1 AMBOY SPECIALTY FOODS: A CHEESY VARIANCE INVESTIGATION PART 1 In 1940, a retired U.S. Marine Colonel established Amboy Specialty Foods to provide canned cheese sauce as meal rations for the United States military. Amboy reported operating income every year since the company was established, until this year. Following tradition, Chris Shaw, a recently retired Marine Colonel, was appointed to lead Amboy. But now, the Colonel, or Sir as Amboy employees called him, was concerned. The possibility of Amboy reporting a loss for the first time ever was very real. If he couldnt figure out what was driving the first quarter loss, Colonel Shaw would forever be known in the tight knit community of retired Marines as the one who failed at Amboy. Failure was not an option during the Colonels military career, and he was not going to fail at Amboy. The Colonel scheduled an early Friday morning meeting with Terry, Amboys new controller, to address the situation. The Order Come in Terry. Youre late! You were supposed to be here at 8AM, the Colonel commented tersely. Im sorry. I got caught in traffic, Terry apologized. My time is valuable, and I expect for you to be in on time. No exceptions. Understood? Terry replied like a soldier under the Colonels command, Yes, Sir. The Colonel began, I am certain you are aware that the company reported a net loss for the first three months of the year. I doubt you are aware that in 75 years of operation, Amboy has never reported a fiscal year loss. Not once! I was not aware of that, Sir. I do know that we made a change to the cheese sauce recipe this quarter and that the new recipe uses more block cheese, Terry replied, silently considering the possibility that the new recipe was behind the current quarter loss and wondering what was next. Thats correct, but we also increased the sales price enough to cover the increased cost of the block cheese. Focus on the problem! Under my watch, the company will not lose money this or any year. I never failed in my 30-year Marine Corps career, and I am not going to start now. By close of business today, you need to figure out what is causing the loss, and report back to me. 2 The Financials After leaving the Colonels office, Terry prepared a comparative variable costing income statement for the last two quarters. Terry also generated a report of input costs for the two quarters. Staff Accountant I completed a quantitative Variance Analysis, as shown in the Excel file. See Case Info tab in the Excel file for the information and other tabs for the staff accountants analysis. The Interviews Terry noted that the volume of sales in the current quarter significantly increased over last quarter. He knew it was reasonable to expect variable cost of goods sold to increase proportionate to the change in sales volume. An additional analysis (below) demonstrated that all components of variable costs of goods sold increased more than could be expected due to the change in sales volume alone. The analysis also clearly showed that the bulk of the quarterly loss resulted from a drastic increase in direct materials cost. Direct Materials-Block Cheese 60.20% 80.97% 20.77%Direct Materials-Oil etc 1.67% 1.86% 0.19%Direct Materials-Packaging 1.00% 1.12% 0.11%Direct Labor 5.02% 6.80% 1.79% Variable Overhead 10.03% 12.45% 2.42%Contribution Margin 22.07% -3.20% -25.27%Components of Variable Cost of Goods Sold & Contribution Margin as Percentage of RevenueExpected Actual ChangeSetting down the list of job titles and related responsibilities that the Director of Human Resources gave him, Terry smiled. He was confident that Jordan, the Plant Manager and Shelby, the Director of Purchasing would have more information about the cost overruns. He decided to talk with both of them. 3 Job Title Job Responsibilities Plant Manager Responsible for choice of production levels; production scheduling; hiring and firing production employees/supervisors; determining acceptable range for grade of inputs; maintenance of production equipment; supervise production line operations Director of Purchasing Responsible for choosing vendors; negotiating purchase prices and discounts; timing of purchases; grade of materials purchased (within ranges specified by Plant Manager) The Plant Manager Terry decided to meet with Jordan first. How are you today? he asked. I am a little worn out. Driving four hours to take our girls to the soccer tournament on Friday after work, coaching four games and getting home late last night took it out of me. I know what you mean. It was worth it though since they won. Absolutely! I dont know if I can handle another weekend like that anytime soon. Me neither. Not to mention the Colonel compelled me to report early this morning. Ive already been here two hours. I suspect the Colonel is concerned about the record. Yes. I was ordered to investigate why Amboy has not reported operating income this year. Cost increases appear to be driving the loss. Can you help me understand what happened? Sure, I will do anything for a friend. As you probably know, my responsibilities include supervising the production line, where the cheese sauce is made. We mix block cheese and other ingredients, mostly oil and water, based on recipes called product specifications. Since the beginning of the year, block cheese usage is