DO NUMBER 1-3

Fashion Designs International, Inc. George Gonzalez, PhD, Assistant Professor Accounting University of Lethbridge-Calgary Campus Calgary, Alberta, Canada INTRODUCTION Rossi started her fashion business in 2001 by selling women's apparel to small U.S.-based boutique shops. Her designs particularly popular with women in their 20s, 30s, and 40s-sold quickly, and her business grew accordingly. After several years, her market expanded to include Canada, Mexico, and a few countries in Europe. Rossi tends to be a perfectionist both with her designs and in her insistence on high production quality. This manifests itself in her close supervision of production processes, to a point of near-obsession with ensuring the high apparel standards that she demands. Balancing quantitative and qualitative factors can be quite a challenge," Charles Riley thought to himself. Riley is the CFO of Fashion Designs International, Inc. (FDI), a small women's apparel business. The CEO and sole shareholder of FDI, Alina Rossi, had asked Riley for suggestions about how to increase the company's profits to the level that matched her financial goals. Riley knew, however, that there were qualitative factors of importance to Rossi that posed challenges. FDI, based in Greensboro, North Carolina, manufactures and distributes women's apparel to retailers worldwide under the brand name RossiDesigns. Headed by Rossi, an Italian- educated, award-winning fashion designer with a high work ethic and a perfectionist streak, the company's products are considered of excellent quality by consumers and retailers. The designs, fabric, and processes used in production all contribute to this high level of quality. Since its inception in 2001, the company has grown steadily to annual sales of US$2.25 million in 2016 (see Table 1). APPAREL PRODUCTION ALINA ROSSI, FASHION DESIGNER The production of FDI's products is composed of three major phases: (1) manufacturing the fabric to be used for apparel pieces, (2) cutting the fabric according to the particular apparel piece's design, and (3) sewing the cut fabric into apparel wear. FDI's women's outfits are made from high-quality fabric, which Rossi specifies to the fabric manufacturer, a company based in Toronto, Ontario, Canada. Large rolls of fabric manufactured for FDI are shipped to FDI's warehouse in Greensboro, where they are stored until ready to be used in production runs. At such time, fabric is sent to the cutting shop where the fabric is cut into large pieces of specific size and shape, as specified by Rossi's design. Finished cut pieces are then delivered to the sewing shop. In the sewing process, cut pieces are sewn as prescribed by Rossi into final products, which is then transported to FDI's warehouse until ready for shipment to retailers (for instance, FDI's main customers). The cutting Alina Rossi studied fashion design in Italy and, upon completing her studies, moved back to the United States where her family had emigrated when she was 10 years old. Rossi was a highly creative designer who almost certainly could have done well by selling her designs to large international fashion companies but chose instead to start her own company. brand name.' The Rossi Designs label is sewn into each piece that FDI produces. focus on her financial goal, convincing her that achieving those goals will require tradeoffs in production supervision, and convincing her that the tradeoffs will be well worth it. FDI PROFITABILITY ASSIGNMENT QUESTIONS FDI's profitability is attributable to a lean company structure and Rossi's talents and work ethic. The company, however, has not achieved the level of profitability that Rossi desires. While her goal is an annual net cash payout from the company of US$600,000, currently the net cash paid or available to her (for instance, combined salary and net profit) is only about two-thirds that amount.? 1. Based on the information presented in Tables 1 and 2, calculate the number of unit sales required to (a) break even and (b) reach the target profit that achieves Rossi's profitability goal. 2. Using Riley's projected growth rates (Table 2), prepare a pro forma income statement for the year 2017. RILEY'S RESEARCH AND PREPARATION 3. Based on your answer to Question 2, what would be the net cash paid or available to the owner? 4. Assuming FDI continues all production in North America, and using Riley's projected growth rates (Table 2), how long would it take to achieve Rossi's profitability goal? 5. Assuming that FDI decides to move all manufacturing overseas, and using Riley's expected changes in costs from this move and projected growth rates (Table 2), prepare a pro forma income statement for the year 2017. 