Identify the cost issues facing the firm in this case.

Chrystal Moulding and Repairs Works (CMRW) is a successful SME based in Ashhurst, a small rural town close to Palmerston North. CMRW manufactures a variety of products and provides a range of services to clients. Work involves (a) moulding of plastics and other materials, (b) custom builds using plastic, fibreglass, kevlar, carbon fibre and other new age materials and (c) the repair of anything using these materials.

George Hood, one of the two owners of CMRW has approached your accounting firm, Brian Associates Ltd (BAL), to provide some help with their costing as profits have been failing even though the total level of work done has been increasing. He explains they cannot understand how they can be busier but make lower profits. Christina John, the other owner of CMRW, who oversees all CMRW’s operations, explains that they have had to increase staff numbers to cope with the increasing work but this does not seem to be translating into better cash flows.

Jessica Hunt, the BAL partner who looks after CMRW, has asked you to do the initial investigation of CMRW’s costing issues and to generate two possible solutions. Your first action is to visit CMRW and talk to the people involved to gain an understanding of the firm. Your visit results in the following information:

1. General information

The firm runs from one site in Ashhurst which is owned by CMRW who purchased the property and three buildings in 2015 when their previous landlord put the property up for sale. The location was chosen due to the availability of low-cost industrial building space and land as well as the close proximity to Palmerston North which as a major distribution center provides ready access to transport networks that help the company serve nationwide clients.

The business is owned jointly by George Hood and Christina John. George runs the administration side of the business and deals with customers, while Christina manages the operations of the firm. George has a wide background in marketing, while Christina is the “technical brains” of the firm with many years’ experience in the industry.

All staff are multi-skilled so can work in any aspect of the firm. Staff are assigned to work each week based on the production deadlines for the week. This allows the firm the flexibility to draw on a number of staff for setups to make these as quick as possible while providing work for them once Moulding equipment is running.

2. Moulding

The Moulding department produces moulded products for customers in set production runs. CMRW has some long-standing customers who place regular orders. CMRW also prides itself on its ability to provide fast delivery of rush orders to customers as part of their outstanding customer service strategy.

The molding department has been growing at a significant rate, with growth exceeding 15% in each of the last three years. Much of the increase in Moulding orders is rush orders. Christina explains they see this as a result of the good service they provide and the flexibility the firm has to produce product quickly. Molding requires a significant amount of equipment and due to the increasing level of work gained CMRW is considering increasing their capacity by investing in more equipment. Most of the equipment is automated meaning once set up one employee can monitor and run several machines at once. Set up of each machine averages 30 minutes for each production run with rush order often requiring regular production runs to be suspended and set up again once the rush order is complete. All molding customers are also granted credit with some having agreements allowing them 60 days’ credit without charge. CMRW generally pays the transport costs for molding jobs as a way of offsetting their distance from customers. George explains this means they can compete with competitors based closer to the main centers.

George explains the moulding work has been the most profitable work in the past although custom work has traditionally had a higher gross profit margin. George comments that he has been able to increase the mark-up he applies to moulding work in recent years as customers have been very happy with the prices charged and have not reacted when he increased the mark-up slightly.

3. Custom Work

The Custom department provide a wide range of custom work for customers from across New Zealand. The work is frequently one-off work although an increasing amount is for limited runs of up to 5 similar items at a time. The designs are received from customers, or their designers, as CMRW does not provide any design services. The work is varied with much of it being labour intensive due to the set-up times needed for each design.

Custom work is produced for a range of customers. Some are repeat customers who regularly get work done – most of these are businesses who are getting the work done as part of their work for their own customers. Christina explains these commercial customers are easy to deal with as they know how CMRW work. They provide work in a form which is easily transferred into the equipment and provide clear instructions. One-off customers tend to be private individuals. These customers generally spend significant time with George detailing exactly what is required and negotiating quotes before the work is accepted. Custom work tends to be labour intensive with a lot of work begin competed by hand. Christina also explains that custom work does not provide the same efficiencies as moulding work as the machines are often set up for production runs of one meaning set up labour is a significant cost for this work. Staff enjoy this work and are often involved with delivering the product to customers or discussing the finished result with customers when it is collected.

All custom work requires a deposit to be paid and the full selling price to be paid within 7 days from completion.

The level of custom work has been falling which is concerning Christina as this work has the highest mark up. One bright point in the custom work is that they are gaining more work that involves small production runs - so rather than producing a single unit they are getting orders for jobs which require the production of up to 5 units at a time which increases factory efficiency.

4. Repair Workshop

The Repair Workshop provides a range of repairs to customers. Much of this work is local although historically they have performed repair work for customers from throughout the lower North Island. Repairs include work on canoes (for both recreational and sports), boats (both for commercial customers and recreational owners), custom cars and industrial equipment (for example cabs and panel work for tractors and excavators). Many customers need a fast turnaround, especially the industrial and sports customers. CMRW built its repair business on the quick turnaround it provides, with stocks of a wide range of materials being held to ensure no repair is held up waiting for materials to arrive from suppliers. The Repair workshop also sells repairs kits and materials to customers so they can complete their own repairs. The material sales are a mixture of direct sales at the workshop door and online sales from a basic website CMRW has developed.

Repairs are carried out in a separate building and mainly completed by hand. This work is popular with staff as they get to see the whole job through themselves and often get the satisfaction of returning the finished work to the customer. Christina also explains the repair work plays a key role in staff training as staff are trained in new skills and materials on repair work as the smaller size of the jobs makes them an ideal training ground. The equipment involved in repair work is limited being mostly props and benches to support work as it is worked on and cures. The firm sells repair materials and specially stocked repair kits directly to customers from the workshop door with staff providing advice on the best products to use and how to use them. Online sales are also made via CMRW’s website – these sales are processed and managed by Estelle the Office manager. Estelle often asks workshop staff about queries she receives via the website to ensure these online customers also get excellent service and the correct products for their projects.

The level of repair work has been falling with customers commenting on the high costs involved in repairs. CMRW regularly received repair work from throughout the entire lower North Island but this work has been falling by more than 20% per year for the last few years.

All repair work must be paid for on collection or before dispatch.

5. CMRW’s Costing System.

CMRW’s uses a job costing system for all of its costing calculations, (Moulding treats each production run as a separate job). Job costs include all manufacturing and factory costs. Actual direct labour and materials costs are traced to each job using job sheets. Factory overheads are applied on a plant wide rate using labour hours as the base. George and Christina estimate the level of activity expected in labour hours for the year and total factory overheads costs at the beginning of the year to calculate a new overhead rate each year. Labour hours includes both direct labour and set up labour as these roles are both performed by the same staff. George explains this system is simple and he believes it means they will always recover all their factory overhead costs. All jobs are priced at cost plus a mark-up (20% for moulding, 30% for custom work and 25% for repair work).