CASE SCENARIO Company Background The Paper Products Factory (PPF) is a local manufacturer of a single product: paper party hats. They sell primarily to specialty stores in the all the municipalities within the Kingdom of Bahrain. There are several other national and international manufacturers of similar products; therefore, it is a very competitive marketplace. The market is very price sensitive; small increases in price can result in large decreases in product demand. The PPF is a family-owned company that employs approximately 100 people. The owner and CEO of the company is Shahira Osama. At this time no other family members are involved in the business. The company employs administrative staff including the president, vice presidents, and support staffengineers who design and develop the products; sales representatives: manufacturing labor, distribution center employees; and customer service representatives. Ahmed Musa, the owner's son, recently completed his M.B.A. Wanting to impress his mother with his newly acquired skills, he presented his mother with a business proposal to add a second product line - paper chains "Mom, by adding paper chains, we can expand our product line to our existing customer base. For the most part, our current sales and customer service structure can remain as is since we will be selling more products to our existing customers. We would need to add an additional Production Manager to oversee the new product line. We have excess manufacturing capacity, skilled labor, and almost all the manufacturing equipment necessary to make the chains. We can offer our hourly employees more steady work. The only additional costs will be the additional capital investment involved due to the purchase of some specialized cutting machines, which will cost $180,000 and can be expected to last about five years. We'll also have to lease a bit more space." Page 1 of 6 Shahira Osama thought it over for a few days and told her son that Ahmed, your proposal makes sense to me. By adding a product line, we should be able to decrease our unit product costs because our fixed costs will be spread over many more units. This should be good for the new chain product line and the hat product line. I can get additional manufacturing space by moving our administrative offices out of our manufacturing site and into an office complex nearby. This will free up more space in the factory. I investigated the purchase of the cutting machines, and it seems that we will be able to finance the purchase at a low interest rate. There's only one more thing to consider. I will implement your idea only on the condition that you will join the company as the production manager for paper chains." Ahmed agreed and is now the Paper Chain Production Manager reporting to the Director of Manufacturing. There are a variety of manufacturing departments that are involved in producing the products including: Warehouse, Materials Handling, Cutting, Assembly, Finishing. Quality Control, and Factory Supervisor. Supervision is provided throughout the process. Quality Control is provided at the end of the manufacturing process. Below is a description of each manufacturing department: Description of Manufacturing Departments Receiving / Warehouse Responsible for storing and distributing raw materials used in the manufacturing process Materials Handling Responsible for requesting materials from Warehouse for the day's jobs. Also responsible for moving items in process between departments and keeping factory clean during downtime. Cutting Responsible for cutting the paper sheets used in products. Assembly Responsible for fastening the product parts. Finishing Responsible for decorating the products. Quality Control Responsible for ensuring that products are made according to specification and checking the accuracy of the final jobs. Factory General Manager Responsible for setting the manufacturing schedule after consulting with the Sales Department, coordinating materials ordering with the Purchasing Department, and supervising the manufacturing process. The PPF utilizes job order costing by assigning direct material, direct labor, and manufacturing overhead to each individual job. The costs are accumulated using a Job Cost Sheet. Given the simple, one-product nature of the manufacturing and cost environment in the past, they have Page 2 of 6 always used the following method for determining job costs: (1) Direct material and direct labor are traced to each job based on timecards and materials requisition requests. (2) Manufacturing Overhead is applied based on total direct labor hours for the month. The selling price of each job is determined using a cost-plus pricing method. The final selling price is 115% of the cost determined on the job cost sheet. The introduction of the paper chain product line has been a great success. During the six months that the company has offered the paper chains, demand has exceeded all the initial projections. During September, PPF made and sold 80,000 paper chains, which is 50% higher than their initial projections. Shahira Osama is thrilled with her son's performance but has been less impressed with the Paper Hats Product Manager, Hashim Hakem. Mrs. Shahira remarked, "Hashim Hakim -- what is the problem with the sales for hats lately? Your sales have been down for the past five months. Maybe I should go out and hire another M.B.A. like Ahmed. He sure knows how to bring in the sales and some fresh ideas." Hashim Hakem has been an excellent and loyal employee for over ten years. He has become frustrated