Should Superior lower as of January 1, 2006 its price of product 101 to $22.5? Why? Hint: what does Superiors contribution margin look like if the price is $24.5? What does Superiors contribution margin look like if lowering the price to $22.5? (Can you provide me with a step by step solution for this case in a cvp format?)

Waters relied on the authority arrangement Harvey had agreed to earlier and continued production of the three products. Midvear Results In the first week of July 2005, Waters received from the accounting department the six months ctual costs from statement of cumulative standard costs including variances of total company a standard (see Exhibit 4) It showed that the first half of 2005 had been a successful period. In order to expedite the availability of interim-period results, Superior did not determine actual product-line revenues, costs, and profits. Rather, product-line data was prepared using standard per unit data and actual unit sales. Reduce 101 Price? During the latter half of 2005, the sales of the entire industry weakened. Even though Superion retained its share of the market, its proit for the last six months was expected to be small. In November 2005, the Samra Company announced a price reduction as of January 1, 2006 on product 101 from $24.50 to $22.50 per 100 pounds. This created a pricing problem for all its competitors. Waters forecast that if Superior held to the $24.50 price duing the first six months of 2006, the company's unit sales would be 750,000. He felt that if it dropped its price to $22.50, the six months unit volume would be 1 million. Waters knew that competing managements anticipated a further decline in activity. He thought a general decline in prices of all products was quite probable The accounting department reported that the standard costs in use would probably apply during 2006, with two exceptions: materials and supplies would be about 5% below the 2005 standard. Waters and Harvey discussed the pricing problem. Harvey observed tat even with the anticipated decline in material and supply costs, a sales price of $22.50 would be below cost. Harvey therefore wanted the $24.50 price to be continued, since he felt the company could not be profitable while selling a key product below cost. Questions 1. Based on the 2004 statement of profit and loss data (Exhibits 1 and 2), do you agree with Waters's decision to keep product 103? Should Superior lower as of January 1, 2006 its price of product 101? To what price? 2. 3. Why did Superior improve profitability during the period January 1 to June 30, 2005? How useful was the data in Exhibit 4 for the purpose of this analysis? 4. Why is it important that Superior has an effective cost system? What is your overall appraisal of the company's cost system and its use in reports to management? List the strengths and weaknesses of this system and its related reports for the purposes management uses the system's output. What recommendations, if any, would you make to Waters regarding the company's cost accounting system and its related reports? cost. Total cost was the sum of the product factory's direct costs plus allocated indirect costs less an allocated other-income amount. Allocated indirect costs included the company's interest cost related to bank loans. Costs designated as direct costs were assigned directly to the product factory in which they were incurred. For example, the cost of materials used to manufacture product 10 in 101 Factory was charged directly to the 101 Factory account. This material cost could be traced directly to 101 Factory through material purchase and requisition orders. Indirect costs were allocated to the product factories using a variety of allocation methods (see Exhibit 2). For example, the total company rent expense ($5,324,000) was allocated to each product factory based on its enclosed cubic space. Cubic space was selected as the allocation basis to capture the fact that the production process for each of the three products included enclosed scrubber towers that varied in height depending on the product produced. Using the cubic space as the allocation base, the total company rent was charged as shown in Figure A to each product factory Figure A Total Company Rent ($5,324,000) Actual Rent Expense Allocation Basis (cubic space) 101 Factory ($1,872,000) 102 Factory ($1,570,000) 103 Factory ($1,882,000) Allocated Rent Source: Casewriter The allocated per 100-pound rent cost of each product was derived by dividing the unit output of each product factory into the respective product factory's allocated rent. A standard cost system was introduced in early 2005. It was used to value inventories, prepare budgets, and analyze performance (see Exhibit 4). Next year's standard costs were last year's actual per unit costs adjusted for anticipated cost changes. Since Superior's three products were each sold in 100-pound bags, per unit standards were expressed in terms of 100 pounds of finished