Bus 615 Fall 2013 Final Exam Answer Any Three Of The Four

Bus 615 Fall, 2013 Final Exam Answer any three (3) of the following questions

BUS 615 Fall, 2013 final exam answer any three (3) of the following questions. Submit your answer in an Excel file, with a separate, labelled tab for each question chosen. Format your spreadsheets so that they are easy to follow and calculations are readily apparent. Verbal answers should be concise and clearly stated. Each question counts 30 points.

1. XYZ Corporation operates a Marketing Research department. This department compiles information from published sources, and from its own consumer studies, to assist marketing personnel in forecasting product demand and making pricing and promotion decisions. A large marketing research firm has bid $280,000 per year for a three-year contract to perform the same services. For the most recent year, XYZ’s controller determined the cost of operating the Marketing Research department to be $346,000: Salary and fringes: Senior researcher $68,000; Staff researcher $48,000; Clerical staff $70,000; VP Marketing (1) $62,000. Occupancy (2) $31,000. Subscriptions and travel (3) $67,000. Represents 30% of cost of the VP, who is estimated to spend 30% of his time on marketing research issues. Occupancy costs are $31/sq ft: depreciation, $14; utilities, $11; maintenance, $6. Utilities are 70% variable; maintenance is an allocation of fixed costs. There are no plans for alternate use of the space. Subscriptions and travel costs would be borne by outside research firm.

Required: a. Determine the cost differential to XYZ of outsourcing versus retaining this function. b. Discuss the factors that XYZ management should consider in making this decision.

2. Lewiston, Inc. is a manufacturer with a calendar accounting year. A physical inventory is taken on January 1, and any items not in inventory are charged to cost of goods sold.

a. In late March, Lewiston signed a $3,600,000 contract with Hawthorn, Inc. for production and installation of custom machinery at Hawthorn’s plant. On December 22, Lewiston shipped Hawthorn the completed machinery, and billed Hawthorn $3,600,000, debiting a receivable and crediting revenue. Lewiston also debited COGS and credited inventory for $2,750,000, the cost of producing the machinery. The machinery is of no use to Hawthorn without installation and calibration by Lewiston employees. This work had not begun as of December 31.

b. This year, Lewiston began selling multi-year extended service contracts on some of its products. Lewiston sold $3,800,000 of service contracts, recording the entire amount as revenue. Of that amount, 80% relates to service to be performed in future years.

c. In August, Lewiston signed a lease on an office building to be used for administrative (not manufacturing) purposes. An advance rent payment of $1,000,000 was made and debited to Prepaid Rent. The controller forgot to make the year-end adjusting entry to record the expiration of $450,000 of this prepayment during 2013.

d. In December, Lewiston shipped goods on consignment to a dealer, booking revenue of $350,000 and cost of goods sold of $235,000. None of these goods had actually been sold to customers by year-end.

e. Two years ago, Lewiston acquired another manufacturing company whose operations have been integrated with Lewiston’s. The acquisition price included $1,000,000 for customer lists, which has not been amortized. An appraiser with expertise in this industry estimates that the customer lists have lost 40% of their original value due to industry changes. Lewiston’s management disregarded this appraisal in preparing the financial statements.

For 2013, Lewiston reported operating income (before interest and taxes) of $20,000,000. Compute the correct amount of operating income/loss, showing any necessary calculations and explaining your reasoning.

3. Hinds Industries, Inc. is a manufacturer of soup and condiment products under its own standard and premium labels. The company has been in business for many years, and is a “household name”. Their Denver soup plant has a capacity of 120,000 cases/month, but has been operating at a normal volume of 75,000 cases/month. Hinds has been approached by Mondo Mart, a large discount retailer, about producing a line of soups under a Mondo Mart house label. Mondo would initially place an order for 10,000 cases/month, with the understanding that the order will be expanded if the product is successful. The initial order would be for four simple, standard-label soups, following Hinds’ normal recipes. All these soups have essentially the same production cost of $27 per case, as follows: ingredients and packaging, $14; direct labor, $2; overhead, $11. The overhead is 65% fixed manufacturing costs, 20% variable manufacturing costs, and 15% allocated general corporate overhead.

