Dey and Knight are the owners of the Modern Processing Company and the Oldway Manufacturing Company, respectively. These companies manufacture and sell the same product, and competition between the two owners has always been friendly. Cost and profit data have been freely exchanged. Uniform selling prices have been set by market conditions.

Dey and Knight differ markedly in their management thinking. Operations at Modern are highly mechanized, and the direct labor force is paid on a fixed-salary basis. Oldway uses manual hourly paid labor for the most part and pays incentive bonuses. Moderns salesmen are paid a fixed salary, whereas Oldways salesmen are paid small salaries plus commissions. Mr. Knight takes pride in his ability to adapt his costs to fluctuations in sales volume and has frequently chided Mr. Dey on Moderns inflexible overhead.

During 2018, both firms reported the same profit on sales of $100,000. However, when comparing results at the end of 2019, Mr. Knight was startled by the following results:

modern oldway

2018 2019 2018 2019

Sales revenue $100,000 $120,000 $100,000 $150,000

Costs and expenses 90,000 94,000 90,000 130,000

Net income $ 10,000 $ 26,000 $ 10,000 $ 20,000

Return on sales 10% 21 2/3% 10% 13 1/3%

On the assumption that operating inefficiencies must have existed, Knight and his accountant made a thorough investigation of costs but could not uncover any evidence of costs that were out of line. At a loss to explain the lower increase in profits on a much higher increase in sales volume, they have asked you to prepare an explanation.

You find that fixed costs and expenses recorded over the two-year period were as follows:

Modern $70,000 each year

Oldway $10,000 each year

1. Provide guidance supported by numbers on the relative future positions of the two companies when there are reductions as well as increases in sales volume. For example, in 2020, due to Covid-19 and economy-wide lockdowns both firms sales dropped significantly to levels even below that in 2018. However, recovery from the pandemic in 2021 is expected to be fast and sales for both firms are likely to reach 2019 levels.