product. Drop 103? To familiarize Paul Harvey with his methods, Waters sent copies of Exhibits 2 and 3 to Harvey and they discussed them. Harvey stated that he thought product 103 should be dropped immediately as it would be impossible to lower expenses on product 103 as much as $2.16 per 100 pounds. In addition, he stressed the need for economies on product 102 Exhibit 2 Analysis of Profit and Loss by Products and Departments Year Ended December 31, 2004 (thousands except per 100 lbs.) Classification Product 102 t 103 Allocation Basis r 100 lbs $.88 $ 5,324 Cubic space Taxes Property Insurance Compensation Insurance Direct Labor Value of equipment Direct labor (S) Direct labor (S) 2,309 Machine horsepower Building Service Selling Expense S value of sales $ value of sales Value of equipment Value of equipment General Administrative 1,783 $ value of sales Unit Sales (100 bs.) Quoted Selling Price Per Unit Cash Discount Taken (% of 2,132,191 1,029,654 1.48% 1.08% Source: Casewriter Note: Figures may not add exactly because of rounding. Exhibit 4 Pr and Loss by Products and Departments at Standard and Total Company Variances from January 1 to June 30, 2005 (thousands except per 100 lbs.) Product 101 Product 102 Product 103 Variances Favorable Unfavorable Standard Standard r 100 lbs Standard Total at Standard Total at Standard Total Standard Total Actual Item r 100 lbs. r 100 lbs. Standard S 952 $ 877 S 1,090 S 2,919 839 793 $2,660 +259 Property Insurance Compensation Insurance Direct Labor Indirect Labor 249 +61 6,041 2,063 109 5.92 3.496 13,751 13,820 4.485 4,698 Light & Heat Building Service 08 147 9,301 747 3,261 3,579 4,91 2,461 25 180 $14.09 $14,034 4,257 1,615 2,642 $ 16.44 S 9,248 2,386 902 1,855 $34,406 9,830 3,289 6,817 730 $55,072 Total S 11,708 3,162 897 2,962 $34,990 9,805 Selling Expense General Administrative 4.27 1.26 1.80 2.65 3.70 7.459 793 $56,461 Total Cost $22.88 $22,797 $26.69 S19,007 $29.24 $14,657 +1,389 Less: Other Income $ 26.64 25.23 $ 18,971 17,961 $22.84 24.24 S 1.40 996,859 $22,757 $29.19 $14,632 $56,360 55,675 685 $54,962 +1,398 Actual Sales (net)a Profit Unit Sales (100 Ibs.) 27.03 13.550 55,675 S1,407 +1,398 712,102 501,276 Source: Casewriter Actual unit sales times standard net revenue per unit. Exhibit1 Profit and Loss Statement for Year Ending December 31, 2004 (000) Gross Sales $105,905 1,567 $104,338 65,251 $39,087 Cash Discount Cost of Manufacturing Less: Selling Expense Net Sales Manufacturing Profit $18,383 6.534 13,591 General Administration Depreciation 38,508 Operating Profit $579 205 784 1472 $ 688 Other Income Net Profit before Interest Less: Interest Net Loss Source: Casewriter Waters relied on the authority arrangement Harvey had agreed to earlier and continued production of the three products. Midvear Results In the first week of July 2005, Waters received from the accounting department the six months ctual costs from statement of cumulative standard costs including variances of total company a standard (see Exhibit 4) It showed that the first half of 2005 had been a successful period. In order to expedite the availability of interim-period results, Superior did not determine actual product-line revenues, costs, and profits. Rather, product-line data was prepared using standard per unit data and actual unit sales. Reduce 101 Price? During the latter half of 2005, the sales of the entire industry weakened. Even though Superion retained its share of the market, its proit for the last six months was expected to be small. In November 2005, the Samra Company announced a price reduction as of January 1, 2006 on product 101 from $24.50 to $22.50 per 100 pounds. This created a pricing problem for all its competitors. Waters forecast that if Superior held to the $24.50 price duing the first six months of 2006, the company's unit sales would be 750,000. He felt that if it dropped its price to $22.50, the six months unit volume would be 1 million. Waters knew that competing managements anticipated a further decline in activity. He thought a general decline in prices of all products was quite probable The accounting department reported that the standard costs in use would probably apply during 2006, with two exceptions: materials and supplies would be about 5% below the 2005 standard. Waters and Harvey discussed the pricing problem. Harvey observed tat even with the anticipated decline in material and supply costs, a sales price of $22.50 would be below cost. Harvey therefore wanted the $24.50 price to be continued, since he felt the company could not be profitable while selling a key product below cost. Questions 1. Based on the 2004 statement of profit and loss data (Exhibits 1 and 2), do you agree with Waters's decision to keep product 103? Should Superior lower as of January 1, 2006 its price of product 101? To what price? 2. 3. Why did Superior improve profitability during the period January 1 to June 30, 2005? How useful was the data in Exhibit 4 for the purpose of this analysis? 