What specifically stands out in this case? What questions could be asked regarding this case on a mid term exam? Professor provided case for mid term but not the questions yet. The questions will be posted during a timed mid term period.

Case 1: HEF GROUP Prologue As soon as Margaret Paine received the September 2011 Profit Statement for her Tri-cities Rubber Division of HEF (Exhibit 1), she called her Controller and Sales Manager into her office to discuss the results. Next week, as division manager of Tri-cities, she would make her presentation to the HEF Management Board and the results were not as good as expected. Margaret thought that Tri-cities had performed well. Sales to her target customers were up and costs on the whole were down. She wondered why the bottom line looked so bad. Margaret also knew that Caleb Suarez, her counterpart in the Copenhagen Division of HEF, was doing much better. The Board would likely compare Copenhagen profits (Exhibit 2) to Tri-cities' performance. How would the Board react? Background and Operations As part of a large European conglomerate, HEF Group produced synthetic (artificial) rubber used in a variety of applications. Major competitors included Goodyear, Exxon, and Dupont. HEF competed in two product categories or lines; a regular type rubber traditionally used in inner tubes and general purpose applications (hereafter, R-line) and a more specialized type (hereafter, S-line). S-line products were similar to R-line rubbers but also had additional properties that allowed bonding to other materials (e.g., liners and sidewalls in tubeless tires). Both R-rubbers and S-rubbers were produced from basic raw materials such as crude oil, naphta, butane, propane, and ethane. HEF manufactured its rubber products in three operating divisions, all managed as profit centers; Tri-cities (Iowa) which focused on R-line in North and South America, Akron (Ohio) which focused on S-line products in North and South America, and Copenhagen (Denmark) which catered to customers in Europe and the Middle East for both R-line and S-line products. In addition to the three operating divisions, the HEF Group included a Global Marketing Department and a Research Division. The costs of these departments were not charged or allocated to the operating divisions, but instead were charged against Group profits. The original HEF rubber plant was built in Tri-cities around the time of World War II when R- type rubbers were becoming increasingly useful in a variety of consumer and military applications. While R-rubbers continued to be HEF's main focus over the next several decades, innovations in production technology and changes in market demand (e.g., increasing rubber applications and demand for S-rubbers) required significant capital upgrades and the ability to produce both regular and specialty rubbers. Partly in response to market and technological trends, in the mid 80s HEF built a state-of-the-art plant in Akron Ohio that focused exclusively on S-rubber products. At the same time, it committed to upgrading the Tri-cities plant over the coming decades with its renewed focus on producing R-type products. For instance, recently in 2008, HEF upgraded its Tri-cities facilities at a cost of over $100 million, which among other things increased the facility's nameplate (i.e. design or theoretical) capacity of regular R-rubbers to 95,000 tons of rubber per year. The Copenhagen plant was built in the mid 70s. At first, it was built as a regular R-rubber unit but was modified in late 90s to allow it to produce both R and S rubbers. The annual nameplate production capacity of the Copenhagen plant was also about 95,000 tons of rubber. In 2010, as in previous years, the Copenhagen plant operated close its nameplate capacity with a little over half of the capacity dedicated to meet its entire S-rubber demand. Copenhagen capacity not used to produce S-rubber was used to produce regular R-rubber. However, because demand for Copenhagen's regular R-rubber in Europe and the Middle East outpaced the plant's remaining capacity, Copenhagen satisfied its shortfall by purchasing R-rubber from Tri-cities. Although customers occasionally purchased received shipments from the divisions outside their designated geographic region, such purchases/shipments were rare. For instance, cost and/or logistical considerations usually precluded European customers from buying R-rubber from Tri-cities directly. In order to coordinate transfers of regular R-rubber from Tri-cities to Copenhagen, in September and October of each year, Tri-cities and Copenhagen prepared production estimates for the upcoming year. These estimates were based on estimated sales volumes and capacity utilization. Because the Copenhagen plant operated near its nameplate capacity already (as noted above), the planning exercise was largely for the benefit of Tri-cities' managers