and corporate-level management. Patterson has remained He also said, "By outsourcing the Gudgeon EH40, we can profitable since the acquisition, but its return on investment release three administrative managers, eight administrative has been declining. support staff, 128 general production personnel, and 10 supervisors. Exhibit 1: Your first stop at the Patterson complex is a meeting with The firm will incur a one-time charge of $1 million for severance Patterson Manufacturing Five-Year Summary of Operations he controller. He provides some additional background: pay and pension contributions for dismissed employees. We'll Jessica, like her predece most of her time with also need to spend $200,000 for the construction of receiving Year 5 Year 4 Year 3 Year 2 Year 1 customers developing new products to meet customer needs acilities for the outsourced product." Total Revenues $90.2 $94.9 $99.1 $106.2 $111.4 She didn't concern herself with costs. Customers were willing The controller continued: "The supplier's cost quotation Net Income $3.1 $3.8 $4.4 $7.3 $7.5 to pay for products that solved problems. Upon Jessica's Exhibit 4) needs to be adjusted for the expected 15% Domestic Sales $74.7 $76.9 $79.3 $85.0 $88.1 retirement, Columbia appointed Paul, our former production increase in volume. The cost for materials and labor will International Sales $15.5 $18.0 $19.8 $21.2 $23.3 manager, to CEO. Paul has done wonders in rationalizing and increase proportionately, but the overhead and 'other' costs Sales of Established Products* $73.9 $75. $74.4 $76.3 $76.6 standardizing our product lines. He substantially reduced are unlikely to be affected. The supplier's mark-up will be Sales of New Products* $16.3 $19 .8 $24.7 $29.9 $34.8 manufacturing costs, which led to record profits in the two 10% of the new total cost. In addition to the product cost, Research and Development $0.9 $1.1 $1.5 $1.2 $1.3 years following the sale of the company. Those early results Patterson will incur transportation costs to get the product Return on Assets 2.0% 2.3% 2.7% 4.1% 4.2% have apparently set high expectations for our continuing from the manufacturer to our warehouse. The transportation Number of Employees 480 485 502 492 510 performance. Our proposal will help move us toward meeting costs are variable and would have been $0.6 million for the Note: Dollar figures are in millions. those expectations," he said. volume of product in Year 5." "Established products are those that have been marketed for five years or more. New products have been marketed for less than five years. "Our proposal is to stop manufacturing our largest-selling product, the Gudgeon EH40, and instead acquire it from an THE TASK overseas supplier," continued the controller. "This product currently represents 30% of our total sales revenue and After his brief overview, the controller hands you the exhibits Exhibit 2: Exhibit 3: production volume. But sales have been declining because and says, "You should go through the numbers yourself to Summary Income Statement for Patterson Manufacturing Distribution of Current Patterson Employees by Job Title competitors are offering a similar product at lower prices. We ensure that my projection for the increase in profit is correct." think that by reducing our price by 5% we can increase our As you make your way to an empty office to review the unit sales volume by 15%. The increased volume coupled numbers, the marketing manager approaches you. She pleads, Year 5 Number of Average Salary Job Title Employees Per Employee with a lower product cost from the offshore supplier should "Don't let them do this. The proposed action will deal a Sales $90.2 Administrative Manager 10 $45,000 nearly double our firm-wide profit." devastating financial blow to our community. Wesley Patterson Cost of Goods Sold (COGS) 14.3 Administrative Staff 24 32,000 The controller also provided some supporting would have never approved such a move. He loved this town." Gross Margin 15.9 29 50,000 documents. Exhibit 1 summarizes operations for the five Administrative Costs 1.6 Production Supervisor General Production Personnel 417 37 000 years since Patterson Manufacturing was sold to Columbia REQUIRED Selling Costs 11.2 Holdings. Year 1 represents the first full year after Jessica 1. Using the controller's projections, prepare an analysis Operating Income $ 3.1 retired, and Year 5 is the year that just past. Exhibits 2, 3, of the expected effect of outsourcing the product on Note: Dollar figures are in millions. Interest expense and income taxes are only and 4 provide an income statement for Year 5, the current Patterson's profitability. shown on Columbia's consolidated financial statements. employee staffing levels by job title, and a detailed price 2. Would it be a viable alternative to produce the product proposal from the overseas supplier. locally and lower the price to achieve the increase in sales The controller continued: "The analysis is pretty volume? Exhibit 4: straightforward. Sales of the Gudgeon EH40 were $27 3. Does the firm have an obligation to maintain Off-Shore Supplier's Price Proposal for the Volume of million last year. The direct material costs came to $14.3 employment levels in the town? Product in Year 5 ABOUT IMA million, while overhead costs of $4.2 million were allocated 4. What risks are associated with the proposal? Material Costs $12.7 With a worldwide network of more than 65,000 professionals, to the product. But only $2.9 million of the overhead will be 5. Make a recommendation to your vice president on Labor Costs 1.8 IMA (Institute of Management Accountants) is the world's avoided if we stop manufacturing the Gudgeon EH40. The whether the proposal should be accepted. Provide Overhead Costs 2.7 leading organization dedicated to empowering accounting remaining overhead costs are nearly all fixed and not subject your reasoning and any suggestions for additional or Other 1.5 and finance professionals to drive business performance. to reduction in the near future. Our direct selling costs consist alternative actions that Patterson should take. Total 18.7 IMA provides a dynamic forum for professionals to advance mostly of an 8% commission paid to sales representatives. In their careers through CMA (Certified Management addition, there's a $2 million advertising allowance devoted to Profit Mark-Up (10%) 19 Accountant) certification, research, professional education, promoting the Gudgeon EH40 in trade magazines." Total Price $20.6 networking, and advocacy of the highest ethical and Note: Dollar figures are in millions. The total price is quoted for supplying the quantity of professional standards. For more information about IMA, product Patterson sold in Year 5. The quoted price is FOB the supplier's manufacturing plant. please visit www.imanet.org. IMA EDUCATIONAL CASE JOURNAL 2 VOL. 6, NO. 4, ART. 1, DECEMBER 2013 IMA EDUCATIONAL CASE JOURNAL 3 VOL. 6, NO. 4, ART. 1, DECEMBER 2013