up significantly, said Jordan. OK. I can see that in the numbers. Now, help me understand what caused the increase. Shortly after taking control last summer, the Colonel told us he wanted the company to improve nutritional value and cheese flavor. He directed us to increase the block cheese content 4 in the cheese sauce by the first of the year. We did. Thats why you see the big increases in block cheese cost. That makes sense, but based on the specifications sheet, I only expected a 5 percent increase, Terry questioned. Sorry. There is another factor I forgot to mention. Our primary block cheese supplier could not meet our increased demand, so we were forced to hastily approve another block cheese supplier. Unfortunately, the majority of the cheese from the new supplier fails to meet our standards for quality and wholesomeness. We do some rework, but we also have to throw away a lot of cheese. Let me see if I understand. There was an expected increase in costs due to the planned 5% increase in the block cheese content of the sauce, but due to the poor quality of the block cheese from the secondary supplier, we used more cheese than expected. Is that correct? Terry queried. Exactly. If purchasing would have approved a new supplier sooner than the last week of the year, we surely could have avoided these issues. Thanks. I knew I could count on you. I look forward to seeing you at the girls game this weekend. Go Tigers. The Director of Purchasing Feeling confident in Jordans explanation, Terry entered Shelbys office. Shelby greeted Terry warmly, Good morning. Its been awhile since Ive seen you. How is your day? 5 So far, its been long. My second week on the job and the Colonel calls me into an 8AM meeting. I was up at o-dark-hundred this morning! It reminded me of getting up for those early morning band practices in high school. Terry reminisced. Nodding in agreement, Shelby replied, I will never forget the endless hours of practice and fundraising before our performance in the Thanksgiving Day parade in New York. Terry agreed, That trip was awesome! The, he abruptly changed subject, So, I suspect you know why Im here the record. Shelby nodded. I was expecting you. The Colonels directive to increase block cheese content in the cheese sauce definitely led to some scrambling around here. First, we estimated what it would cost to increase the amount of block cheese, so that Marketing and Sales could raise the price to cover the cost. The real problems started when our primary supplier of block cheese notified us they didnt have sufficient capacity to meet our request for more cheese. We were forced to approve a secondary supplier. What was the issue with the secondary supplier? Terry asked. The secondary supplier charged a higher price than our primary supplier. OK. Terry replied as he took notes. So, can you tell me when the Colonel issued his cheese content directive? And when the secondary supplier was approved? Shelby replied, If I remember, the directive came in early July. My team and I put together a list of potential suppliers during the summer, but the production guys didnt have time to meet with us to narrow down the list until later in the year. Then, they had trouble agreeing on the precise level of quality we were willing to accept from our suppliers. By the time we knew what they wanted, half the suppliers on our list were too busy to take our orders. We got stuck picking the best deal among the leftover suppliers. 6 Thank you so much. This has given me a much better picture of what has been happening. I really appreciate your help Terry said as he gathered his things readying to leave. Say, are you going participate in the alumni drum line at the football game on Friday? You bet! I wouldnt miss it. Everybody is going to be there. Me too!! See you Friday night. 7 REQUIREMENTS Terry went back to his office and typed up notes from the interviews. He asked you into his office to discuss the findings. Believing it is important to give young professionals opportunities to learn on the job, Terry asked you to answer a few questions. He explained that these are questions he will have to answer himself to prepare a report for the Colonel. You and he will discuss the situation in the coming days. 1. Based on the interviews, what did Terry learn about potential causes of the current quarters net operating loss? 2. Does it make sense that Jordan, Shelby, and Terry focused discussion on block cheese? Explain why or why not. 3. Identify and explain possible reasons why Terry would be uncertain about what caused the block cheese variance and who is responsible for it. 4. If you were Terry, would you want to search for additional information to decrease your uncertainty? Identify information you would gather and explain why/how the information could reduce your uncertainty. If you would not search for any additional information, explain why not. 5. Consider what the variance analysis and interviews revealed about the current quarter net operating loss. If you were Terry, what information would you include in a report to the Colonel? Is there any information you would not include in the report to the Colonel? Explain how you decided which information to include/exclude in your email to the Colonel. Please limit your response to a total of 2 pages.