who needed to know how much regular R-rubber Copenhagen would need from Tri-cities. Exhibit 3 highlights the shipments of regular R-level shipments from Tri-cities to Copenhagen from 2006 to 2010. Product Costing The cost system in all divisions was a standard absorption cost system (i.e., product costs included both standard variable costs and standard fixed costs of production). Variances from standard - i.e., differences between actual and standard costs - were routinely tracked and monitored to ensure the plants were running efficiently. Variances were expensed (or credited) in the income statement in the year in which they occurred. Variable production costs included the costs of raw materials, chemicals, energy, and some labor. Because raw material prices varied with worldwide market conditions, standard costs for many of these variable inputs were revised frequently, usually on a monthly basis. Fixed production costs included indirect labor, utilities, support service costs (e.g., engineering, procurement, etc.,), and depreciation. Standard fixed costs were calculated and assigned to production based on a plant's "attainable capacity" as follows: Standard fixed cost per ton = Estimated annual total fixed costs Annual attainable plant capacity Attainable Capacity was defined in the Controllers' manual as: Attainable capacity is annual production that is practically attainable; taking into account the likelihood of abnormally low or high unscheduled production, scheduled shutdowns, and unusual items which may impact how much of a plant's nameplate capacity is practically attainable. Managers at both Copenhagen and Tri-cities were encouraged to produce at or near attainable capacity. Product transfers between Tri-cities and Copenhagen for performance reporting purposes were recorded at a transfer price equal to standard full cost, representing for each ton the sum of standard variable cost and standard fixed cost. There were no product transfers to or from Akron. Performance Evaluation and Compensation Historically, employees at the HEF Group had been paid by fixed salary with little use of bonuses except at the senior executive level. In 2009, a bonus system was instituted throughout HEF to link pay with performance and strengthen the profit center orientation of the Group. For non-management employees, annual bonuses were awarded, in amounts up to 10% of salary, based on Group and Divisional performance. For managers, the annual bonus was greater than 10% of salary and increased with responsibility levels. The bonuses for top Division management in 2010 were calculated by a formula that awarded 50% of the bonus potential to meeting and exceeding Divisional profit targets, 40% to meeting or exceeding HEF Group profit targets, and 10% to meeting or exceeding overall parent company corporate profit targets. Margaret Paine and Caleb Suarez Margaret Paine was Vice-President and Division Manager of the Tri-cities Division. A professional engineer, she had begun her career with HEF in plant management. Over the years, she had assumed responsibilities for product management as well as sales. She remarked: My rubber business is managed largely on price and margin. Quality, service, and technology are also important, but it's difficult to truly differentiate ourselves from other competitors on these dimensions. It's also important to note that this is a continuous process industry. The plant is computerized so that we need the same number of people and incur most of the same overhead costs whether the plant is running fast or slow. Unfortunately, my Tri-cities plant is currently running at less than capacity. Although with the recent upgrades the plant's nameplate is 95,000 tons, its attainable capacity currently is set at 85,000 tons. In 2010, we actually produced 65,000 tons of R-rubber, well below the attainable capacity. For 2011, we budgeted for a little more but unfortunately it doesn't look like we will get to 85,000 tons anytime soon. For instance, for the first 9 months of 2011, we budgeted to produce 55,000 tons but it didn't quite turn out that way, we produced 47,500 tons instead. Of course, it didn't help that Copenhagen took a lot less rubber volume than they had projected. I suppose I could have produced 55,000 tons as originally planned but I didn't want to carry the extra inventory. You see, we get charged for working capital in our profit report and I didn't want to take a hit for the extra inventory. Caleb Suarez, Vice-President and Division Manager of the Copenhagen Division, was also a professional engineer. His career included management responsibilities in plant operations, market research, venture analysis and corporate planning. He remarked: The Copenhagen plant's attainable capacity is 95% of nameplate capacity, about 90,000 tons. And, we typically hit our target with almost 40,000 tons of regular R-rubber