Canadian Valve Company (CVC) manufactures three types of industrial valves: flow-control valves, pressure-control valves, and custom valves. During the past three years, CVC has seen a decline in demand for the flow-control valve, steady demand for the pressure-control valve, and substantially increased demand for the custom valves. The income statement by product line is included in Appendix I.
Jerry Chwang, vice-president of operations, is concerned about the recent trends he is witnessing in the company. "We have top-of-the-line equipment and great employees. Most of our competitors generate a profit margin of 10% before taxes ? we do not. The cost of the flow-control valve is constantly increasing while the unit cost of the custom valve seems to be getting cheaper every year. It makes no sense."
It is July 15, 2021, and you are a CPA working for Barden Management Consultants. Jerry is seeking your advice on changes that should be made to improve profitability. He has provided you with the following information on the three product lines for the year ended June 30, 2021.
Flow Control Pressure Control Custom Control
Sales price $47 $68 $112
Direct Material 10 14 22
Direct Labour (1) 15 22.50 37.50
Variable Overhead (2) 6 9 15
Total Variable Cost 31 45.50 74.50
Contribution Margin $16 22.50 37.50
Units Sold 50,000 25,000 5,000
Direct Labour Hours/Unit 1.0 1.5 2.5
Machine Hours/unit 0.1 0.2 2
Notes:
(1) The standard labour rate is $15.00 per hour.
(2) Variable overhead include small tools, lubricants, and indirect labour charges. It is apply at a rate of 40% of direct labour.
Task #1
Jerry wants to know whether fixed costs are being allocated appropriately, and if not, he would like your suggestions for an improved allocation methodology, including how these changes would impact the financial statements under current production levels.
Task #2
Jerry is also wondering if the current pricing strategy is appropriate. He would like you to consider the pricing of the current products and make any recommendations you might have. He advised you to meet with his employees since they have some thoughts in this area. Your meeting notes with key personnel are included in Appendix II.
Task #3
Jerry is certain that a great way for CVC to improve profitability is to expand its product line. He believes a new knife-gate valve has a very promising future. CVC's CEO still needs to be convinced; while she would like to increase profits, there are capacity concerns. Jerry provided you with the following information on the knife-gate valve:
Estimated variable costs:
Direct materials $20.00 per unit
Direct labour (3.0 hours) $45.00 per unit
Variable overhead $18.00 per unit
Target selling price $115.00 per unit
Estimated annual demand 5,000 units
In addition, engineering advised that the knife-gate valve can be produced on existing machinery. According to the engineers, manufacturing the knife-gate value should not result in any increased to fixed production costs. Only the allocation of fixed costs will change.
Jerry would like your help in drafting a production schedule that includes the knife-gate valve, to maximize profits for CVC.
Task #4
Finally, Jerry want to know how all of your recommendations will impact the financial statements.
Home Tools BU467 - Group C... x (? Sign In H T 4 17 + 75% Appendix I Income Statement by Product Line Search 'Redact' For the year ended June 30, 2021 Flow . Pressure- Lo Export PDF control control Custom Total Volume (units) 50,000 25,000 5,00 80,000 Sales price $47 $68 $112 Adobe Export PDF Revenue $2,350,000 $1,700,000 $560,000 $4,610,000 Convert PDF Files to Word or Excel Online Variable costs: Direct material 500,000 350,000 110,000 960,000 Select PDF File Direct labour 750,000 562,500 187,500 1,500,000 225,000 BU467 - ...W2021.pdf 300,000 600,000 X Variable overhead 75,000 Total variable costs 1,550,000 1, 137,500 372,500 3,060,000 800,000 562,500 187,500 1,550,000 Convert to Contribution margin Microsoft Word (".docx) Fixed costs: Engineering? 40,000 30,000 10,000 80,000 Document Language: Quality control? 65,000 48,750 16,250 130,000 English (U.S.) Change Depreciation 407,500 305,625 101,875 815,000 Other manufacturing+ 125,000 62,500 12,500 200,000 Selling and administrative4 78, 125 39.063 7,812 125,000 Total fixed costs 715,625 485,938 148,437 1,350,000 Convert Net income $84,375 $76,562 $39,063 $200,000 Net income/revenue 3.6% 4.5% 7.0% 4.3% Notes: 1. It has been reliably determined that variable overhead is a function of direct labour dollars. Edit PDF 2. Engineering and quality control are allocated to products based on their relative proportion of total direct labour dollars. Lo Create PDF 3. Depreciation is allocated to products based on their relative proportion of total direct labour dollars. The depreciation charge includes $125,000 of R&D costs associated with the knife- gate valve. Because this product is not likely to be launched in the near future, it was decided Comment to expense these costs. 