made in the first semester of 2005 represent the 53% of total production and thus a little change in total activity level. Light and heat costs (almost non variable, allocated on the area) were a little bit higher than standard one probably because in the considered semester there are more days of winter (valid explication only if the factories are located in the north hemisphere).Last but not least, there was the role of selling expense that increased considerably both considering the standard costs and the period costs of competence.

In the tables below there are all the costs recalculated in two different ways: in the column “our suggestion” there is a sort of budget, in which all the fixed or non-variable costs are attributed to the production of the semester taking the annual result of the previous year (divided by two, to assess the quota of the cost for the semester) and the direct costs are calculated with the unitary costs of previous years and the actual sales. In the “hybrid” column, we use the same method but with actual sales and costs.The unitary costs relative to this second column are those shown in the other columns; only direct variable costs present the same unitary costs of previous year. [pic] The difference between the final profit of our suggested method and the “hybrid” one is mainly due to the increased cost of selling expenses: they had an unexpected increase in costs so that we can think that the general bad and worsening conditions of the market caused a more difficult costs management by sales that had to increase their effort even only to maintain the same sales levels. The situation of the second semester shows how was right our hypothesis about the unexpected profitability of the first semester of 2005.

[pic]In the end, this is the situation for 2005; as we can see the losses are very similar to those of 2004, with the difference mainly due to the previous underlined costs of sales. [pic] As regarding the usefulness of data from the exhibit 4, we will explain how inaccurate it was in detail in the answer to the fourth question. Anyway, we already said that, even considering the highly timeliness of this system that allows to have results of the semester only one week later, the way to consider full costs and allocate them on products was totally wrong and it doesn’t seem that can give some useful advice to the top management, except for the evidence that a better use of the total capacity can’t do nothing but improving the total profitability of the company.In fact, higher quantities obviously would help to cover the fixed costs, increasing the profitability of the single products. This would be possible whether the logics of production are totally untied by those of sales: if it is not possible to quickly improve sales results, it is useless to produce at the maximum capacity, even if the benefits would be unquestionable. Q4.

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 report to management? List the strengths and weaknesses of the system and its related reports for the purpose 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? Why is it important that Superior has an effective cost system? An effective costing system makes it possible for the management to follow their processes/products and have a realistic understanding about the difference between what was planned and how it is actually happening. It can help plan further activities and course of action. In the case of “Superior Manufacturing Co” it is critical for some reasons. First of all there’s been a recent change of management. In two consecutive years two different managers take the lead of the company.

It is understandable that they more or less are unfamiliar with the exact way company operations are lead. On the other hand the market situation is getting more complicated every day and as well because of the major shift in management, the morale and support of the employees drops drastically. In a case like this a good cost system could be of great help as it can show to the new management the way operations are lead historically and the position the company has benchmarked to its competitors and on the market nowadays. It also can indicate the flaws and point out a clear course of action for the new management to follow. Having an effective costing system also shortens drastically the period of adaptation of the new management.

Secondly the company operates in a really rigid, non growing market. It has heavy competition, some of which is superior in terms of scale of operations and therefore financially. Obviously in a situation like this the only flexibility in terms of margin and strategic actions could come from lowering the cost of production. Because of this it is critical that an exact and meaningful cost and expenses control system is established. It should be used to identify the possibilities for lowering costs, choosing alternative scenarios or different balance and distribution of costs. What is your overall appraisal of the company’s cost system and its use in report to management?Overall we can conclude that the company’s costing system is highly insufficient for the managerial purposes it is intended to serve.

We know from the data provided that each from the dedicated factories has the process horizontally integrated and therefore include raw material storage, product-process facilities, finished-product inventories and shipping. The information provided by the current costing system is quite brief, aggregated and unpunctual to describe these in debt. More over the company is currently using this system in order to do its strategic planning, product-line decisions, identifying manufacturing process-improvement opportunities, to conduct profitability analysis, performance evaluation, cost control, and inventory valuation purposes.As it appears the Superior Manufacturing Company is using the same costing system in order to: ? Perform planning & controlling activities and processes, like identifying manufacturing process-improvement opportunities, performance evaluation, cost control ? Take short-term strategic decisions, like product-line decisions, conduct profitability analysis, inventory valuation, cost control ? Take long term strategic decisions, like strategic planning This is obviously impossible as the different audiences require different information in order to make the decisions corresponding to their level. With some assumptions (ex.