6. Based on your answer to Question 5, what would be the net cash paid or available to the owner? As mentioned previously, all of FDI's production activities are in North America: The fabric is produced in Canada, and the cutting and sewing are done in the United States. Riley believes that the quickest and surest way for FDI to increase its profitability is by moving manufacturing activities overseas to a low-cost country where labor and other production costs would be significantly reduced. Based on his prior research, Riley has estimated how the company's costs would change if all manufacturing was moved overseas (see Table 2). He has prepared a schedule of revenue and expense growth rates that allow him to project future net profits under either scenario- for instance, keeping manufacturing in North America or moving it overseas (see Table 2, Projected Annual Growth column). Riley determined the cost behavior of each item of expense based on cost drivers and used this information to arrive at formulas for projecting each expense item (see Table 2, "Formula column). Riley believes that it is in the company's best interest to move production overseas and that this course of action is the best way to reach Rossi's goals for the company. He recognizes, however, that a big challenge in convincing Rossi of this is her strong desire for close supervision of all production processes. Riley knows that Rossi is a perfectionist, and he believes that other related aspects of Rossi's personality represent potential hurdles to an overseas move. Fashion design is, at its essence, an artistic skill. 7. Assuming that FDI decides to move its production overseas, and using Riley's expected changes in costs from such a change in manufacturing and projected growth rates (Table 2), how long would it take to achieve Rossi's profitability goal? 8. What do you think FDI should do with its production: continue in North America or move it overseas? Discuss the quantitative, qualitative, and ethical factors, if any, that come into play with this decision. Table 1. Comparative Income Statements Year ended December 31, 2014 2015 2016 Sales $1,987,050 $2,124,885 $2,249,830 250,390 264,260 Cost of Goods Sold: Fabric Cutting Sewing 237,250 201,500 212,660 224,440 260,000 274,400 289,600 Brand labels 3,900 4,116 4,344 Thread etc. 686 724 32,580 Shipping and freight Total Cost of Goods Sold 650 29,250 732,550 1,254,500 30,870 773,122 1,351,763 815,948 1,433,882 Gross Profit 1,260 1,260 1,320 350,000 360,000 370,500 323,275 263,250 63,000 291,722 64,800 35,007 66,690 31,590 38,793 22,450 22,450 23,124 8,220 8,340 8,520 15,000 5,400 14,304 1,452 18,840 5,400 15,019 20,280 5,400 15,925 1,740 1,860 Operating Expenses: Bank charges Salary expense Wage expense Employee benefits - salaried employees Employee benefits - hourly employees Insurance Information Technology services Legal fees Licenses and permits Meals and entertainment Printing and reproduction Professional Fees Marketing and promotion Rent - Office Rent - Warehouse Repairs and maintenance Security expense Office supplies Telephone and internet Vehicle expenses Travel expenses Utilities Total operating expenses Profit before taxes 16,920 15,504 30,996 36,996 16,260 34,104 36,996 42,234 41,004 8,592 2,100 30,996 37,380 42,234 10,188 2,184 7,380 2,100 2,136 2,844 2,472 5,760 21,000 1,956 2,532 2,604 5,875 21,210 2,808 6,051 21,846 2,034 2,156 944,442 997,907 353,856 106,157 1,051,295 382,587 310,058 93,017 Income taxes 114,776 Profit after taxes $217,041 $247,699 $267,811 unit sales 32,500 34,300 36,200 Table 2. Assumptions for Expense Projections Projected F/Va Effect of overseas move Formula 2016 amount annual growth Expense Item Cost of Goods Sold: Fabric V units soldo x VC per unit $7.30000 3.00% -50% V units sold x VC per unit -50% Cutting Sewing Brand labels $6.20000 $8.00000 3.00% 3.00% V -50% V $0.12000 3.00% units sold x VC per unit units sold x VC per unit units soldex VC per unit units soldex VC per unit -50% -50% Thread etc. V $0.02000 3.00% Ship & freight V $0.90000 3.00% 300% F fixed monthly cost x 12 1.5% 0% F fixed annual cost x 1 $1,320 $150,000 $220,500 0% 0% F fixed annual cost x 1 2% 0% Operating Expenses: Bank charges Sal exp - owner Sal exp-employees Wage expense Emp benis - sal Emp benis - hrly Insurance V $8.93025 2% -20% F $66,690 same % 0% V $1.07163 same % 0% F $23,124 1.5% 250% IT services F $8,520 1.5% 0% F $20,280 1.5% 200% F $5,400 1.5% 75% Legal fees Lic & permits M&E Print & reprod Professional Fees F 1.5% 0% F $15,925 $1,860 $16,920 0% 1.5% 1.5% F 0% units produced x VC per unit salary expense x percentage wage expense x percentage fixed annual cost x 1 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed quarterly cost x 4 fixed monthly cost x 12 M&P F 1.5% 0% Rent - Office F 1.5% 0% Rent - Warehouse F 1.5% 0% R&M $30,996 $37,380 $42,234 $10,188 $2,184 $2,844 $2,808 1.5% F F. 20% 1.5% 0% Security expense Office supplies Tel & internet F 1.5% 0% F 1.5% 0% F 1.5% 0% Vehicle expenses Travel expenses F $6,051 $21,846 $2,156 1.5% 400% Utilities F 1.5% 0% 1aF = fixed cost; V = variable cost; Tufor variable (V): amount per unit; for fixed (F): annual amount 2cost paid on per yard basis; cost paid on per piece basis cost paid on per label basis ; Scost paid on weight and volume basis Sunits sold and units produced both projected to grow at annual rate of 6% Fashion Designs International, Inc. George Gonzalez, PhD, Assistant Professor Accounting University of Lethbridge-Calgary Campus Calgary, Alberta, Canada INTRODUCTION Rossi started her fashion business in 2001 by selling women's apparel to small U.S.