Mini Case 7: Absorption and Variable Costing and Inventory Management (Ch. 8) Hindt Chocolate Company is interested in acquiring another chocolate maker, Russell Hover Chocolates (RHC). RHC recently filed for bankruptcy. Hindt believes that with their experience in the chocolate industry in Canada they can generate a profit from this bankrupt company. Also, RHC has accounts with all of the drug store chains across Canada, a segment of the market where Hindt is not present. The following GAAP Income Statement shows the summarized results of RHC for the past year: Sales Cost of goods sold Gross margin Selling and admin. (fixed/common) Operating income $767,190 689.598 $77,592 98,000 S(20,408) RHC makes two products: chocolate bars and boxed chocolates. They use the absorption method of costing and provided the information below to Hindt. The controller of RHC, when presenting this financial information, suggested that Hindt discontinue the chocolate bar product line after the acquisition. The company uses just-in-time (JIT) to manage inventories and, as a result, beginning and ending inventories are kept near zero (note: at the beginning and end of the prior year, inventories had zero values). Information provided by RHC: Chocolate Bar 245,000 $1.59 Boxed Chocolates 36,000 $10.49 Production Sales price Product costs: Direct materials Direct labour Variable overhead $166,600 $29,400 $24.500 $230,400 $7,200 $4,680 Fixed overhead is applied to both products based on total direct labour dollars at a rate of $6.15 for bars and $6.39 for boxed chocolates. As part of its due diligence and prior to making the final decision to acquire this company, Hindt's finance experts were given access to RHC's detailed financial production data. After reviewing the financial data (provided below) and company operations, Hindt management is certain they can eliminate 40% of RHC's fixed direct manufacturing overhead and 80% of the selling and administrative costs. Required: 1. Calculate the unit cost of each product as RHC would have, using the absorption costing model. What is a likely reason for RHC's controller's suggestion to eliminate the bars (round to 2 decimal places)? 2. Calculate the contribution margin of each product and prepare a contribution margin income statement (using the format below). Your income statement should reveal the overall impact of Hindt management's expected savings resulting from the merger. Would you suggest that the chocolate bars be discontinued under Hindt's control? 3. Analyze the Numbers: Have your team play the role of a managerial accountant consultant and explain to Joyce what the numbers really mean for their business. 4. Creative Consulting: Use your team's creativity to analyze the business problem and come up with various solutions for the business going forward. (ie. How to increase profits, customer satisfaction, make processes more efficient, people/staff happier, short, mid term and long term strategy). Total SO Russell Hover Chocolates Restated Segmented Income Statement For prior year Boxed Bar Chocolates Sales SO SO Variable cost of goods sold 0 0 Contribution margin SO $0 Direct fixed costs 0 0 Segment margin $0 $0 Selling and administrative Operating income 0 $0 0 $0 0 SO Mini Case 7: Absorption and Variable Costing and Inventory Management (Ch. 8) Hindt Chocolate Company is interested in acquiring another chocolate maker, Russell Hover Chocolates (RHC). RHC recently filed for bankruptcy. Hindt believes that with their experience in the chocolate industry in Canada they can generate a profit from this bankrupt company. Also, RHC has accounts with all of the drug store chains across Canada, a segment of the market where Hindt is not present. The following GAAP Income Statement shows the summarized results of RHC for the past year: Sales Cost of goods sold Gross margin Selling and admin. (fixed/common) Operating income $767,190 689.598 $77,592 98,000 S(20,408) RHC makes two products: chocolate bars and boxed chocolates. They use the absorption method of costing and provided the information below to Hindt. The controller of RHC, when presenting this financial information, suggested that Hindt discontinue the chocolate bar product line after the acquisition. The company uses just-in-time (JIT) to manage inventories and, as a result, beginning and ending inventories are kept near zero (note: at the beginning and end of the prior year, inventories had zero values). Information provided by RHC: Chocolate Bar 245,000 $1.59 Boxed Chocolates 36,000 $10.49 Production Sales price Product costs: Direct materials Direct labour Variable overhead $166,600 $29,400 $24.500 $230,400 $7,200 $4,680 Fixed overhead is applied to both products based on total direct labour dollars at a rate of $6.15 for bars and $6.39 for boxed chocolates. As part of its due diligence and prior to making the final decision to acquire this company, Hindt's finance experts were given access to RHC's detailed financial production data. After reviewing the financial data (provided below) and company operations, Hindt management is certain they can eliminate 40% of RHC's fixed direct manufacturing overhead and 80% of the selling and administrative costs. Required: 1. Calculate the unit cost of each product as RHC would have, using the absorption costing model. What is a likely reason for RHC's controller's suggestion to eliminate the bars (round to 2 decimal places)? 2. Calculate the contribution margin of each product and prepare a contribution margin income statement (using the format below). Your income statement should reveal the overall impact of Hindt management's expected savings resulting from the merger. Would you suggest that the chocolate bars be discontinued under Hindt's control? 3. Analyze the Numbers: Have your team play the role of a managerial accountant consultant and explain to Joyce what the numbers really mean for their business. 4. Creative Consulting: Use your team's creativity to analyze the business problem and come up with various solutions for the business going forward. (ie. How to increase profits, customer satisfaction, make processes more efficient, people/staff happier, short, mid term and long term strategy). Total SO Russell Hover Chocolates Restated Segmented Income Statement For prior year Boxed Bar Chocolates Sales SO SO Variable cost of goods sold 0 0 Contribution margin SO $0 Direct fixed costs 0 0 Segment margin $0 $0 Selling and administrative Operating income 0 $0 0 $0 0 SO