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CASE STUDY Uncle Grumps Toys

One morning John Worby, President of Uncle Grumps Toys, sat down with Anne McMullen, Executive Vice President, to discuss year-end performance evaluations of the management group. These discussions were important because the company had traditionally given its managers a sizable bonus based on their evaluation. To the extent that it was possible, John and Anne preferred to base their evaluation on objective measures of performance with an emphasis on achievement of budgeted goals. The budget process began in late August, and by mid-November the management team supplied the board of directors with a complete budget outlining monthly sales estimates, production cost estimates, and capital spending requirements. The directors then discussed the implications of the budget and, upon acceptance, authorized it. The firm's progress throughout the year was monitored against this budget every six months at the board meetings, which were held on the fifteenth of January and July. At the January meeting the board also voted on the management bonuses for the prior fiscal year. Uncle Grumps Toys was a New England-based company that manufactured a very successful line of foam rubber toys called "Uncle Grumps." These were cuddly Hobbit-like dolls with large noses, a discerning smile, and enormous feet, which sold for $20 wholesale. From the moment of introduction, they had been a runaway success. Plans to expand the line were on the drawing board, and a smaller baby version was to be introduced in the spring of 1997. The business was highly seasonal with over half of the sales occurring from mid-August to early November. This was followed by a two-month trough before birthday and occasional gift sales picked up again. Sales were then fairly stable until the next Christmas rush began. Budgeted sales for fiscal 1996, ending November 30, 1996, had been $40 million with an expected gross margin, on full production cost, of 24 percent. Management had decided that even though sales were highly seasonal, production would be level throughout the year. This enabled Uncle Grumps Toys to stabilize employment and to sell a greater number of toys during the Christmas period than would have been possible if a shift approach had been used. Normal production was at full capacity using one shift a day, five days a week. In 1995 sales had been considerably greater than expectation and had almost resulted in orders being rejected due to a lack of inventory. In fact, by year-end only 44,000 toys were left in stock to begin fiscal 1996. John and Anne decided to discuss the production manager's performance first. The production manager, Holly Frost, had been with the firm for just over a year, and this was to be her first bonus. John and Anne admired Holly and felt she had been very innovative and had substantially improved the production process. One improvement, introduced at the beginning of the third quarter, resulted in the average material content of each toy being reduced from 5 lbs. to 4.5 lbs., a substantial savings. In measuring Holly's managerial performance, John and Anne felt that some adjustment was necessary because 1996 had been a rather turbulent year. The factory had been closed from February 5 through March 1 (20 working days) due to "The Great Blizzard of '96," when the factory roof collapsed under the weight of three feet of snow. During this period employees did not work but were given half of their normal pay. To make up for lost production, a four-hour Saturday morning shift was introduced from March 9 until the end of the year. Employees were paid time-and-a-half for this work. Additional

overtime was required in the fourth quarter when the sales department managed to gain a $750,000 order from a catalog sales company for an extra 50,000 toys. The order was placed in the middle of October and, along with other orders, required that overtime be increased to 16 hours per weekend, at time-and-a-half, for seven weekends (this includes the Saturday morning time already planned). Sales for fiscal 1996 were 2,094,000 units, as the company had literally sold every toy available. John and Anne started with the budgeted and actual figures reported in Exhibit 1. The company had not implemented a standard cost system. Because unit costs were relatively stable, direct materials were tracked in pounds, direct labor in hours, and actual usage was compared with budget. Before they could adequately judge Holly's performance, however, John and Anne decided they needed additional information. John spoke with the materials inventory clerk and came back with an inventory listing (Exhibit 2) and a reminder that the company used FIFO inventory costing. Anne contacted the payroll clerk and was given a summary of quarterly payroll listings (Exhibit 3). Looking at the pile of information they had collected, John and Anne settled down to the process of evaluating Holly's performance. After several hours John and Anne took a break. Over coffee Anne remarked to John, "Well, now we have a lot of facts but it's not clear to me how we can use them to analyze Holly's performance." "I have the same concern," replied John. "There are so many numbers and only some are relevant to Holly." "I know, but which ones? That's the question." "That's first on the agenda when we finish coffee. But there is something else bothering me and that is a comment Holly made about those catalog sales," said John. "What was that?" asked Anne. "Well, Holly thinks we lost money on the deal because we sold them to the catalog company below cost." "Didn't you explain to her about contribution analysis?" asked Anne. "Well, yes, but she said she understood that, and we were still losing out. Unfortunately, she was called away before she could explain what she meant." Questions: 1. 2. What was the budgeted cost per toy? Explain, with an approximate standard cost card. Prepare a (balanced) evaluation of Holly Frost's performance as production manager. Be as specific as possible. Evaluation criteria would include effectiveness and efficiency. You might start with as many variances as you can compute, and make an interpretive judgement as to responsibility. Was the catalog order profitable? Explain, being as specific as possible.

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EXHIBIT 1 QUARTERLY PRODUCTION REPORT (all figures in thousands) Quarterly Actuals Quarterly Budget* Variable costs Raw materials purchases Direct labor Indirect labor Supplies Power Fixed costs Repairs and Maintenance Depreciation Insurance Manufacturing costs Units produced *Budget based on raw materials of 5 lbs/toy and direct labor of 0.962 hrs/toy $1,800 3,848 300 75 375 300 700 250 $7,648 500 1 $1,410 3,205 250 50 270 130 700 252 $6,267 350 2 $1,775 4,406 350 100 420 120 700 231 $8,102 550 3 $2,190 4,466 356 50 410 500 700 260 $8,932 550 4 $1,880 5,453 410 90 450 280 700 260 $9,523 600 Total 1996 $7,255 17,530 1,366 290 1,550 1,030 2,800 1,003 $32,824 2,050

EXHIBIT 2 SUMMARY OF RAW MATERIAL MOVEMENTS (all figures in thousands) Opening balance (December 1, 1995) Purchases (Dec.1, 1995Nov. 30, 1996) Raw materials available - Closing balance (November 30, 1996) Usage (Dec.1, 1995-Nov. 30, 1996) EXHIBIT 3 SUMMARY OF DIRECT LABOR EXPENSES (all figures in thousands, except employees) Average number of employees 960 970 980 990

Pounds 718 10,000 10,718 1,148 9,570

Cost $500 7,255 $7,755 864 $6,891

Regular Hours 494 500 505 510 2,009

Overtime Hours 0 52 54 135 241 Cost $3,205 4,406 4,466 5,453 $17,530

13 weeks ending 3/1/96 13 weeks ending 5/31/96 13 weeks ending 8/31/96 13 weeks ending 11/30/96 TOTAL * First quarter regular hours include the 153,000 hours when factory was closed for 20 days, during which time employees received half pay. Holly was responsible for negotiating all labor contracts.