Heritage Cabinets Inc. (HCI) is a manufacturer and installer of kitchen and bathroom cabinets. HCI was founded 20 years ago by Darren Helton, who is the CEO and sole shareholder of HCI.

HCI manufactures its cabinets from start to finish in its facility in British Columbia. Centralizing all steps of the cabinet-making process in one facility allows HCI to ensure it maintains the quality craftsmanship and excellent customer service for which the company is known. HCI manufactures 11 different styles of cabinets, with the three most popular accounting for 60% of sales and the three least popular accounting for less than 5%. HCI experienced steady growth up until 2020, when sales declined for the first time, with HCI dropping from full capacity to 80%.

HCI has two divisions a manufacturing division and a sales and installation (SI) division. Each division's manager reports directly to Darren. Luke is the head of the manufacturing division and Michelle is the head of the SI division. The divisions are treated as profit centres, with the managers evaluated and paid a bonus based on divisional profits. Darren is frustrated because the divisional managers are often in disagreement over decisions impacting the company. He is hoping your guidance will help address some of their issues.

Today is February 3, 2021. You, CPA, have been hired by Darren as an external consultant to provide an independent point of view.

General information on HCI and the cabinet-manufacturing industry is provided in the Appendix.

Appendix

You have visited HCI's plant and made the following notes on HCI's operations and the cabinet-making industry.

Cabinet industry

Low interest rates and declining unemployment over the past five years have led to increased spending in the housing market, including home renovations. This demand is expected to continue to increase over the next five years. A shift toward cabinets with improved amenities such as charging ports for electronic devices and LED lighting will also drive growth.

Competition in the industry has increased, in part due to an increase in cabinets being imported from overseas. Generally, imported cabinets are priced lower than those manufactured in Canada.

The well-established distribution networks between existing manufacturers and their suppliers can deter new entrants. In order to be successful, cabinet manufacturers must secure a steady source of wood supply for an affordable price. This is especially important given that the price of lumber has been increasing, a trend that is expected to continue.

HCI operations

HCI prides itself on being a great place to work. As a result of the caring atmosphere and generous incentives, most of HCI's 500 employees have been with the company at least five years.

HCI is located in close proximity to two large sawmills, with which it has developed excellent relationships over the years. HCI has been able to purchase enough quality lumber from these two suppliers to meet all of its needs.

The manufacturing division struggled to meet production deadlines in 2020 because cabinets took longer on average to manufacture. The cabinet assemblers have complained that they have to spend time searching for the right hardware and screws to use. Each cabinet type requires specific hardware, and the small pieces often get mixed up in the storage bins. The assemblers also noted that an increasing number of pieces are having to be sent back for rework. The problem was traced to a lack of maintenance on one of the older cutting machines that has problems with calibration.

HCI uses batch processing, which means that raw materials and work in progress are often sitting on the factory floor between stages. Employees have complained that they find it difficult to manoeuvre around the factory because of all of the clutter. Plant supervisors are responsible for initiating purchase orders for materials when they notice that stock is running low. Sometimes orders are initiated by more than one person, resulting in excess inventory that may sit around for weeks or months. Other times, orders are not placed soon enough and production is delayed while workers wait for the materials to arrive. Sometimes the hardware required is not in stock, especially for the less popular cabinets.

Currently, the manufacturing division transfers all of its production to the SI division. Similarly, the SI division sources cabinets exclusively from the manufacturing division. The transfer price is set at variable costs plus 30%.

Task #1

HCI is considering a new line of lower-cost kitchen cabinets to target the price-conscious consumer and compete with cheaper imported cabinets. No new machinery or equipment would be required, but the cabinets would be made with cheaper materials and use less labour.

Since HCI's focus has always been on higher-end, semi-custom cabinets, Darren is unsure how to price the new line. He would like you to explain the various pricing strategies that could be applied, including the advantages and disadvantages of each. He is interested in your recommendation as to which strategy would be most appropriate for the new line of lower-cost cabinets.

Also, given the following information, he would like to know the minimum price that HCI should charge for the lower-cost cabinets as well as the price that you would recommend.

Direct labour hours 2.1 per unit

Direct labour rate $38.50 per hour

Direct materials $78 per unit

Variable overhead $23 per unit

Fixed overhead (allocated based on direct labour hours) $49 per unit

Average selling price of comparable cabinets $210 per unit

Task #2

A condominium developer has offered HCI a contract to supply cabinets for all of the units in a new condominium project. HCI has capacity in the factory to fill the order without impacting production of other cabinets. Luke is in favour of accepting the contract and Michelle is opposed. The details of the offer are as follows:

Direct labour hours 2.6 per unit

Direct labour rate $38.50 per hour

Direct materials $128 per unit

Variable overhead $38 per unit

Fixed overhead (allocated based on direct labour hours) $42 per unit

Delivery (per cabinet) $10 per unit

Installation labour hours 0.7 per unit

Installation labour rate $35 per hour

Selling price $340 per unit

Darren would like your independent assessment of whether accepting the contract is in the best interests of HCI as a whole. He also wants to understand why Luke is in favour of accepting the contract while Michelle is opposed, and if there is anything he can do to avoid these types of conflicts in the future and ensure that decisions are consistent with HCI's best interests as a whole.