1. Case Summary Katy EH Manufacturing Company The owners of Katy EH Manufacturing, a small manufacturer of gas grills, have prepared a preliminary budget for the upcoming year and would like to assess the financial impact of several alternative scenarios, including dropping a product; changing the price on a product, with a resulting increase in volume; and shifting advertising focus, with a resulting shift in volume from one product to another. A new budget must be prepared. At year-end, the actual results are better than had been planned, but not necessarily better than what should have been, given actual sales volumes. 2. Hint Consider using the cost-volume-profit analysis as to analyze profit-planning issues such as adding or dropping a product or service; changing a price; adding or decreasing expected volumes; or preparing a profit budget. In this particular situation, there are three products, each with different proportions of variable and fixed costs. Make sure you can identify variable and fix costs. Pay attention to the relation of profit and contribution margin. In addition, you also need to consider non-financial factors when making your final decision in your executive summary. 3. Please explicitly answer the following questions in your executive report and clearly label them. a) Should Katy EH drop Grill A? The owners wanted to know the impact of dropping Grill A from their line of products. Sharp was told to assume that the volumes and selling prices of the other two products would be the same whether or not the Grill A product line was dropped (5 points). b) Should Katy EH lower the price of Grill C? The owners wanted to know the impact if they lowered the price of Grill C to $75 and if doing so led to a 20,000-unit increase in sales of Grill C (5 points). c) Should Katy EH change its advertising focus? The owners wanted to know the impact of a 10,000-unit increase in Grill C volume and a related 10,000-unit decrease in Grill A volume because of a shift in advertising emphasis (5 points). d) Should Katy EH lower the price of Grill C and change its advertising focus? The owners wanted to know the impact of lowering the price of Grill C to $75 and shifting the advertising focus more to Grill C, thereby decreasing Grill A volume by 10,000 units and increasing Grill C volume by 30,000 units (10 points). Katy EH Manufacturing Company In mid-December 2015, Peter Johnson and Lily Brown were almost through with the 2016 operating budget for their company, Katy EH Manufacturing Company (EH). EH produced gas grills in three primary models (Grills A, B, and C). The industry was dominated by Lukey, Coleman, Bonnie, Sunshine, and Highland, which together made dozens of types of grills, smokers, and cooking kettles. EH was a small player in the industry, but business had been good, and it was expecting another profitable year. A draft of the companys operating budget is shown in Exhibit 1. Standard costs for the three products are explained in Exhibit 2. Selling, general, and administrative (SG&A), other costs, interest income, and interest expense were likely to remain the same no matter which product-line combinations the company produced. Before calling it a day, the two owners asked their assistant, Jane Sharp, to determine the impact of several options on income before tax. They agreed to meet the following day, the Sharp hurried off to look at what these latest ideas would mean. She had six questions to address (see page 1) and was asked to consider each option independent of all other options. Sharp and the owners met the following morning to review her work. Having finished her duties, she left for an early weekend getaway. She didnt give the budget another thought. Early in January 2017, Sharp prepared a rough draft of the actual 2016 volume, selling price, and financial results (Exhibit 3 & 4). (This case is adopted and modified from Cases in Managerial and Cost Accounting, Cambridge Business Publishers) Exhibit 1 Katy EH Manufacturing Company Operating Budget 2016: Draft 12/18/2015 Operating Budget 2016: Draft 12/18/2015 Sales $41,200,000 Less: costs of products sold 22,800,000 Gross margin $18,400,000 SG&A 9,350,000 Other costs 2,100,000 Operating income $6,950,000 Less: Interest expense 420,000 Plus: Interest income 150,000 Income before tax $6,680,000 Income taxes 2,338,000 Net income $4,342,000 Exhibit 2 Katy EH Manufacturing Company Operating Budget 2016: Draft 12/18/2015 Grill A Grill B Grill C Notes Planned units 80,000 120,000 200,000 Per unit Sales price $150 $110 $80 Direct costs: Materials 17 10 7 directly related to volume Labor 21 16 4 directly related to volume Subtotal $38 $26 $11 Indirect cost: Supplies 7 2 1 directly related to volume Labor 10 8 4 one-half varies with direct labor, the rest is fixed Supervision 8 3 1 unrelated to volume Energy 12 6 4 one-half varies with directlabor, the rest is fixed Depreciation 22 7 5 unrelated to volume Support* 12 6 3 unrelated to volume All other 11 2 1 unrelated to volume Subtotal $82 $34 $19 Total cost $120 $60 $30 Profitability $30 $50 $50 *This category comprises accounting, IT, human resources, legal, and others supporting the production of these products. Exhibit 3 Actual 2016 Volume & Price (Dec.31, 2016) Grill A Grill B Grill C Price $150 $110 $75 Volume 115,000 110,000 225,000 Exhibit 4 Katy EH Manufacturing Company 2016 Operating Results: Draft 1/19/2017 Revenue $46,225,000 Variable costs: Materials 4,800,000 Direct labor 5,200,000 Supplies 1,300,000 Indirect labor 1,500,000 Energy 1,600,000 Total variable cost $14,400,000 Fixed costs: Indirect labor 1,300,000 Supervision 1,200,000 Energy 1,350,000 Depreciation 3,660,000 Support 2,300,000 All other 1,380,000 Total fixed cost $11,190,000 Total cost $25,590,000 Gross margin $20,635,000 SG&A 9,350,000 Other costs 2,100,000 Operating income $9,185,000 Less: interest expense 420,000 Plus: interest income 150,000 Income before tax $8,915,000 Income taxes 3,120,250 Net income $5,794,750