and about 50,000 tons of S-rubber. In addition, we import approximately 20,000 to 25,000 tons regular R-rubber from Tri-cities. We inform Tri-cities each Fall of our estimated needs. These estimates are based on our sales forecasts and how hard we can push our plant. For example, we budgeted to produce 150 tons of R-rubber per day this year and we have got it up to about 175 tons per day. Why not - if I can squeeze more out of my plant here, why bother shipping it from Tri-cities. The Copenhagen operation has been extremely successful since I arrived here in 2007/2008. We have increased our market share in both R and S rubbers and we're running the plant better than ever. Looking at our nine-month Profit Statement for R- rubber only (Exhibit 2), our margins are better than Tri-cities' margins for the same product. While our plant is quite a bit older than Tri-cities' plant and the market dynamics are a bit different in Europe than in North America, I sometimes tease my good friend Margaret in lowa that my success here is attributable to my superb management skills. Exhibit 1 Tri-cities Rubber Division - Statement of Divisional Profit Nine Months Ended September 30, 2011 Actual Plan/budget ($000s) ($000s) Sales Revenue 61,050 - third party - to Copenhagen 35,800 tons @$1,855 12,200 tons @ $1,350 66,409 33,000 tons @$1,850 16,470 19,500 tons @ $1,350 26,325 Less: Delivery cost (2,400) (2,625) Net Revenue 80,479 84,750 Cost of Sales-at standard 48,000 tons @ $1,350 64,800 52,500 tons @ $1,350 70,875 Production cost variances (1,075) n/a (vs budget) Excess-idle capacity cost 11,375 6,125 Total cost of sales 75,100 77,000 Gross Profit 5,379 7,750 Selling, General & Admin 4,029 3,950 Business Contribution 1,350 3,800 Interest on working capital 1,375 1,800 Division Profit (Loss) (25) 2,000 Other: Inventory units - beginning 500 ton 500 ton Inventory units - ending 0 ton 3,000 ton Exhibit 2 Copenhagen Rubber Division - Statement of Divisional Profit (R-rubber products only) Nine Months Ended September 30, 2011 Actual (S000s) Sales Revenue (47,850 tons) $ 92,829 Delivery cost (4.829) Net Revenue 88,000 Cost of Sales - at standard 60,676 Production cost variances - vs budget 1.324 Total cost of sales 62.000 Gross Profit 26,000 Selling, General & Admin 7,600 Business Contribution 18,400 Interest on working capital 1.600 Division Profit (R-rubber only) 16,800 Exhibit 3 Schedule of shipments of R-rubber from Tri-cities to Copenhagen Actual tons Budgeted tons 2010 21,700 23,800 2009 12,800 13,800 2008 1,400 4,000 2007 800 600 2006 1,070 700 Case 1: HEF GROUP Prologue As soon as Margaret Paine received the September 2011 Profit Statement for her Tri-cities Rubber Division of HEF (Exhibit 1), she called her Controller and Sales Manager into her office to discuss the results. Next week, as division manager of Tri-cities, she would make her presentation to the HEF Management Board and the results were not as good as expected. Margaret thought that Tri-cities had performed well. Sales to her target customers were up and costs on the whole were down. She wondered why the bottom line looked so bad. Margaret also knew that Caleb Suarez, her counterpart in the Copenhagen Division of HEF, was doing much better. The Board would likely compare Copenhagen profits (Exhibit 2) to Tri-cities' performance. How would the Board react? Background and Operations As part of a large European conglomerate, HEF Group produced synthetic (artificial) rubber used in a variety of applications. Major competitors included Goodyear, Exxon, and Dupont. HEF competed in two product categories or lines; a regular type rubber traditionally used in inner tubes and general purpose applications (hereafter, R-line) and a more specialized type (hereafter, S-line). S-line products were similar to R-line rubbers but also had additional properties that allowed bonding to other materials (e.g., liners and sidewalls in tubeless tires). Both R-rubbers and S-rubbers were produced from basic raw materials such as crude oil, naphta, butane, propane, and ethane. HEF manufactured its rubber products in three operating divisions, all managed as profit centers; Tri-cities (Iowa) which focused on R-line in North and South America, Akron (Ohio) which focused on S-line products in North and South America, and Copenhagen (Denmark) which catered to customers in Europe and the Middle East for both R-line and S-line products. In addition to the three operating divisions, the HEF Group included a Global Marketing Department and a Research Division. The costs of these departments were not charged or allocated to the operating divisions, but instead were charged against Group profits. The original HEF rubber plant was built in Tri-cities around the time of World War II when R- type rubbers were becoming increasingly useful in a variety of consumer and military applications. While R-rubbers continued