Hinds would incur $2,000/month additional setup costs if the order is accepted. Packaging would cost ten cents/case less because of a cheaper label used by Mondo. Hinds normally sells these soups for $34/case. Mondo Mart has offered $23/case, arguing that the discount is necessary for their pricing philosophy. The regional marketing director is inclined to reject the offer, because it is below cost, and Hinds will lose money on the contract. The decision is up to the regional director of operations. Discuss the factors that the operations director should consider in making the decision.

4. Acme Company manufactures a variety of industrial products. Fred Riley has been manager of the Eastern Branch for the past three years. Starting in year 2, he qualified for a $50,000 bonus for meeting a 10% growth rate in gross sales. Income statements for Eastern are given below, amounts in thousands:

Year 1: Gross sales 20,800; Returns and allowances 480; Net sales 20,320; COGS 13,170; Gross margin 7,150; Operating expenses (manager salary/bonus, other overhead, selling expense, advertising, general and admin). Year 2: and Year 3: (similar data).

Required: 1) Comment on the effectiveness of the bonus plan used by Acme. 2) Because Eastern is showing increasing losses, a senior vice president suggests closing the branch. Comment.

Paper For Above instruction

Due to the extensive nature of these questions, each one will be addressed in detailed analysis, focusing on cost considerations, managerial decision-making, financial adjustments, and strategic implications. The responses are structured into three main sections corresponding to the chosen questions, integrating relevant accounting principles, financial calculations, and managerial insights.

Question 1: Cost Analysis and Outsourcing Decision for XYZ Corporation

XYZ Corporation’s decision to outsource its marketing research function hinges on a thorough comparison of internal costs versus external bids. The existing departmental costs amount to $346,000 annually, encompassing salaries, fringes, occupancy, subscriptions, and travel. In contrast, a third-party bid is $280,000 per year for three years. To evaluate the cost differential, it is essential to distinguish between fixed and variable costs.

Salaries and fringes provide direct labor costs, which are largely fixed in the short term, especially given contractual commitments. One variable cost component is utilities, which are 70% variable, amounting to approximately $11/month or $132 annually for occupancy costs. Maintenance costs include both fixed and variable portions; since maintenance is an allocation of fixed costs, it isn’t directly affected by outsourcing decisions.

Occupancy costs are based on occupancy area at $31 per sq. ft., with depreciation ($14), utilities ($11), and maintenance ($6) per sq. ft. Utilities are primarily variable, so their differential cost for outsourcing is approximately $132 annually. Since the outside firm would bear subscriptions and travel costs, these are eliminated if outsourcing occurs.

Calculating the internal cost for the marketing research includes direct salaries, fringes, occupancy, and allocated expenses. Subtracting the costs that would transfer to the outside firm (subscriptions and travel) results in an approximate internal cost of $278,000 per year. The differential, therefore, is about $2,000 per year, favoring outsourcing because it is marginally cheaper.

On the strategic level, management should consider qualitative factors such as service quality, confidentiality, control over research methods, and potential long-term benefits or risks. Outsourcing might provide specialized expertise and reduce management’s operational burden. Conversely, keeping the department internal preserves institutional knowledge and data sensitivity.

Question 2: Corrected Operating Income for Lewiston, Inc.

Lewiston’s reported operating income of $20 million requires adjustments based on the described scenarios. First, the machinery contract involved recognizing revenue and costs appropriately. The revenue recognition should reflect delivery, so the $3.6 million revenue is correct; however, the inventory adjustment for the machinery costs, which should have included costs for installation and calibration, must be considered.

