Waters relied on the authority arrangement Harvey had agreed to earlier and continued production of the three products. Midyear Results In the first week of July 2005, Waters received from the accounting department the six months' statement of cumulative standard costs including variances of total company actual costs from 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 Superior retained its share of the market, its profit 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 during 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 that 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? 2. Should Superior lower as of January 1, 2006 its price of product 101? To what price? 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? Exhibit 1 income statement for year ending December 31, 2014 (in thousands) Gross sales Cash Discount Net Sales Cost of Manufacturing Gross profit $105,905 (1,567) $104,338 (65,251) $39,087 Less: Selling Expense $18,383 General Administration 6,534 Depreciation 13,591 (38,508) Operating Profit $579 Plus: Other Income 205 Net Profit before Interest $784 Less: Interest Net Income (1.472) ($688) Exhibit 2 Analysis of income statement by products and departments-Year ended December 31, 2014 (thousands $ except per 100 Kilograms.) Product A Product B Product C Classification Per 100 kgs. Per 100 kgs. Per 100 kgs. Total Direct Indirect Allocation Basis Rent $ 1.872 $.88 $1,570 $1.53 $1,882 $1.90 $5,324 X Property Taxes Cubic space 621 .29 503 .49 401 .40 1,525 X Area Property Insurance 524 .25 405 .39 534 .53 1,463 X Value of equipment Compensation Insurance 836 .39 439 .42 458 .46 1,733 X Direct labor ($) Direct Labor 12,937 6.06 6,107 5.92 6,879 6.97 25,921 Indirect Labor 4,413 2.07 2,124 2.06 2,309 2.33 8,846 Direct labor ($) Power 220 .11 251 .24 302 .31 773 X Light & Heat 158 .07 130 .12 106 .10 394 Building Service 109 .05 82 .08 75 I .08 266 XXX Machine horsepower Area Area Materials 7641 3.59 4,716 4.58 4,851 Supplies 525 .25 485 .46 350 4.91 .36 17,208 X 1,360 X Repairs 184 .08 150 .15 104 .10 Total $30,040 $14.09 $16,962 $16.44 $18,249 $18.45 438 $65,251 X Selling Expense 9,100 4.27 4,582 4.44 4,701 4.76 General Administrative 3,451 1.62 1,300 1.26 1,783 1.80 Depreciation 5,659 2.65 4,274 4.16 3,658 3.70 18,383 6,534 13,591 X $ Value of sales X $ Value of sales X Value of equipment Interest 524 .25 409 .39 Total Cost $48,774 Less: Other Income 101 $48,673 $22.88 .04 $22.84 Sales (Net) 51,672 24.24 Profit (Loss) $2,999 $1.40 Unit Sales (100 kgs.) 2,132,191 $27,527 53 $27,474 25,996 (1,478) 1,029,654 $26.69 .05 $26.64 25.23 ($1.41) 539 $28,879 51 $28,879 26,670 .53 $29.19 .05 $29.19 27.03 ($2,209) ($2.16) 1,472 $105,231 205 $105,026 104,338 ($688) X Value of equipment X $ Value of sales 986,974 Quoted Selling Price Per Unit $24.50 $25.80 $27.50 Cash Discount Taken (% of 1.08% 2.14$ 1.74% 1.48% Selling Price) Exhibit 4 Income statement by products and departments at standard and total company variances from January 1 to June 30, 2015 (Thousands $ except per 100 kgs.) Product A Product B Product C Item Standard Per 100 kgs. Total at Standard Standard Per 100 kgs. Total at Standard Standard Per 100 kgs. Total at Standard Total Standard Total Actual Rent $.88 $877 $1.53 $1,090 $1.90 $952 $2,919 $2,660 Property Tax .29 289 .49 349 .40 201 839 770 Property Insurance .25 249 .39 278 .53 266 793 732 Compensation Insurance .39 389 .42 299 .46 231 919 917 Direct Labor 6.06 6,041 5.92 4,216 6.97 3,496 13,751 13,820 Indirect Labor 2.07 2,063 2.06 1,467 2.33 1,168 4,698 4,485 Power .11 109 .24 171 .31 155 435 432 Light & Heat .07 70 .12 85 .10 50 205 200 Building Service .05 50 .08 57 .08 40 147 107 Materials 3.59 3,579 4.58 3,216 4.91 2,461 9,301 9,282 Supplies .25 239 .46 328 .36 180 747 750 Repairs .08 79 .15 107 .10 50 236 251 Total $14.09 $14,034 $16.44 $11,708 I $18.45 $9,248 $34,990 $34,406 Selling Expense 4.27 4,257 4.44 3,162 4.76 2,386 9,805 9,830 General Administrative 1.62 1,615 1.26 897 1.80 902 3,414 3,289 Depreciation 2.65 2,642 4.16 2,962 3.70 1,855 7,459 6,817 Interest .25 249 Total Cost $22.88 $22,797 .39 $26.69 278 .53 $19,007 $29.24 266 $14,657 Less: Other Income Actual Sales (net) Profit (Loss) .04 $22.84 24.24 $1.40 40 .05 36 $22.757 $26.64 24,164 25.23 $18,971 17,961 $1,407 ($1.41) ($1,010) Unit Sales (100 kgs.) 996,859 712,102 .05 $29.19 27.03 ($2.16) 501,276 25 $14,632 13,550 ($1,082) 793 $56,461 101 $56,360 55,657 ($685) 730 $55,072 110 $54,962 55,675 $713 a: Actual unit sales times standard net revenue per unit