The Birdy Company is a multidivisional company and its managers have been delegated divisional profit responsibility. Each division produces and markets its own products. Divisional managers are accountable also for inventory levels. The corporate head office provides common administrative services. Actual costs for these services are allocated to all divisions based on their budgeted sales and are included under divisional operating costs as administration expenses. Annually, all divisions prepare their operating budgets and present these for review to the corporate head office. During the review process, additional information is often requested to explain major changes from past trends in sales, costs, or expenses. Final budget approval is given when the proposed return on the assets employed by the division is satisfactory.

Divisional performance is monitored monthly and any significant difference from the approved budget is to be documented and explained by the divisional manager. The submission of a revised budget along with details of specific action to be taken is required when any significant difference from the approved budget is expected to continue. A formal review of divisional performance and of any revised budget submission is held each quarter at each division with senior corporate executives.

The Eagle Division has shown acceptable profits for a number of years. However, during the most. recent quarter, particularly during the month of September, major problems appeared.

The division produces electrical switches which are sold to electric supply dealers. Eagle's sales personnel work on a commission basis. Products are advertised monthly in trade magazines. Until recently, the dealer price had been $$13\mathrm{.}50$ per switch. Quality and timely deliveries were factors which had contributed to the division's success.

During the last few months, a new brand of switches had entered the market rather unexpectedly. Backed by full page advertisements in trade magazines and lower dealer prices, the new competitor had gained a significant share of the market within a three$-$month period. A sample of the new competitive switch had been examined and tested, and it was found to be of the same quality as the Eagle switch. The manager of the Eagle Division suspects that the current low prices may continue for another three months and then slowly return to the normal price level of $$13\mathrm{.}00$ to $$14\mathrm{.}00.$

During the last month, September, the Eagle Division had reduced production from its normal level of $30,000$ units to $22,000$ units. Sales, on the other hand, were only $14,500$ units leaving the division with an inventory at September $30$ of $50,000$ units. The annual operating budget for the division included an inventory target of $20,000$ units at year end, December $31.$

The following standard manufacturing costs per switch were used for the annual operating budget and will remain in effect for the budget year.

Cost Component per unit

Direct materials $$2\mathrm{.}40$

Direct labor $($$$9\mathrm{.}60/$hour$)$ $$3\mathrm{.}20$

Variable overhead $($$$3\mathrm{.}60/$DLH$)$ $$1\mathrm{.}20$

Fixed overhead $($$$6\mathrm{.}60$ DLH$)$ $$2\mathrm{.}20$

TOTAL $$9\mathrm{.}00$

DLH $=$ Direct Labor Hours

The standard overhead rate per unit of $$3\mathrm{.}40$ is based on normal annual production volume of $360,000$ units or $30,000$ units per month. The maximum production capacity without increasing the fixed manufacturing overhead is $35,000$ units per month or $420,000$ units per year.

The actual results for the nine$-$month period ended September $30$ are as shown in Exhibit I.

Early in September, the Eagle Division manager had asked his plant supervisor to check with engineering for any possible cost savings in production to minimize losses from budget. The supervisor made the following proposal:

"During the switch assembly, eliminate an alignment and an adjustment operation which will reduce the production time by four minutes per switch. This will result in producing some defective switches, but they will be detected during the final inspection and discarded immediately.

Based on several tests, the average number of defective switches were $50$ for every $1,000$ good switches produced."

Some rough calculations done by the plant supervisor indicated a net saving in the unit production cost. The divisional manager would like to have this verified.

Exhibit $1$

Eagle Division

Statement of Results for the Nine Month Period Ended September $30$

Actual Budget Variances

Sales $($units$)252,000270,00018,000$ U

Revenue $$3,333,500$ $$3,645,000$ $$311,500$ U

Cost of goods sold$*2,297,9002,430,000132,100$ F

Gross margin $1,035,6001,215,000179,400$ U

Expenses:

Advertising $191,500189,0002,500$ U

Shipping$/$delivery$**151,200162,00010,800$ F

Commission$**201,600216,00014,400$ F

Administration $290,800297,0006,200$ F

Total expenses $835,100864,00028,900$ F

Eagle Division Profit $$200,500$ $$351,000$ $$150,500$ U

$*$Actual production volume during the nine$-$month period was $262,000$ units. Cost of goods sold for the nine$-$month period ended September $30$ is detailed as follo