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MEMORANDUM

TO: Herbert Waters, President, Superior Manufacturing Company


CC: Dr. DeWayne Searcy, University of Miami
FROM: Eric Antmann, Cordel Cook, Joshua Jordan, Sam Matthew, Fabiano Praca, Sathvika
Ramaji, and Raul Velarde, Hurricane Consulting Engineers
DATE: January 30th, 2015
SUBJECT: Cost Accounting System Analysis and Recommendations

Hurricane Consulting Engineers (the Analyst) has completed an analysis of the cost accounting
system utilized at Superior Manufacturing Company and submits the findings in this
Memorandum. Should you have any further questions please do let us know.

Introduction
The Superior Manufacturing Company manufactures three industrial products: 101, 102, and
103. Superior manufactures products based on a dedicated factory concept, meaning each
product is produced in a separate warehouse with a dedicated direct labor force with indirect
labor floating between factories. These factories also include raw material storage, receiving,
production-process facilities, finished-product inventory, and shipping. After several poor
management decisions primarily by the old president, the organization had suffered and caused a
net loss of $688,000 at the end of 2004. Since then Waters, has decided to review figures for the
first-half of 2005 to make better sense of what decisions to make.
Superior competes with a group of eight companies in the New England area, some of
which are larger and offer a greater range of products. Each company sells a similar product and
the largest company, Samra, releases its selling prices at the end of each year by which the
smaller companies must match to remain competitive. This can have a damaging effect for the
smaller companies because if prices were cut by Samra they would have to match prices and
subsequently reduce their profits. During 2004, Superiors share of industry sales was 12%, 8%,
and 10% for product 101, 102 and 103 respectively.
By utilizing a simple cost system Superior is able to efficiently track the cost of
production for each product and use to value inventories, prepare budges and analyze present and
future performance. Since each product is produced separately with its own group of dedicated
workers, accounting followed this method to easily track all direct and indirect costs (the two

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categories of Superiors cost allocation system. The following are important points of Superiors
cost system:
1. Unit costs were expressed in terms of 100 pounds of finished product cost. Per 100pound rent cost of each product =unit output/respective factory rent (based on cubic
space)
2. Total cost = Factory direct cost + allocated indirect costs (which includes interest on
loans)
3. Costs were assigned directly to each individual product factory.

Drop or Keep Product 103?


By analyzing the years sales for 2004 and first half of 2005 for profit and loss it shows that
product 103 is operating at a loss of in both statements (2.2 million and 1 million respectively).
At a glance this could seem that 103 is draining resources and should be dropped from
production. But by simple cost analytics we can determine the true value of product 103. It
should be noted that there are more methods to analyze the cost data from Superiors accountants,
but we will only discuss the techniques described in class. By computing a contribution margin
of product 103 we can see value in the product. The following table shows the variable costs,
selling price and calculated contribution margin of product 103:
Variable Costs
Compensation
Insurance
Direct Labor
Power
Materials
Supplies
Repairs

0.46
6.97
0.31
4.91
0.36
0.10
13.11

Selling Price
with discount
Contribution
Margin

$
27.03
$
13.92

As the table shows, superior produces a product with a contribution margin of $13.92
which constitutes 51.5% of the total selling price. This indeed shows the product has potential to
make profit for the company. By producing more units, increasing sales the company could

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breakeven and begin to make a profitable product. If Superior dropped product 103 this would
bring as loss to all the non-variable and fixed costs, would cause a drop in sales, and would have
to renegotiate the factory rental agreement (a large portion of revenue expense) to offset this
decision. In addition, dropping product 103 would create a boom in excess capacity from which
a large portion of workers would have to be restructured or laid off in order to remain profitable
for product 101 and 102. If direct labor force were kept and the current market share remained
rigid then prices would have to drop dramatically to keep sales up, further reducing the
contribution margin. Overall we believe 103 should be continued into production and as sales
gradually increase in the long-term the product could bring valuable profit to the company.

Lower Price of Product 101? (as of January 1, 2006)


As we know, the sales for the first half of 2005 were still weak, Waters has deliberated on
the future scenario of pricing for product 101. As this is a competitive market, largely dictated by
Samras price setting, Superior has to be careful on where it places it price point. Waters made
two forecasts of the company sales of first semester 2006. The first one was to maintain the
original price of $24.5 while the second one was lowering the price to $22.5 as the competitors
planned to do. Maintaining the previous price Waters forecasted to reach 750, 000 units sales,
while reducing the price as Samra has planned to do, he forecasted 1,000,000 unit sales. The
following is a table producing a contribution margin of the product at both price points. It is
important to note that all prices have remained the same as the previous year with the exception
of materials and supplies which were predicted to drop by 5% below the 2005 standard.

$22.50

$24.50

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Variable Costs
Compensation
Insurance
Direct Labor
Power
Materials
Supplies
Repairs

$
0.39
$
6.06
$
0.11
$
3.41
$
0.24
$
0.08
$
10.29

$
0.39
$
6.06
0.11
$
3.41
$
0.24
$
0.08
$
10.29

Selling Price
Selling price
with discount
Contribution
Margin
Units Sold
Total Contribution
Margin

$
22.50
$
22.26
$
11.97
1,000,000
$
11,969,000

$
24.50
$
24.24
$
13.95
750,000
$10,460,55
0

By forecasting the sales figures with the predicted price points and unit sales, each
scenario Superior would be at a great loss, and would not be profitable. The contribution margin
calculation offers little insight to a solution to this problem, though favors the lower price largely
due to the increased units sold. Analyzing this solution from a strategic point of view, setting the
price to $23.00 with total sales at 975,000 will let us to reduce the losses, however this would
only be a short term solution due to the fact that maintaining this price higher than the one of
competitors in long term will likely lead to Superior lose market share.

Why did Superior improve profitability From Jan 1st to June


30th, 2005?
The 2005 statement was useful because it provided feedback on Waters decision to not make
changes at the end of 2004. The statements were increased in detail, showing cumulative costs
and variances of total company actual cots. Though the fundamental flaw of the 2005 statement
is that they did the determine actual product line reventues, costs and products. Instead unit

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prices were predicted and were not tailored to the current market. This way, Superior can not
accurately determine

Cost-System Appraisal
It is extremely important for Superior to have an effective cost system. This way the
company can actively monitor and predict its finances and give current feedback on whether
there management decisions are creating positive impact on the company. With a company such
as Superiors, the structure of the company offers little flexibility, as each factory at acts
independently from each other. This creates problems since each product factory has to be
assessed individually. By carefully tracking expenses Superior is able to make better judgments
on the progress of the company.
The strengths of this system are that is can be easily carried out at low cost, with good
punctuality, and covers the full costs of the company. By using the given data you can predict
accurate cost data and make good predictions. Though is does lack detail, and would benefit by
creating monthly cost analysis with further breakdown of costs.