4. Why is it important that Superior has an effective cost system? What is your overall appraisal of the company's cost system and its use in reports to management? List the strengths and weaknesses of this system and its related reports for the purposes management uses the system's output. What recommendations, if any, would you make to Waters regarding the company's cost accounting system and its related reports? cost. Total cost was the sum of the product factory's direct costs plus allocated indirect costs less an allocated other-income amount. Allocated indirect costs included the company's interest cost related to bank loans. Costs designated as direct costs were assigned directly to the product factory in which they were incurred. For example, the cost of materials used to manufacture product 10 in 101 Factory was charged directly to the 101 Factory account. This material cost could be traced directly to 101 Factory through material purchase and requisition orders. Indirect costs were allocated to the product factories using a variety of allocation methods (see Exhibit 2). For example, the total company rent expense ($5,324,000) was allocated to each product factory based on its enclosed cubic space. Cubic space was selected as the allocation basis to capture the fact that the production process for each of the three products included enclosed scrubber towers that varied in height depending on the product produced. Using the cubic space as the allocation base, the total company rent was charged as shown in Figure A to each product factory Figure A Total Company Rent ($5,324,000) Actual Rent Expense Allocation Basis (cubic space) 101 Factory ($1,872,000) 102 Factory ($1,570,000) 103 Factory ($1,882,000) Allocated Rent Source: Casewriter The allocated per 100-pound rent cost of each product was derived by dividing the unit output of each product factory into the respective product factory's allocated rent. A standard cost system was introduced in early 2005. It was used to value inventories, prepare budgets, and analyze performance (see Exhibit 4). Next year's standard costs were last year's actual per unit costs adjusted for anticipated cost changes. Since Superior's three products were each sold in 100-pound bags, per unit standards were expressed in terms of 100 pounds of finished product. Drop 103? To familiarize Paul Harvey with his methods, Waters sent copies of Exhibits 2 and 3 to Harvey and they discussed them. Harvey stated that he thought product 103 should be dropped immediately as it would be impossible to lower expenses on product 103 as much as $2.16 per 100 pounds. In addition, he stressed the need for economies on product 102 Exhibit 2 Analysis of Profit and Loss by Products and Departments Year Ended December 31, 2004 (thousands except per 100 lbs.) Classification Product 102 t 103 Allocation Basis r 100 lbs $.88 $ 5,324 Cubic space Taxes Property Insurance Compensation Insurance Direct Labor Value of equipment Direct labor (S) Direct labor (S) 2,309 Machine horsepower Building Service Selling Expense S value of sales $ value of sales Value of equipment Value of equipment General Administrative 1,783 $ value of sales Unit Sales (100 bs.) Quoted Selling Price Per Unit Cash Discount Taken (% of 2,132,191 1,029,654 1.48% 1.08% Source: Casewriter Note: Figures may not add exactly because of rounding. Exhibit 4 Pr and Loss by Products and Departments at Standard and Total Company Variances from January 1 to June 30, 2005 (thousands except per 100 lbs.) Product 101 Product 102 Product 103 Variances Favorable Unfavorable Standard Standard r 100 lbs Standard Total at Standard Total at Standard Total Standard Total Actual Item r 100 lbs. r 100 lbs. Standard S 952 $ 877 S 1,090 S 2,919 839 793 $2,660 +259 Property Insurance Compensation Insurance Direct Labor Indirect Labor 249 +61 6,041 2,063 109 5.92 3.496 13,751 13,820 4.485 4,698 Light & Heat Building Service 08 147 9,301 747 3,261 3,579 4,91 2,461 25 180 $14.09 $14,034 4,257 1,615 2,642 $ 16.44 S 9,248 2,386 902 1,855 $34,406 9,830 3,289 6,817 730 $55,072 Total S 11,708 3,162 897 2,962 $34,990 9,805 Selling Expense General Administrative 4.27 1.26 1.80 2.65 3.70 7.459 793 $56,461 Total Cost $22.88 $22,797 $26.69 S19,007 $29.24 $14,657 +1,389 Less: Other Income $ 26.64 25.23 $ 18,971 17,961 $22.84 24.24 S 1.40 996,859 $22,757 $29.19 $14,632 $56,360 55,675 685 $54,962 +1,398 Actual Sales (net)a Profit Unit Sales (100 Ibs.) 27.03 13.550 55,675 S1,407 +1,398 712,102 501,276 Source: Casewriter Actual unit sales times standard net revenue per unit. Exhibit1 Profit and Loss Statement for Year Ending December 31, 2004 (000) Gross Sales $105,905 1,567 $104,338 65,251 $39,087 Cash Discount Cost of Manufacturing Less: Selling Expense Net Sales Manufacturing Profit $18,383 6.534 13,591 General Administration Depreciation 38,508 Operating Profit $579 205 784 1472 $ 688 Other Income Net Profit before Interest Less: Interest Net Loss Source: Casewriter