Scenario (90 minutes) Sweet Tooth Co. (STC) is a privately owned manufacturer and distributor of packaged baked goods. Its products include individually packaged snack cakes, brownies, cookies, and donuts, and are sold in grocery, convenience, and discount stores throughout Canada. It is February 1, 2022, and the board of directors is meeting to discuss STC's financial performance. STC has incurred losses for the years ended December 31, 2020, and 2021, and the board is concerned that STC will not be able to make its next long-term debt payment, due on March 1, 2022, due to a cash shortage. The board has hired a consulting firm, Shapiro & Atkins LLP (S&A), to assist in the evaluation of STC's performance and operations. You, CPA, work for S&A and have been assigned to work on the engagement. The board has provided you with STC's draft financial statements for the year ended December 31, 2021 (Appendix I). The financial statements were prepared by the assistant controller, who joined STC in October 2021, because both the chief financial officer and the controller resigned unexpectedly in December 2021. Jonathan Tang, the chief executive officer, admits that he is focused on operations and prefers to "leave the numbers to the accountants to manage." The board also provided you information on STC's operations (Appendix II).Task #2 The partner in charge of the engagement believes that an analysis of STC's production variances will help the board to understand the root causes of the decline in profitability. The following information has been obtained from the production records for STC's most popular product, the snack cake. As a first step, the partner has asked you to calculate the flexible budget rate and efficiency and price variances for materials and labour for the snack cake. He believes that this analysis is a good starting point, as the other products are likely to show similar variances. Standard units of Standard input per unit of cost per unit output (batch of 1,000) of input Raw ingredients (standard recipe) 10.2 $18.50 Labour hours 2.1 $22.00 Actual results Actual output (units) 46,400* Actual quantity of raw ingredients used 479,405 Actual cost of raw ingredients $8,744,344 Actual labour hours 111,360 Actual labour cost $2,422,080 *47,000 units were produced, but 600 units were spoiled. To help the board better understand STC's performance, the partner has asked you to comment on the likely causes of any variances identified.Appendix I Extracts from financial statements Balance sheet as at December 31: 2021 2020 (unaudited) (audited) Cash $ 46,980 $ 1,208,765 Inventories 2,512,908 1,999,885 Accounts receivable 4,978,020 4,334,984 Prepaid expenses 265,843 205, 111 Property, plant, and equipment 3,899,223 4,400.400 Total assets $11,702,974 $12,149,145 Accounts payable and accruals $ 2,334,567 $ 1,198,765 Current portion of long-term debt 1,500,000 1,500,000 Non-current portion of long-term debt 5,000,000 6,500,000 Total liabilities 8.834.567 9,198,765 Common shares 100 100 Retained earnings 2,868,307 2,950,280 Total liabilities and equity $11,702,974 $12,149,145 Income statement for the year ended December 31: 2021 2020 (unaudited) (audited) Revenue $48,412,412 $50, 132,581 Cost of sales 40.839.210 40.858.054 Gross margin 7,573,202 9,274,527 Salaries and benefits 3,595,945 3,900,921 Management bonus 1,000,000 1,000,000 Advertising 1,364,427 2,654,675 Insurance and property taxes 170,890 180,100 Repairs and maintenance 210,810 470,333 Interest 517,500 652,500 Amortization 621,090 688,974 Other 200.400 210.233 Income before taxes (107,860) (483,209) Income taxes (25,887) (86.978) Net income S (81,973) $ (396,231)Appendix II Information on STC operations Industry The packaged snack food market is highly competitive with a number of producers competing for limited shelf space and market share. In recent years, sales have been negatively impacted by a movement toward healthier snacking, particularly for children. Workforce STC's workforce consists of 260 non-unionized staff. While the production employees at most of STC's competitors are unionized, STC has been able to avoid unionization by providing above-average working conditions, wages, and benefits. Having a non- unionized workforce is an advantage because it allows for more flexibility with respect to scheduling and task allocation, which contributes to efficiency. Recently, many employees have been unhappy with the cost-cutting measures that management has undertaken. Turnover has increased across all departments from an overall average of 5% in 2020 to 25% in 2021. It takes approximately two weeks to train a new production employee, and it takes the employee about six months to become fully efficient. Raw materials The raw ingredients for STC's products are flour, oil, sugar, eggs, yeast, milk, preservatives, and other additives such as nuts and chocolate. As sugar and flour are commodities, their prices fluctuate based on crop supply and demand. STC has not taken any steps to lock in long-term prices for ingredients, as management believes that the fluctuations will even out over time. The price of flour and sugar decreased by 12% from 2020 to 2021. Production Production capacity is limited by the availability of ovens and mixing equipment. In 2021, the factory operated at 70% of its available capacity. In late 2021, the thermostat on one of the ovens began malfunctioning on a regular basis. This results in waste, as batches are either over- or undercooked. The production supervisor can reset the thermostat, but it takes approximately 30 minutes, during which time employees that load and unload the oven are idle. Replacement of the thermostat is on the list of maintenance items needing attention but has been deferred as part of the cost-cutting plan.Appendix II (continued) Reduced-fat product line In early 2021, STC launched a new reduced-fat product line, which includes reduced-fat versions of its four most popular items. The reduced-fat products retail for the same price as the original version, despite the ingredient cost being significantly higher. To date, the reduced-fat products have not been as popular as expected, with sales 50% below budget. On January 15, 2022, STC received notification from Health Canada that it would be investigating the fat substitute used in STC's reduced-fat products. Some medical professionals have claimed that the ingredient is carcinogenic (that is, it causes cancer). Health Canada is allowing sales of products containing the ingredient to continue pending the outcome of the investigation; however, it is urging manufacturers to recall unsold product from stores and find an alternative fat substitute. STC has a significant amount of the fat substitute on hand and plans to continue using it as long as it is permitted by Health Canada. Cost-cutting measures STC management implemented a cost-cutting program in 2021 in an attempt to restore profitability. The measures included: reducing employee health and dental benefits from 100% coverage of premiums to 50% coverage freezing employee wages, with no increases awarded in 2021 deferring any non-essential capital purchases, repairs, and maintenance discontinuing the recycling program, under which 80% of STC's waste was being recycled and 50% of STC's packaging was being made from recycled materials