If the system is applied in a correct way regarding the period costs etc. we can say that the present system is fit in order to support short-term decisions for marketing, product, business and senior managers. In no way it can support planning and control, not to say about long-term strategic decisions. If we go back to the previous analysis we can state that overall the company has problems mostly on these levels. Probably one of the things the new management noticed was the insufficiency of the system and that is why from the beginning 2005 a new system was introduced. This system was supposed to help focus on valuation of inventories, budget preparation, performance analysis.

It had a different model of cost allocation but still could not support the necessary scale of managerial decisions.List the strengths and weaknesses of the system and its related reports for the purpose management uses the system’s output. Regarding to the previous paragraph we obviously can not evaluate the costing system in absolute terms. IF we should speak about its strengths and weaknesses it should be related to the purposes it was supposed to serve, served and could serve. Strengths: No matter that the costing system seems to have a lot of imperfections it obviously served some purpose to the management and was not a random casual one. If we take into consideration the current company state and the continuously increasing complexity of the market environment we could list some points that support the relevance of such reporting system.

These are: Timeliness – in the paper is mentioned that the preliminary semestrial statement for 2005 was issued at the end of the first week of July. Of course the timeliness is a compensation for non punctualities on the costing model but still when information is needed quickly it is better to have some than none. ? Low Cost – obviously both the 2004 and the new 2005 systems does not require a lot to prepare. They use mostly information that is available from previous years and the sales force. Also because of its nature it is prepared annually and only if explicitly ordered on the half year. In extreme cases it might be prepared even quarterly (although it might not be very indicative for short and long-term purposes) but in any case the price f this report would on the scale of a simple bookkeeping report.

? Simplicity – another benefit of this costing system and its derivative reports is the simplicity. The data is quite aggregated and straightforward. For many purposes this would be inefficient but it might serve a new manager to get the basic picture of the state of the company and give a reference point for further actions. Weaknesses: If w should take into consideration the purposes the system was intended to serve as noted above we found it quite weak as a managerial tool. ? Incorrect allocation of costs on non full operating cycle, by which serves more to confuse than to inform Only straightforward data, which limits the possibilities of its use by the superior management ? Not enough detail in the data, which gives no possibility for low level analysis on the real causes by mid level (product, marketing, sales) and superior management. No possibilities for evaluation on cost control.

What recommendations, if any, would you make to Waters regarding the company’s cost accounting system and its related reports? We would recommend a couple of things listed from the most tactical to most strategic. First and most urgent, the management should correct its current costing systems to indicate the correct mid-term results and to make the relevant conclusions.If they believe it might be more efficient (as they might decide to implement a new costing system from the next year) they could disregard them and consider the annual result which should be relatively correct. In a mid-term (at about 1-3 year plan) we recommend to them to apply a set of cost accounting systems that are to serve the respective audiences (low, mid, top level managers) with the relevant for them information. Why would this be necessary? ? At planning & controlling activities and processes level we know that the management is not being trusted and lacks support.

Also we know that it is critical that the company be as cost effective as possible.A system that establish a process coherence with top management strategic planning (which is financial and non comprehensible for the lowest levels of the company) and a framework of specific goals, objectives and procedures for control would give understanding about the mission and the direction of the company. If applied with the correct system of control (evaluation, feedback and coaching) this would raise morale and regain trust for the management. Also is going to help the management perform the necessary changes in an effective way. ? At the level of short-term strategic decisions we could see that these require much more information that is currently being provided.

Not only for the superior management but also for the sales, marketing, operations and business managers, disaggregated, financial and non-financial information should be provided.For instance if a lifecycle of a product is regarded using the principles of activity based costing or JIT this could serve to a totally different approach to determining the production process and therefore the price. ? At a long-term strategic level we need a more complicated approach as none of the so far suggested cost accounting systems support forecast of scenarios and future cash flow. These however could serve as a basis for a future analysis using elements of capital budgeting and investment management. Last we suggest that the company not only integrates the set of costing systems recommended but continuously monitor the effectiveness of these systems, in order to prevent extra and repetitive or useless reporting which would only add another cost. ———————– [pic]

Superior Manufacturing Co. Case Analysis

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