4. Other fixed manufacturing overhead and fixed selling and administrative expenses are allocated to products based on the number of units sold. Convert, edit and e-sign PDF forms & agreements Page 4 of 7 Free 7-Day TrialHome Tools BU467 - Group C... x (? Sign In H 6 / 7 + 75% BU467 - Winter 2021 Case Assignment #2 Search 'Redact' our prices are very attractive to customers. I think we should reinforce the company's strategy of marketing base models and offering the custom model as a service to regular Lo Export PDF customers at a premium price. If we limit the selling price of the custom model at or below $350, we would be able to sell around 1,000 custom units per year, which is the level we operated at several years ago Adobe Export PDF Convert PDF Files to Word Kris Bevin (engineering department): or Excel Online Our new computer-assisted design system has really changed the way we do things around Select PDF File here. When an order comes in, it is tagged as flow-control, pressure-control, or custom. I would guess that 75% of our time is spent on the custom orders, as they usually require BU467 - ...W2021.pdf X significant adaptations. With the reduced demand for the flow-control model, it currently takes up only about 5% of our time. The pressure-control model takes up the remainder of Convert to our efforts. If we were to return to more normal levels of production, I guess that we would spend about half of our time on the custom orders and split the remaining hours between Microsoft Word (".docx) the other two lines. Document Language: Mo Parna (quality control): English (U.S.) Change Nothing leaves this plant that isn't strictly to our customer's specifications. We check the output of the work centres when they begin each job and monitor output randomly. Because the two basic models (flow-control and pressure-control valves) are produced in large batches, I estimate that each model currently takes about 20% of our time. If the volume of Convert flow-control sales returned to its normal level, I am sure that the amount of quality control would increase to about 30%. The pressure-control model would remain at 20% and the remaining time goes to the more difficult custom work. Dev Patel (supervisor machining and assembly): Edit PDF This new computer-aided manufacturing equipment has really improved our manufacturing procedures, but the machinery is very expensive. The annual depreciation charge is Lo Create PDF $690,000. We also incur $200,000 in other fixed manufacturing charges, which relate mostly to the volume of goods produced and sold. It seems logical to allocate the other Comment manufacturing charge based on sales volume; however, I have never understood why the accounting system charges so little depreciation to the custom line, because we invested a lot in the machinery to accommodate these special orders for customers. Convert, edit and e-sign PDF Jerry asked me if our current manufacturing facility could accommodate a new product such forms & agreements as the knife-gate valve that is likely to gain in popularity in the near future. I told him that my biggest problem is scheduling the direct labour hours. The maximum number of direct abour hours per year is 112,000, and nothing can be done to increase this in the next 12 Free 7-Day Trial months. Also, the minimum level of production for a specific valve type is 500 units per yearHome Tools BU467 - Group C... x (? Sign In H T 5 / 7 + 75% Appendix II Highlights from Employee Discussions Search 'Redact' Gord Downie (controller): Although I have no formal training in accounting, I have been doing this for a long time and Lo Export PDF am very proud of the internal accounting system and the changes that I have introduced over the past five years. We've carefully analyzed the variable and fixed costs using some Adobe Export PDF pretty powerful software. I'm confident that we have an accurate handle on how costs behave as volume rises and falls in the various product lines. Convert PDF Files to Word or Excel Online Stephanie Li (marketing): Select PDF File Marketing expenses are included in the fixed selling and administrative costs. The amount of time, energy, and expenses devoted to each of the product lines seems to depend on the BU467 - ...W2021.pdf X volume sold, and I think the current allocation is appropriate. Convert to The big problem I hear about from the sales centres is around our prices. We currently base all of our prices on an approximate 50% markup over variable costs. I am not an expert, but Microsoft Word (".docx) I believe that our selling prices should be more in line with our competitors, and our price should be based on the total costs of the resources really consumed by a product. Instead Document Language: of our current approach, I would like to see us using the market benchmark, or a total cost + English (U.S.) Change 10% margin pricing strategy. But I certainly would like a third party to analyze these three pricing strategies in order to figure out which one would provide the highest profitability. Flow-control model: We charge $2.50 above our competitors' prices on the flow-control model, and this is really Convert cutting into our sales volume. During the past three years, sales have dropped 24,000 units. If we could reduce price to a level at or below the current average market price of $44.50, I expect sales would jump back to 72,000 units per year, which, for us, has always been a level of production that we consider normal. Edit PDF Pressure-control model: Lo Create PDF With respect to the pressure-control model, I feel that the current sales price is aligned with the current market price and, thus, volume should remain at current levels for the foreseeable future if we don't make any changes to the product or its price. It has been Comment stable for the past three years. Custom model: Convert, edit and e-sign PDF Sales of the custom valves have grown by 4,000 units over the past three years. It is difficult forms & agreements to find out what our competitors are charging, but there is some evidence to suggest that Page 5 of 7 Free 7-Day Trial