-based boutique shops. Her designs particularly popular with women in their 20s, 30s, and 40s-sold quickly, and her business grew accordingly. After several years, her market expanded to include Canada, Mexico, and a few countries in Europe. Rossi tends to be a perfectionist both with her designs and in her insistence on high production quality. This manifests itself in her close supervision of production processes, to a point of near-obsession with ensuring the high apparel standards that she demands. Balancing quantitative and qualitative factors can be quite a challenge," Charles Riley thought to himself. Riley is the CFO of Fashion Designs International, Inc. (FDI), a small women's apparel business. The CEO and sole shareholder of FDI, Alina Rossi, had asked Riley for suggestions about how to increase the company's profits to the level that matched her financial goals. Riley knew, however, that there were qualitative factors of importance to Rossi that posed challenges. FDI, based in Greensboro, North Carolina, manufactures and distributes women's apparel to retailers worldwide under the brand name RossiDesigns. Headed by Rossi, an Italian- educated, award-winning fashion designer with a high work ethic and a perfectionist streak, the company's products are considered of excellent quality by consumers and retailers. The designs, fabric, and processes used in production all contribute to this high level of quality. Since its inception in 2001, the company has grown steadily to annual sales of US$2.25 million in 2016 (see Table 1). APPAREL PRODUCTION ALINA ROSSI, FASHION DESIGNER The production of FDI's products is composed of three major phases: (1) manufacturing the fabric to be used for apparel pieces, (2) cutting the fabric according to the particular apparel piece's design, and (3) sewing the cut fabric into apparel wear. FDI's women's outfits are made from high-quality fabric, which Rossi specifies to the fabric manufacturer, a company based in Toronto, Ontario, Canada. Large rolls of fabric manufactured for FDI are shipped to FDI's warehouse in Greensboro, where they are stored until ready to be used in production runs. At such time, fabric is sent to the cutting shop where the fabric is cut into large pieces of specific size and shape, as specified by Rossi's design. Finished cut pieces are then delivered to the sewing shop. In the sewing process, cut pieces are sewn as prescribed by Rossi into final products, which is then transported to FDI's warehouse until ready for shipment to retailers (for instance, FDI's main customers). The cutting Alina Rossi studied fashion design in Italy and, upon completing her studies, moved back to the United States where her family had emigrated when she was 10 years old. Rossi was a highly creative designer who almost certainly could have done well by selling her designs to large international fashion companies but chose instead to start her own company. brand name.' The Rossi Designs label is sewn into each piece that FDI produces. focus on her financial goal, convincing her that achieving those goals will require tradeoffs in production supervision, and convincing her that the tradeoffs will be well worth it. FDI PROFITABILITY ASSIGNMENT QUESTIONS FDI's profitability is attributable to a lean company structure and Rossi's talents and work ethic. The company, however, has not achieved the level of profitability that Rossi desires. While her goal is an annual net cash payout from the company of US$600,000, currently the net cash paid or available to her (for instance, combined salary and net profit) is only about two-thirds that amount.? 1. Based on the information presented in Tables 1 and 2, calculate the number of unit sales required to (a) break even and (b) reach the target profit that achieves Rossi's profitability goal. 2. Using Riley's projected growth rates (Table 2), prepare a pro forma income statement for the year 2017. RILEY'S RESEARCH AND PREPARATION 3. Based on your answer to Question 2, what would be the net cash paid or available to the owner? 4. Assuming FDI continues all production in North America, and using Riley's projected growth rates (Table 2), how long would it take to achieve Rossi's profitability goal? 5. Assuming that FDI decides to move all manufacturing overseas, and using Riley's expected changes in costs from this move and projected growth rates (Table 2), prepare a pro forma income statement for the year 2017. 