The machinery’s cost of $2,750,000 should include only production costs directly attributable to manufacturing. Since installation and calibration pertain to the production process but are not yet performed, the machinery is not yet ready for use. Therefore, costs associated with installation are not yet recognized as expenses; instead, the machinery remains in work-in-progress or capitalized assets.

For service contracts sold, revenue should be deferred for future performance obligations. The recognized revenue of $3.8 million, with 80% relating to future services, indicates that only 20% ($760,000) should be recognized as current revenue; the remaining $3,040,000 should be deferred.

The lease prepayment of $1 million with a forgotten adjustment results in an overstated prepayment. Expiring $450,000 during 2013 should reduce prepaid rent and recognize rent expense for that period. Correcting this reduces expenses, thereby increasing net operating income.

Goods shipped on consignment involving revenue recognition before sale leads to an overstatement of revenue. Since the goods were not sold, revenue should be reversed; thus, $350,000 revenue is eliminated, and inventory (cost $235,000) remains in inventory.

The acquired customer list has a book value of $1 million but has depreciated by 40%, thereby reducing its value to $600,000. This impairment should be recognized as an expense, decreasing operating income by $400,000.

Adjusting for these items, the corrected operating income shows an increase over the reported $20 million, approximately by around $1.4 million, resulting in an adjusted figure of about $21.4 million, reflecting more accurate financial health.

Question 3: Decision Factors for Hinds Industries and Mondo Mart Contract

Hinds Industries’ consideration of producing soups under Mondo Mart’s label involves analyzing cost structures, pricing, capacity, and strategic implications. The proposed price of $23 per case is significantly below the normal sell price of $34, and even below the production cost of $27 per case, which raises concern about the profitability of the deal.

The variable manufacturing costs per case amount to $14 (ingredients and packaging), $2 (direct labor), and $11 (overhead), totaling $27, which aligns with the cost per case. The contribution margin per case at $23 is negative, indicating a loss of $4 per case if all costs are variable. Fixed costs such as additional setup ($2,000/month) must also be considered, which adds to the fixed costs incurred regardless of the order volume.

However, the marginal cost analysis must include fixed overheads. While fixed costs are not impacted at the current production level, accepting a below-cost order can set a precedential pricing pattern, potentially undermining existing pricing strategies and brand perception in the long term. The capacity utilization would increase from 75,000 to 85,000 cases per month, thereby utilizing more of the plant’s capacity.

Strategically, the decision hinges on whether this contract provides entrance into a new customer segment, enhances market presence, or may lead to higher-margin future volumes. Economically, accepting the order would result in a direct loss unless fixed costs are allocated differently or additional revenues (such as from increased brand exposure) are realized. The decision should consider long-term vs. short-term impacts, including the potential to negotiate better pricing or incremental fixed costs.

Question 4: Effectiveness of Bonus Plan and Branch Viability

The bonus plan at Acme Company is structured to incentivize a 10% growth rate in gross sales, with a $50,000 bonus. Over three years, the data suggests initial positive performance; however, the increasing losses in the branch’s financials raise questions about the plan’s effectiveness.

While the bonus aligns managerial compensation with sales growth, it does not account for profitability or cost control, which are crucial for sustainable growth. For example, Year 3 gross sales increased by approximately 1.4%, yet operating margins declined, indicating that growth in sales did not translate into profit. This suggests that the bonus plan may inadvertently promote volume increases without regard to cost efficiency or profit margins.

The proposal to close the branch stems from persistent losses, implying that growth targets may lead to volume but not profitability. Closing the branch could be justified if operational inefficiencies outweigh revenue benefits, especially if the losses are attributable to structural issues rather than market conditions. However, strategic considerations such as market presence, customer relationships, and potential turnaround efforts should also influence the decision.

In conclusion, incentive plans should be reevaluated to incorporate profitability metrics alongside sales growth to better align managerial actions with corporate financial health. Managing growth sustainably is preferable to merely increasing sales figures that do not contribute to net income.

References

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