to be HEF's main focus over the next several decades, innovations in production technology and changes in market demand (e.g., increasing rubber applications and demand for S-rubbers) required significant capital upgrades and the ability to produce both regular and specialty rubbers. Partly in response to market and technological trends, in the mid 80s HEF built a state-of-the-art plant in Akron Ohio that focused exclusively on S-rubber products. At the same time, it committed to upgrading the Tri-cities plant over the coming decades with its renewed focus on producing R-type products. For instance, recently in 2008, HEF upgraded its Tri-cities facilities at a cost of over $100 million, which among other things increased the facility's nameplate (i.e. design or theoretical) capacity of regular R-rubbers to 95,000 tons of rubber per year. The Copenhagen plant was built in the mid 70s. At first, it was built as a regular R-rubber unit but was modified in late 90s to allow it to produce both R and S rubbers. The annual nameplate production capacity of the Copenhagen plant was also about 95,000 tons of rubber. In 2010, as in previous years, the Copenhagen plant operated close its nameplate capacity with a little over half of the capacity dedicated to meet its entire S-rubber demand. Copenhagen capacity not used to produce S-rubber was used to produce regular R-rubber. However, because demand for Copenhagen's regular R-rubber in Europe and the Middle East outpaced the plant's remaining capacity, Copenhagen satisfied its shortfall by purchasing R-rubber from Tri-cities. Although customers occasionally purchased received shipments from the divisions outside their designated geographic region, such purchases/shipments were rare. For instance, cost and/or logistical considerations usually precluded European customers from buying R-rubber from Tri-cities directly. In order to coordinate transfers of regular R-rubber from Tri-cities to Copenhagen, in September and October of each year, Tri-cities and Copenhagen prepared production estimates for the upcoming year. These estimates were based on estimated sales volumes and capacity utilization. Because the Copenhagen plant operated near its nameplate capacity already (as noted above), the planning exercise was largely for the benefit of Tri-cities' managers who needed to know how much regular R-rubber Copenhagen would need from Tri-cities. Exhibit 3 highlights the shipments of regular R-level shipments from Tri-cities to Copenhagen from 2006 to 2010. Product Costing The cost system in all divisions was a standard absorption cost system (i.e., product costs included both standard variable costs and standard fixed costs of production). Variances from standard - i.e., differences between actual and standard costs - were routinely tracked and monitored to ensure the plants were running efficiently. Variances were expensed (or credited) in the income statement in the year in which they occurred. Variable production costs included the costs of raw materials, chemicals, energy, and some labor. Because raw material prices varied with worldwide market conditions, standard costs for many of these variable inputs were revised frequently, usually on a monthly basis. Fixed production costs included indirect labor, utilities, support service costs (e.g., engineering, procurement, etc.,), and depreciation. Standard fixed costs were calculated and assigned to production based on a plant's "attainable capacity" as follows: Standard fixed cost per ton = Estimated annual total fixed costs Annual attainable plant capacity Attainable Capacity was defined in the Controllers' manual as: Attainable capacity is annual production that is practically attainable; taking into account the likelihood of abnormally low or high unscheduled production, scheduled shutdowns, and unusual items which may impact how much of a plant's nameplate capacity is practically attainable. Managers at both Copenhagen and Tri-cities were encouraged to produce at or near attainable capacity. Product transfers between Tri-cities and Copenhagen for performance reporting purposes were recorded at a transfer price equal to standard full cost, representing for each ton the sum of standard variable cost and standard fixed cost. There were no product transfers to or from Akron. Performance Evaluation and Compensation Historically, employees at the HEF Group had been paid by fixed salary with little use of bonuses except at the senior executive level. In 2009, a bonus system was instituted throughout HEF to link pay with performance and strengthen the profit center orientation of the Group. For non-management employees, annual bonuses were awarded, in amounts up to 10% of salary, based on Group and Divisional performance. For managers, the annual bonus was greater than 10% of salary and increased with responsibility levels. The bonuses for top