Case 1 Alberta Gauge Company, Ltd.
Alberta Gauge Company, Ltd., a small manufacturing company in Calgary,
Alberta, manufactures three types of electrical gauges used in a variety of
machinery. For many years the company has been profitable and has operated
at capacity. However, in the last two years, prices on all gauges 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.
Alice Carlo, the company’s president, is concerned about the results of the
pricing, selling, and production prices. After reviewing the second-quarter results,
she asked her management staff to consider the following three suggestions:
•
•
•
Discontinue the R-gauge line immediately. R-gauges would not be
returned to the product line unless the problems with the gauge can be
identified and resolved.
Increase quarterly sales promotion by $100,000 on the Q-gauge product
line in order to increase sales volume by 15 percent.
Cut production on the E-gauge line by 50 percent, and cut the traceable
advertising and promotion for this line to $20,000 each quarter.
Jason Sperry, 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 JoAnn Brower, the assistant controller, to prepare an analysis. Brower
has gathered the following information.
•
•
•
All three gauges are manufactured with common equipment and facilities.
The selling and administrative expense is allocated to the three gauge
lines based on average sales volume over the past three years.
Special selling expenses (primarily advertising, promotion, and shipping)
are incurred for each gauge as follows:
•
The unit manufacturing costs for the three products are as follows:
•
The unit sales prices for the three products are as follows:
•
The company is manufacturing at capacity and is selling all the gauges it
produces.
Required:
1. JoAnn Brower says that Alberta Gauge Company’s product-line income
statement for the second quarter is not suitable for analyzing proposals
and making decisions such as the ones suggested by Alice Carlo. Write a
memo to Alberta Gauge’s president that addresses the following points.
a. Explain why the product-line income statement as presented is not
suitable for analysis and decision making.
b. Describe an alternative income-statement format that would be more
suitable for analysis and decision making, and explain why it is
better.
2. Use the operating data presented for Alberta Gauge 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 three suggestions cost-effective? Support your
discussion with an analysis that shows the net impact on income
before taxes for each of the three suggestions.
b. Was the president correct in proposing that the R-gauge line be
eliminated? Explain your answer.
c. Was the president correct in promoting the Q-gauge line rather than
the E-gauge line? Explain your answer.
d. Does the proposed course of action make effective use of the
company’s capacity? Explain your answer.
3. Are there any qualitative factors that Alberta Gauge Company’s
management should consider before it drops the R-gauge line? Explain
your answer.
Case 2 Zyler Industries
Zylar Industries is a manufacturer of standard and custom-designed bottling
equipment. Early in December 20×0, Lyan Company asked Zylar to quote a price
for a custom-designed bottling machine to be delivered in April. Lyan intends to
make a decision on the purchase of such a machine by January 1, so Zylar
would have the entire first quarter of 20×1 to build the equipment.
Zylar’s pricing policy for custom-designed equipment is 50 percent markup on
absorption manufacturing cost. Lyan’s specifications for the equipment have
been reviewed by Zylar’s Engineering and Cost Management Departments,
which made the following estimates for direct material and direct labor.
Manufacturing overhead is applied on the basis of direct-labor hours. Zylar
normally plans to run its plant at a level of 15,000 direct-labor hours per month
and assigns overhead on the basis of 180,000 direct-labor hours per year. The
overhead application rate for 20×1 of $9.00 per hour is based on the following
budgeted manufacturing overhead costs for 20×1.
Zylar’s production schedule calls for 12,000 direct-labor hours per month during
the first quarter. If Zylar is awarded the contract for the Lyan equipment,
production of one of its standard products would have to be reduced. This is
necessary because production levels can only be increased to 15,000 directlabor hours each month on short notice. Furthermore, Zylar’s employees are
unwilling to work overtime.
Sales of the standard product equal to the reduced production would be lost, but
there would be no permanent loss of future sales or customers. The standard
product for which the production schedule would be reduced has a unit sales
price of $12,000 and the following cost structure.
Lyan needs the custom-designed equipment to increase its bottle-making
capacity so that it will not have to buy bottles from an outside supplier. Lyan
Company requires 5,000,000 bottles annually. Its present equipment has a
maximum capacity of 4,500,000 bottles with a directly traceable cash outlay cost
of 15
cents per bottle. Thus, Lyan has had to purchase 500,000 bottles from a supplier
at 40 cents each. The new equipment would allow Lyan to manufacture its entire
annual demand for bottles at a direct-material cost savings of 1 cent per bottle.
Zylar estimates that Lyan’s annual bottle demand will continue to be 5,000,000
bottles over the next five years, the estimated life of the special-purpose
equipment.
Required:
Zylar Industries plans to submit a bid to Lyan Company for the manufacture of
the special purpose bottling equipment.
1. Calculate the bid Zylar would submit if it follows its standard pricing policy
for special-purpose equipment.
2. Calculate the minimum bid Zylar would be willing to submit on the Lyan
equipment that would result in the same total contribution margin as
planned for the first quarter of 20×1.
3. Suppose Zylar Industries has submitted a bid slightly above the minimum
calculated in requirement (2). Upon receiving Zylar’s bid, Lyan’s assistant
purchasing manager telephoned his friend at Tygar Corporation: “Hey Joe,
we just got a bid from Zylar Industries on some customized equipment. I
think Tygar would stand a good chance of beating it. Stop by the house
this evening, and I’ll show you the details of Zylar’s bid and the
specifications on the machine.” Is Lyan Company’s assistant purchasing
manager acting ethically? Explain.
