Information/Instructions: 1.Case Summary – Katy EH Manufacturing Company The own
ID: 2481894 • Letter: I
Question
Information/Instructions:
1.Case Summary – Katy EH Manufacturing Company
The owners of Katy EH Manufacturing, a small manufacturer of gas grills, have prepared a preliminary budget for the upcoming year and would like to assess the financial impact of several alternative scenarios, including dropping a product; changing the price on a product, with a resulting increase in volume; and shifting advertising focus, with a resulting shift in volume from one product to another. A new budget must be prepared. At year-end, the actual results are better than had been planned, but not necessarily better than what should have been, given actual sales volumes.
2.Hint
Consider using the topic of contribution analysis as an easy way to analyze profit-planning issues such as adding or dropping a product or service; changing a price; adding or decreasing expected volumes; or preparing a profit budget. In this particular situation, there are three products, each with different proportions of variable and fixed costs. Make sure you can identify variable and fix costs. Pay attention to the relation of profit and contribution margin. In addition, you also need to consider non-financial factors prior to make your decision.
Katy EH Manufacturing Company
In mid-December 2015, Peter Johnson and Lily Brown were almost through with the 2016 operating budget for their company, Katy EH Manufacturing Company (EH). EH produced gas grills in three primary models (Grills A, B, and C). The industry was dominated by Lukey, Coleman, Bonnie, Sunshine, and Highland, which together made dozens of types of grills, smokers, and cooking kettles. EH was a small player in the industry, but business had been good, and it was expecting another profitable year. A draft of the company’s operating budget is shown in Exhibit 1. Standard costs for the three products are explained in Exhibit 2. Selling, general, and administrative (SG&A), other costs, interest income, and interest expense were likely to remain the same no matter which product-line combinations the company produced.
Before calling it a day, the two owners asked their assistant, Jane Sharp, to determine the impact of several options on income before tax. They agreed to meet the following day, the Sharp hurried off to look at what these latest ideas would mean. She had six questions to address (see page 1) and was asked to consider each option independent of all other options.
Sharp and the owners met the following morning to review her work. Having finished her duties, she left for an early weekend getaway. She didn’t give the budget another thought. Early in January 2017, Sharp prepared a rough draft of the actual 2016 volume, selling price, and financial results (Exhibit 3 & 4). (This case is adopted and modified from Cases in Managerial and Cost Accounting, Cambridge Business Publishers).
Exhibit 1
Katy EH Manufacturing Company Operating Budget 2016: Draft 12/18/2015
Sales $41,200,000
Less: costs of products sold 22,800,000
Gross margin $18,400,000
SG&A 9,350,000
Other costs 2,100,000
Operating income $6,950,000
Less: Interest expense 420,000
Plus: Interest income 150,000
Income before tax $6,680,000
Income taxes 2,338,000
Net income $4,342,000
4
Exhibit 2
Katy EH Manufacturing Company
Operating Budget 2016: Draft 12/18/2015
Grill A
Grill B
Grill C
Planned units
80,000
120,000
200,000
Per unit
Sales price
$150
$110
$80
Direct costs:
Materials
17
10
7
directly related to volume
Labor
21
16
4
directly related to volume
Subtotal
$38
$26
$11
Indirect cost:
Supplies
7
2
1
directly related to volume
Labor
10
8
4
one-half varies with direct labor, the rest is fixed
Supervision
8
3
1
unrelated to volume
Energy
12
6
4
one-half varies with direct labor, the rest is fixed
Depreciation
22
7
5
unrelated to volume
Support*
12
6
3
unrelated to volume
All other
11
2
1
unrelated to volume
Subtotal
$82
$34
$19
Total cost
$120
$60
$30
Profitability
$30
$50
$50
Exhibit 3
Actual 2016 Volume & Price
Grill A
Grill B
Price
$150
$110
Grill C
$75
Volume
115,000
110,000
225,000
Exhibit 4
Katy EH Manufacturing Company
2016 Operating Results: Draft 1/19/2017Revenue
$46,225,000
Variable costs:
Materials
4,800,000
Direct labor
5,200,000
Supplies
1,300,000
Indirect labor
1,500,000
Energy
1,600,000
Total variable cost
$14,400,000
Fixed costs:
Indirect labor
1,300,000
Supervision
1,200,000
Energy
1,350,000
Depreciation
3,660,000
Support
2,300,000
All other
1,380,000
Total fixed cost
$11,190,000
Total cost
$25,590,000
Gross margin
$20,635,000
SG&A
9,350,000
Other costs
2,100,000
Operating income
$9,185,000
Less: interest expense
420,000
Plus: interest income
150,000
Income before tax
$8,915,000
Income taxes
3,120,250
Net income
$5,794,750
Questions:
e) Prepare a revised 2016 profit budget assuming the owners chose Option 2 – lowering the price of Grill C to $75 and expecting sales volume of that grill to increase to 220,000 units.
f) The actual results for 2016 are shown in Exhibits3-4. Was 2016 net income more or less than what should have been expected given these actual volumes and prices? If the results were different, why.
Operating Budget 2016: Draft 12/18/2015
Grill A
Grill B
Grill C
Planned units
80,000
120,000
200,000
Per unit
Sales price
$150
$110
$80
Direct costs:
Materials
17
10
7
directly related to volume
Labor
21
16
4
directly related to volume
Subtotal
$38
$26
$11
Indirect cost:
Supplies
7
2
1
directly related to volume
Labor
10
8
4
one-half varies with direct labor, the rest is fixed
Supervision
8
3
1
unrelated to volume
Energy
12
6
4
one-half varies with direct labor, the rest is fixed
Depreciation
22
7
5
unrelated to volume
Support*
12
6
3
unrelated to volume
All other
11
2
1
unrelated to volume
Subtotal
$82
$34
$19
Total cost
$120
$60
$30
Profitability
$30
$50
$50
Explanation / Answer
Ans 1:
Ans2: The profit or gross margin as shown in the Exhibit 3-4 is more than what should have been expected. This differences in the results is mainly because of the change in the rates for the product (Grill C) as well the change in the volume. The rates & the volume has been changed bot the annual budget what should have been prepared and the actuals for the 2016.
Particulars Grill A Grill B Grill C Total Sales 12000000 13200000 16500000 41700000 Direct Cost 3040000 3120000 2420000 8580000 (Marterial + Labor) Indirect cost Supplies 560000 240000 220000 1020000 Labour Variable 400000 480000 440000 1320000 Labour Fixed 400000 480000 400000 1280000 Supervision 640000 360000 200000 1200000 Energy Variable 480000 360000 440000 1280000 Energy Fixed 480000 360000 400000 1240000 Other Fixed cost 3600000 1800000 1800000 7200000 (Depreciation+Support+All others) Total Indirect cost 6560000 4080000 3900000 14540000 Total Cost 9600000 7200000 6320000 23120000 Profits 2400000 6000000 10180000 18580000