6. Based on your answer to Question 5, what would be the net cash paid or available to the owner? As mentioned previously, all of FDI's production activities are in North America: The fabric is produced in Canada, and the cutting and sewing are done in the United States. Riley believes that the quickest and surest way for FDI to increase its profitability is by moving manufacturing activities overseas to a low-cost country where labor and other production costs would be significantly reduced. Based on his prior research, Riley has estimated how the company's costs would change if all manufacturing was moved overseas (see Table 2). He has prepared a schedule of revenue and expense growth rates that allow him to project future net profits under either scenario- for instance, keeping manufacturing in North America or moving it overseas (see Table 2, Projected Annual Growth column). Riley determined the cost behavior of each item of expense based on cost drivers and used this information to arrive at formulas for projecting each expense item (see Table 2, "Formula column). Riley believes that it is in the company's best interest to move production overseas and that this course of action is the best way to reach Rossi's goals for the company. He recognizes, however, that a big challenge in convincing Rossi of this is her strong desire for close supervision of all production processes. Riley knows that Rossi is a perfectionist, and he believes that other related aspects of Rossi's personality represent potential hurdles to an overseas move. Fashion design is, at its essence, an artistic skill. 7. Assuming that FDI decides to move its production overseas, and using Riley's expected changes in costs from such a change in manufacturing and projected growth rates (Table 2), how long would it take to achieve Rossi's profitability goal? 8. What do you think FDI should do with its production: continue in North America or move it overseas? Discuss the quantitative, qualitative, and ethical factors, if any, that come into play with this decision. Table 1. Comparative Income Statements Year ended December 31, 2014 2015 2016 Sales $1,987,050 $2,124,885 $2,249,830 250,390 264,260 Cost of Goods Sold: Fabric Cutting Sewing 237,250 201,500 212,660 224,440 260,000 274,400 289,600 Brand labels 3,900 4,116 4,344 Thread etc. 686 724 32,580 Shipping and freight Total Cost of Goods Sold 650 29,250 732,550 1,254,500 30,870 773,122 1,351,763 815,948 1,433,882 Gross Profit 1,260 1,260 1,320 350,000 360,000 370,500 323,275 263,250 63,000 291,722 64,800 35,007 66,690 31,590 38,793 22,450 22,450 23,124 8,220 8,340 8,520 15,000 5,400 14,304 1,452 18,840 5,400 15,019 20,280 5,400 15,925 1,740 1,860 Operating Expenses: Bank charges Salary expense Wage expense Employee benefits - salaried employees Employee benefits - hourly employees Insurance Information Technology services Legal fees Licenses and permits Meals and entertainment Printing and reproduction Professional Fees Marketing and promotion Rent - Office Rent - Warehouse Repairs and maintenance Security expense Office supplies Telephone and internet Vehicle expenses Travel expenses Utilities Total operating expenses Profit before taxes 16,920 15,504 30,996 36,996 16,260 34,104 36,996 42,234 41,004 8,592 2,100 30,996 37,380 42,234 10,188 2,184 7,380 2,100 2,136 2,844 2,472 5,760 21,000 1,956 2,532 2,604 5,875 21,210 2,808 6,051 21,846 2,034 2,156 944,442 997,907 353,856 106,157 1,051,295 382,587 310,058 93,017 Income taxes 114,776 Profit after taxes $217,041 $247,699 $267,811 unit sales 32,500 34,300 36,200 Table 2. Assumptions for Expense Projections Projected F/Va Effect of overseas move Formula 2016 amount annual growth Expense Item Cost of Goods Sold: Fabric V units soldo x VC per unit $7.30000 3.00% -50% V units sold x VC per unit -50% Cutting Sewing Brand labels $6.20000 $8.00000 3.00% 3.00% V -50% V $0.12000 3.00% units sold x VC per unit units sold x VC per unit units soldex VC per unit units soldex VC per unit -50% -50% Thread etc. V $0.02000 3.00% Ship & freight V $0.90000 3.00% 300% F fixed monthly cost x 12 1.5% 0% F fixed annual cost x 1 $1,320 $150,000 $220,500 0% 0% F fixed annual cost x 1 2% 0% Operating Expenses: Bank charges Sal exp - owner Sal exp-employees Wage expense Emp benis - sal Emp benis - hrly Insurance V $8.93025 2% -20% F $66,690 same % 0% V $1.07163 same % 0% F $23,124 1.5% 250% IT services F $8,520 1.5% 0% F $20,280 1.5% 200% F $5,400 1.5% 75% Legal fees Lic & permits M&E Print & reprod Professional Fees F 1.5% 0% F $15,925 $1,860 $16,920 0% 1.5% 1.5% F 0% units produced x VC per unit salary expense x percentage wage expense x percentage fixed annual cost x 1 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed monthly cost x 12 fixed quarterly cost x 4 fixed monthly cost x 12 M&P F 1.5% 0% Rent - Office F 1.5% 0% Rent - Warehouse F 1.5% 0% R&M $30,996 $37,380 $42,234 $10,188 $2,184 $2,844 $2,808 1.5% F F. 20% 1.5% 0% Security expense Office supplies Tel & internet F 1.5% 0% F 1.5% 0% F 1.5% 0% Vehicle expenses Travel expenses F $6,051 $21,846 $2,156 1.5% 400% Utilities F 1.5% 0% 1aF = fixed cost; V = variable cost; Tufor variable (V): amount per unit; for fixed (F): annual amount 2cost paid on per yard basis; cost paid on per piece basis cost paid on per label basis ; Scost paid on weight and volume basis Sunits sold and units produced both projected to grow at annual rate of 6%