with the decline in the sales of paper hats too. During September, PPF made and sold only 160,000 hats, which is far below their planned sales of 300,000 hats. "I just can't compete in the marketplace anymore. My unit costs keep rising, and corporate forced us to raise prices to our customers in order to cover our product costs and meet targeted selling price. My unit costs were always around $0.75 per unit and now they are over $0.80 per unit. My previously loyal customers have switched to other lower cost providers. I need to better understand the manufacturing process and talk to the cost accountants to see if they can help figure out why my costs keep rising." The Manufacturing Process At the beginning of each day, the Factory General Manager consults with the sales department and determines which jobs will be completed for the day. The General Manager forwards the Job Cost Sheet and the materials requisition to the Materials Handling Department. Materials Handling obtains the materials needed for each job from the Warehouse stockroom and brings the materials to the appropriate department for the day's manufacturing, Paper Hats are manufactured as follows: 1) Paper is delivered by Materials Handling to the Assembly Department. 2) Paper sheets are folded into a cone shape, taped and stapled in the Assembly Department. 3) Finished hats are moved to the Finishing Department. 4) Hats are decorated in the Finishing Department using four stickers per hat. 5) Hats are placed on a table for inspection by Quality Control. Quality control also checks to ensure that the proper items are included in the order. The manufacturing process for paper chains is as follows: 1) Paper is delivered by Materials Handling to the Cutting Department. 2) Links are cut in to 2" by 8.5" strips. Five strips can be made from one sheet of paper. Cut strips are moved to the Assembly Department. 3) Each link is connected to the previous link and then taped and stapled in the Assembly Department. Completed chains are moved to the Finishing Department 4) Chains are decorated in the Finishing Department using eight stickers per completed chain. 5) Chains are placed on a table for inspection by quality control. Chains are then inspected by Quality Control before being packed for shipment with the completed job. The following raw materials are used in order to manufacture these products: colored paper, staples, tape, and stickers. The following "manufacturing equipment" is used in this factory simulation: stapler, tape dispenser, and scissors. The Product Costing Process The next step is to determine the cost to produce each job and each unit. PPF uses a job costing system, whereby each job is the cost object. Costs are accumulated by job as follows:(1) Direct material and direct labor are traced to each job based on the information obtained from the materials requisition requests and factory employee timecards (2) The company accumulates factory overhead into one Manufacturing Overhead cost pool. At the PPF, Manufacturing Overhead is applied using an application rate based on the total actual direct labor hours. The Paper Products Factory targets its selling price at 115% of product cost. Below is the list of products costs related to the manufacturing process for paper chains and paper hats. Product Costs Paper direct material Stickers direct material Direct labor -- Cutting/Assembly/Finishing direct labor Staples indirect -- manufacturing overhead Tape indirect -- manufacturing overhead Quality control labor indirect -- manufacturing overhead Supervisory labor indirect -- manufacturing overhead Other indirect labor (stockroom, materials handling) indirect -- manufacturing overhead Depreciation on tape machines indirect -- manufacturing overhead Depreciation on stapling machines indirect -- manufacturing overhead Depreciation on cutting machine indirect -- manufacturing overhead Depreciation on the factory portion of the building indirect -- manufacturing overhead Taxes on the factory portion of the building indirect -- manufacturing overhead Page 4 of 6 (e) You are also required to respond to the following questions: (5%) List one advantage and a disadvantage of using direct labor hours as a basis for allocating manufacturing overhead costs. What can you conclude about the product cost of Job "A" based on the two allocation methods which you have used in (a) and (b) above? JOB "A" Costs for the Month of September Production and sales of Hats Production and sales of Chains 15 units 10 units Direct Material #Sheets of paper used to make HATS #Sheets of paper used to make CHAINS #stickers to make HATS #stickers to make CHAINS 1 per unit $ 0.05 per sheet 1 per unit $ 0.05 per sheet 4 per unit $ 0.01 each 8 per unit $ 0.01 cach Hats Direct Labor HOURS Cutting labor hours Assembly labor hours Finishing labor hours Total Direct Labor Hours (September) 2.500 2.500 5.000 Chains Total hours 1.500 1.500 3.000 5.500 1.500 4.000 6,000 11.000 Hats Chains Total Direct Labor COSTS Cutting labor Assembly labor Finishing labor TOTAL DIRECT LABOR COSTS Cost per hour $ 15.00 $ 15.00 $ 15.00 Manufacturing Overhead (TOTALS) Quality control hours 320 Indirect labor -- Supervisor 360 Other indirect labor (stockroom, materials960 handling) Depreciation on tape machines $1,000 hours $40.00 per hour hours $ 60.00 per hour hours $ 15.00 per hour pes $2,000 $3.000 Depreciation on stapling machines Depreciation on cutting machine Rent and taxes on the factory Utilities month per month per month per month per month $10,000 $1,500 Staples Tape $100 $150