CASE 27 Exhibit 1 Operating Statement The financial performances of the extraction and cleaning operations and expenses of the ancillary support and administrative activities combine into a Employees are transported by company bus from two towns where they live to the mine site. The last 27 kilometres into the mine is a company-main- single operating statement. The statement is shown in Exhibit 1. You realize tained road. that to accomplish your project you will need to allocate these costs to the two You find that the annual contract for thermal coal is 450,000 tonnes, and types of coals and two operations. Subsequently, you arrange appointments with 150,000 tonnes for metallurgical coal. For each contract, the King mine is the managers and other employees who are knowledgeable concerning the content prime supplier, and the customers make up any shortage by alternative and and drivers for each expense line item. more expensive secondary suppliers. The mine ships the full amount of cach contract for each year. The metallurgical coal generates revenue at the rate of $78 per tonne. The thermal coal does not generate revenue, because it is shipped to a thermal plant owned by the provincial government. To estimate a KING MINE DIVISION transfer price, you asked the general manager of the thermal plant what would be the landed cost of thermal coal on a long-term contract. She estimated the For the Year Ending December 31 cost to be $71 per tonne (delivered) for comparable coal. The traffic officer REVENUE (responsible for arranging for and monitoring transportation) explained that Thermal coal King ships clean coal at the cost of $6 a tonne. Metallurgical coal 11,700 The mine is a series of interlinked pit mines that produce 652,000 tonnes EXPENSES per year. Excavation equipment and trucks remove the overburden. The pits Extraction wages and benefits Plant wages and benefits differ by coal type, and for efficiency purposes the miners extract thermal coal Diesel fuel, gasoline Amortization, pit trucks, equipment for three weeks, and then metallurgical coal in the fourth Pit mining wages Amortization, buses and benefits, amortization for pit trucks and equipment, and depletion costs are Amortization, plant equipment Amortization, depletion costs Management salaries and benefits 2,700 2 Administration Facilities, utilities and taxes Marketing department Net income before income taxes $128.000 King Coal The provincial government's electrical utility has a coal mine in the King region that produces thermal and metallurgical coal using an integrated pit mine and cleaning plant. Separate reporting is not done for the extraction and cleaning plant or for the thermal coal and metallurgical coal. The assumption is that if the total cost is competitive, then each part must be efficient. Although this may have been a reasonable approximation in the past, new mines have been opened that are more efficient. Now the utility's senior man- agement wants to manage the cost of each part individually. The controller has assigned you to calculate the profitability of the opera- tions. The reason for your assignment is to figure out, as accurately as possible, the exact costs of cach coal (thermal and metallurgical) and each operation (extraction and cleaning) at the King Mine. Then you are to compare the costs with other operations of the utility and with industry averages. These costs will be the starting points for specifying annual improvements in productivity and cost effectiveness. A component of this study will be to devise a transfer price between the extraction and cleaning plant, if that would motivate cost effectiveness. When he assigned the project, the controller conveyed the trans- fer price idea of a board member, but admitted he does not understand why it would be beneficial. The controller asks that you explain transfer pricing and its possible benefits in your report. The production process includes the extraction and hauling of raw coal to the cleaning plant. The cleaning plant prepares both types of coal for shipment by rail, the thermal to a thermal plant and the metallurgical to a private steel mill. in thousands of dollars) $10.500 9.500 3.800 3.000 900 2.800 800 2,300 2.600 - 800 39.700 * Amortization is based on the physical exhaustion of the asset. CASE 27: KING COAL When analyzed according to where they work or how they devote their average work day, the management, administration, and marketing personnel had the following to say in aggregate: Extraction Plant Neither Total Management Administration Marketing 45 45 35 40 20 15 100 100% 100% 100% entirely attributable to the extraction of the coal. These costs are the same per tonne for both thermal and metallurgical coal. Shrinkage in the cleaning plant through the elimination of impurities reduces the weight by eight percent. The expenses for the cleaning plant include plant wages and benefits and amortization for plant and equipment. The metallurgical process has additional stages and, thus, a higher cost per tonne than thermal coal. You estimate that 70 percent of all cleaning costs are attributable to thermal coal, and 30 percent to metallurgical coal. As for diesel fuel and gasoline expenses, you estimate that $3,500,000 was for extraction, $150,000 was for the loaders in the plant, and $150,000 was for the buses. There are nine buses scheduled to drive back and forth between the two towns and the mine site where all employees report for work; 500,000 kilo- metres were driven last year. Employees take the bus about 98 percent of the time. The following table shows the breakdown of employees by department: Extraction 41% Plant Management Administration Marketing 5 About $600,000 of the administration expense item is attributable to buses. Square feet occupied is the cost driver for facilities, utilities, and municipal taxes. You calculate the allocation to be 45 percent for extraction, 35 percent for plant, 10 percent for administration, 5 percent for management, and 5 per- cent for marketing. 