Division management in 2010 were calculated by a formula that awarded 50% of the bonus potential to meeting and exceeding Divisional profit targets, 40% to meeting or exceeding HEF Group profit targets, and 10% to meeting or exceeding overall parent company corporate profit targets. Margaret Paine and Caleb Suarez Margaret Paine was Vice-President and Division Manager of the Tri-cities Division. A professional engineer, she had begun her career with HEF in plant management. Over the years, she had assumed responsibilities for product management as well as sales. She remarked: My rubber business is managed largely on price and margin. Quality, service, and technology are also important, but it's difficult to truly differentiate ourselves from other competitors on these dimensions. It's also important to note that this is a continuous process industry. The plant is computerized so that we need the same number of people and incur most of the same overhead costs whether the plant is running fast or slow. Unfortunately, my Tri-cities plant is currently running at less than capacity. Although with the recent upgrades the plant's nameplate is 95,000 tons, its attainable capacity currently is set at 85,000 tons. In 2010, we actually produced 65,000 tons of R-rubber, well below the attainable capacity. For 2011, we budgeted for a little more but unfortunately it doesn't look like we will get to 85,000 tons anytime soon. For instance, for the first 9 months of 2011, we budgeted to produce 55,000 tons but it didn't quite turn out that way, we produced 47,500 tons instead. Of course, it didn't help that Copenhagen took a lot less rubber volume than they had projected. I suppose I could have produced 55,000 tons as originally planned but I didn't want to carry the extra inventory. You see, we get charged for working capital in our profit report and I didn't want to take a hit for the extra inventory. Caleb Suarez, Vice-President and Division Manager of the Copenhagen Division, was also a professional engineer. His career included management responsibilities in plant operations, market research, venture analysis and corporate planning. He remarked: The Copenhagen plant's attainable capacity is 95% of nameplate capacity, about 90,000 tons. And, we typically hit our target with almost 40,000 tons of regular R-rubber and about 50,000 tons of S-rubber. In addition, we import approximately 20,000 to 25,000 tons regular R-rubber from Tri-cities. We inform Tri-cities each Fall of our estimated needs. These estimates are based on our sales forecasts and how hard we can push our plant. For example, we budgeted to produce 150 tons of R-rubber per day this year and we have got it up to about 175 tons per day. Why not - if I can squeeze more out of my plant here, why bother shipping it from Tri-cities. The Copenhagen operation has been extremely successful since I arrived here in 2007/2008. We have increased our market share in both R and S rubbers and we're running the plant better than ever. Looking at our nine-month Profit Statement for R- rubber only (Exhibit 2), our margins are better than Tri-cities' margins for the same product. While our plant is quite a bit older than Tri-cities' plant and the market dynamics are a bit different in Europe than in North America, I sometimes tease my good friend Margaret in lowa that my success here is attributable to my superb management skills. Exhibit 1 Tri-cities Rubber Division - Statement of Divisional Profit Nine Months Ended September 30, 2011 Actual Plan/budget ($000s) ($000s) Sales Revenue 61,050 - third party - to Copenhagen 35,800 tons @$1,855 12,200 tons @ $1,350 66,409 33,000 tons @$1,850 16,470 19,500 tons @ $1,350 26,325 Less: Delivery cost (2,400) (2,625) Net Revenue 80,479 84,750 Cost of Sales-at standard 48,000 tons @ $1,350 64,800 52,500 tons @ $1,350 70,875 Production cost variances (1,075) n/a (vs budget) Excess-idle capacity cost 11,375 6,125 Total cost of sales 75,100 77,000 Gross Profit 5,379 7,750 Selling, General & Admin 4,029 3,950 Business Contribution 1,350 3,800 Interest on working capital 1,375 1,800 Division Profit (Loss) (25) 2,000 Other: Inventory units - beginning 500 ton 500 ton Inventory units - ending 0 ton 3,000 ton Exhibit 2 Copenhagen Rubber Division - Statement of Divisional Profit (R-rubber products only) Nine Months Ended September 30, 2011 Actual (S000s) Sales Revenue (47,850 tons) $ 92,829 Delivery cost (4.829) Net Revenue 88,000 Cost of Sales - at standard 60,676 Production cost variances - vs budget 1.324 Total cost of sales 62.000 Gross Profit 26,000 Selling, General & Admin 7,600 Business Contribution 18,400 Interest on working capital 1.600 Division Profit (R-rubber only) 16,800 Exhibit 3 Schedule of shipments of R-rubber from Tri-cities to Copenhagen Actual tons Budgeted tons 2010 21,700 23,800 2009 12,800 13,800 2008 1,400 4,000 2007 800 600 2006 1,070 700