Question

Super Skis Inc. (SSI), a small private company in Ontario, manufactures skis and snowboards. It is July 4, 2019, and you, CPA, are the finance manager at SSI, reporting to Andy Thomas, the CEO and owner. The company just completed its year end on June 30, 2019.

SSI's departments are divided by its three product lines. Until last year, SSI produced only two established products, Extra-glide downhill skis and Super-board snowboards, but in July 2018 it introduced Cross-fit cross-country skis. Cross-fit's launch was very successful. Andy had expected this new product would increase the company's profitability, but he had not expected the results to be so impressive. The product immediately became the company's most profitable, representing more than 40% of SSI's gross profit. As a result, he wonders whether SSI should shift its sales and production focus to Cross-fit. SSI has a strong reputation for quality products, which may have been the reason for Cross-fit's success. Also, most of SSI's customers are happy with SSI's fast delivery.

Andy regularly organizes meetings with the three departments' production managers to share news and ideas. At the latest meeting, he says, "Our new product launch was successful. However, I'm disappointed to see decreased gross profit from Extra-glide and Super-board last year."

The Extra-glide production manager says, "I don't think the financial results make sense. My department produced and sold 4,000 more units than in the previous year. The sales volume did not decline, yet gross profit has fallen by more than half. The cost of direct materials and the hourly rates of the employees have increased slightly this year, but I thought we had increased the selling price sufficiently to compensate for these increases."

Andy replies "We will need to have a close look at these financial results. I've gathered the current financial information from the accounting team and demand forecasts from the sales team (Appendix I). Based on the information, we can't meet all the demand with our current capacity. If the gross profits continue to decrease, I think we should drop production of Extra-glide and Super-board and focus on Cross-fit in the long term. CPA, please prepare production plan that would maximize the overall profit for SSI, and let me know which product we should actually focus on."

The Super-board manager says, "CPA, my friend is also an accountant and she suggested that we should be using activity-based costing. Do you think implementing activity-based costing will help increase gross profits of Extra-glide and Super-board and SSI's overall gross profit? Can you please run the numbers under this method?" He provides you with cost information (Appendix II).

The Cross-fit manager adds, "Well, I knew that the Cross-fit launch would contribute significant profit to the company. The results proved I was right. After only a few months of Cross-fit sales, we were able to generate a much higher gross profit than the other two products. We should produce more of Cross-fit, which would increase gross profit across the company. Also, since the Cross-fit requires less labour, this might speed up our process and shorten the delivery time. I've gathered information about further increasing automation of the manufacturing process for the Extra-glide and Super-board lines (Appendix III). CPA, can you please have a look at it and tell us whether this investment is worthwhile?"

Andy finishes up by asking you to analyze the reason for the decrease in gross profits in Extra-glide and Super-board this year; and provide recommendations for the company.

APPENDIX I FINANCIAL INFORMATION As of June 30, 2019 Extra-glide | Super-board Cross-fit Total Total sales $3,008,750 $4,635,000 $1,437,500 $9,081,250 Direct materials $ 544,688 $ 927,000 $ 381,225 $1,852,912 Direct labour $ 551,950 $ 880,650 87,400 $1,520,000 Manufacturing overhead costs (Note 1) $1,452,500 $2,317,500 $ 230,000 $4,000,000* Gross profit $ 459,613 $ 509,850 38,875 Unit information: Extra-glide Super-board Cross-fit Number of units produced and sold (Note 2) 20,750 25,750 11.500 Price per unit $145.00 $180.00 $125.00 Direct material cost per unit $ 26.25 $ 36.00 $ 33.15 Direct labour cost per unit $ 26.60 $ 34.20 $ 7.60 Direct labour hours required per unit 1.4 1.8 D.4 Machine hours required per unit (Note 3) 1.5 1.5 2.5 Demand forecast per year (units) (Note 4) 25,000 30,000 27,000 Notes: 1. Manufacturing overhead costs (MOH) amounted to $4,000,000, which is a $750,000 increase from the previous year. The increase was caused by costs for equipment dedicated to the new product. These costs are allocated to the products based on the direct labour hours. (*The amount of MOH is a rounded number.) 2. SSI holds no inventory, since it manufactures on the basis of orders received. 3. Maximum capacity is 100,000 machine hours. 4. The sales team estimated that the unit demand will increase as shown in the table and will remain the same for the next five years.APPENDIX II COST DRIVERS AND COST INFORMATION Expected Cost Manufacturing per Overhead Cost Activities Cost Drivers Cost Driver Unit by Activity Direct matenals handling Direct material cost (DMS) $0.50 per DMS $ 926,500 Parts manufacturing Machine hours (MH) $15.00 per MH $1,477,500 Assembly Direct labour hours (DLH) $11.25 per DLH $ 900,000 Product packaging Number of units $12 00 per unit $ 696,000 Total manufacturing overhead costs $4,000,000 The cost driver usage for machine hours and direct labour hours were as follows: Extra-glide | Super-board | Cross-fit Total Machine hours used (MH) 31,126 38,626 28,750 98,502 MH Direct labour hours used (DLH) 29,050 46,350 4,600 0.000 D