26 13 15 Required Exhibit 1 shows one set of accounts for two businesses (coal extraction (pit) and coal cleaning (plant)) and two types of coal (thermal and metallurgical). Explain why the revenues and costs need to be reported separately for each business: coal extraction (pit) and coal cleaning (plant). CASE 27 Exhibit 1 Operating Statement The financial performances of the extraction and cleaning operations and expenses of the ancillary support and administrative activities combine into a Employees are transported by company bus from two towns where they live to the mine site. The last 27 kilometres into the mine is a company-main- single operating statement. The statement is shown in Exhibit 1. You realize tained road. that to accomplish your project you will need to allocate these costs to the two You find that the annual contract for thermal coal is 450,000 tonnes, and types of coals and two operations. Subsequently, you arrange appointments with 150,000 tonnes for metallurgical coal. For each contract, the King mine is the managers and other employees who are knowledgeable concerning the content prime supplier, and the customers make up any shortage by alternative and and drivers for each expense line item. more expensive secondary suppliers. The mine ships the full amount of cach contract for each year. The metallurgical coal generates revenue at the rate of $78 per tonne. The thermal coal does not generate revenue, because it is shipped to a thermal plant owned by the provincial government. To estimate a KING MINE DIVISION transfer price, you asked the general manager of the thermal plant what would be the landed cost of thermal coal on a long-term contract. She estimated the For the Year Ending December 31 cost to be $71 per tonne (delivered) for comparable coal. The traffic officer REVENUE (responsible for arranging for and monitoring transportation) explained that Thermal coal King ships clean coal at the cost of $6 a tonne. Metallurgical coal 11,700 The mine is a series of interlinked pit mines that produce 652,000 tonnes EXPENSES per year. Excavation equipment and trucks remove the overburden. The pits Extraction wages and benefits Plant wages and benefits differ by coal type, and for efficiency purposes the miners extract thermal coal Diesel fuel, gasoline Amortization, pit trucks, equipment for three weeks, and then metallurgical coal in the fourth Pit mining wages Amortization, buses and benefits, amortization for pit trucks and equipment, and depletion costs are Amortization, plant equipment Amortization, depletion costs Management salaries and benefits 2,700 2 Administration Facilities, utilities and taxes Marketing department Net income before income taxes $128.000 King Coal The provincial government's electrical utility has a coal mine in the King region that produces thermal and metallurgical coal using an integrated pit mine and cleaning plant. Separate reporting is not done for the extraction and cleaning plant or for the thermal coal and metallurgical coal. The assumption is that if the total cost is competitive, then each part must be efficient. Although this may have been a reasonable approximation in the past, new mines have been opened that are more efficient. Now the utility's senior man- agement wants to manage the cost of each part individually. The controller has assigned you to calculate the profitability of the opera- tions. The reason for your assignment is to figure out, as accurately as possible, the exact costs of cach coal (thermal and metallurgical) and each operation (extraction and cleaning) at the King Mine. Then you are to compare the costs with other operations of the utility and with industry averages. These costs will be the starting points for specifying annual improvements in productivity and cost effectiveness. A component of this study will be to devise a transfer price between the extraction and cleaning plant, if that would motivate cost effectiveness. When he assigned the project, the controller conveyed the trans- fer price idea of a board member, but admitted he does not understand why it would be beneficial. The controller asks that you explain transfer pricing and its possible benefits in your report. The production process includes the extraction and hauling of raw coal to the cleaning plant. The cleaning plant prepares both types of coal for shipment by rail, the thermal to a thermal plant and the metallurgical to a private steel mill. in thousands of dollars) $10.500 9.500 3.800 3.000 900 2.800 800 2,300 2.600 - 800 39.700 * Amortization is based on the physical exhaustion of the asset. CASE 27: KING COAL When analyzed according to where they work or how they devote their average work day, the management, administration, and marketing personnel had the following to say in aggregate: Extraction Plant Neither Total Management Administration Marketing 45 45 35 40 20 15 100 100% 100% 100% entirely attributable to the extraction of the coal. These costs are the same per tonne for both thermal and metallurgical coal. Shrinkage in the cleaning plant through the elimination of impurities reduces the weight by eight percent. The expenses for the cleaning plant include plant wages and benefits and amortization for plant and equipment. The metallurgical process has additional stages and, thus, a higher cost per tonne than thermal coal. You estimate that 70 percent of all cleaning costs are attributable to thermal coal, and 30 percent to metallurgical coal. As for diesel fuel and gasoline expenses, you estimate that $3,500,000 was for extraction, $150,000 was for the loaders in the plant, and $150,000 was for the buses. There are nine buses scheduled to drive back and forth between the two towns and the mine site where all employees report for work; 500,000 kilo- metres were driven last year. Employees take the bus about 98 percent of the time. The following table shows the breakdown of employees by department: Extraction 41% Plant Management Administration Marketing 5 About $600,000 of the administration expense item is attributable to buses. Square feet occupied is the cost driver for facilities, utilities, and municipal taxes. You calculate the allocation to be 45 percent for extraction, 35 percent for plant, 10 percent for administration, 5 percent for management, and 5 per- cent for marketing. 26 13 15 Required Exhibit 1 shows one set of accounts for two businesses (coal extraction (pit) and coal cleaning (plant)) and two types of coal (thermal and metallurgical). Explain why the revenues and costs need to be reported separately for each business: coal extraction (pit) and coal cleaning (plant)