POLITECNICO DI MILANO

Master of Science in
Management, Economics and Industrial Engineering

Management Control Systems

Prof. Paolo Maccarrone

Second Assignment: Analysis

Group
Ferrario Andrea
Rognoni Susanna
Taiana Marco
Trifonov Angel

A.Y. 2007/2008

Q1.Based on the 2004 statement of profit and loss data

(Exhibits 1 and 2), do you agree with Waters decision to
keep product 103?
In order to support an opinion on the side we decided to analyze all the probable
scenarios.
If the company management decided that it is better to stop the production of
product 103, they could do this in one of the following manners:
1. Stop production and any business related to product 103.
2. Stop production but outsource it to another company and continue the
distribution.
3. Stop production and use the available production capacity in order to
produce product 101 or 102.
If the company management decided that it is better to continue the
production of product 103, they could do this in one of the following manners:
1. Maintain the same volume of production.
2. Increase the volume of production.
3. Lower the volume of production.
4. Substitute 102 production capacity with 103 if the 103 facility has not
sufficient capacity to exploit economies of scale
Analysis of the P&L statement of 31 December 2004
If we have a look at the P&L statement for the 2004 it is obvious that product 103
is bringing substantial losses. The calculations show that there is a loss of 2.16$
per unit sold which overall totals for the amount sold to at about 2.209 million $.
A closer look at the costs attributed to product 103 shows the following.
Costs division: Direct/Indirect (000)
Direct

Indirect
$

Direct Labor(v)

25.921,00

$
Rent(non v)

5.324,00

$
Materials(v)

17.208,00

$
Property Taxes(almost non v.)

1.525,00

Property Insurance(non v)

1.463,00

$
Supplies(v)

1.360,00

Repairs(v)
Compensation
Insurance(v)

438,00

Power(v)

773,00

$
1.296,05

Indirect Labor
$ Light & Heat(almost non v,fuel
dep.)
$
Building Sevice(non v)
Compensation Insurance(non
v.)

8.846,00
$
394,00
$
266,00
$
442,30
$

Total:

46996,05

Total:

18.260,30

Percentage of the total

cost:
72%

28%

Total Cost

65.256,35

The size of the indirect non variable costs is quite high. It amounts for 28% of all
the costs. If we keep in mind this information and reason on the statement of the
management that the production facility is normally working under its full
capacity we could suggest that there is a possibility of benefitting from
economies of scale.
If we assume this possibility and plot the change in price related to the change in
production volume we get the following:
Compen
Ins(v)

Direct
Labor(v)
$

209,09

4.181,87
$

226,52
243,94

$
$

$
351,88

$
8.363,75

$
435,61

$
336,58

8.015,26

418,19

$
321,29

7.666,77

400,76

$
305,99

7.318,28

383,34

$
290,69

6.969,79

365,91

$
275,39

6.621,30

348,49

$
260,09

6.272,81

331,06

$
244,79

5.924,32

313,64

$
229,49

5.575,83

296,22

$
214,19

5.227,34

278,79

$
198,89

4.878,85

261,37

$
183,59

4.530,36
$

$
367,18

$
8.712,24

$
453,04

Power(v)
$

$
382,48

$
9.060,73

Other Income Fixed Costs

$

$
397,78

Materials(v)
$
2.949,01
$
3.194,77
$
3.440,52
$
3.686,27
$
3.932,02
$
4.177,77
$
4.423,52
$
4.669,27
$
4.915,02
$
5.160,77
$
5.406,53
$
5.652,28
$
5.898,03
$
6.143,78
$
6.389,53

SGDI
$

Supplies(v)
$
212,77
$
230,50
$
248,23
$
265,96
$
283,70
$
301,43
$
319,16
$
336,89
$
354,62
$
372,35
$
390,08
$
407,81
$
425,54
$
443,27
$
461,01

Repairs(v)
$
63,22
$
68,49
$
73,76
$
79,03
$
84,30
$
89,57
$
94,84
$
100,10
$
105,37
$
110,64
$
115,91
$
121,18
$
126,45
$
131,72
$
136,98

volume
600
650
700
750
800
850
900
950
1000
1050
1100
1150
1200
1250
1300

51,00

5.423,44

volum
e

unit price

600

39,76

650

37,70

700

35,93

750

34,40

800

33,07

850

31,89

900

30,84

10.681,00

Sales
$

$
16.212,90

$
$

$
$

$
$

$
25.670,43
$

25,35

0,06
$
0,64
$

33.776,88
$

1300

$
32.425,80

25,84

$
-0,57

31.074,73
$

1250

-1,27
$

$
26,38

$
29.723,65

26,96

$
-2,03

28.372,58
$

1200

-2,88
$

$
1150

$
27.021,50

27,59

$
-3,81

1100

$
-4,86

24.319,35

28,29

$
-6,04

22.968,28
$

1050

$
-7,38

21.617,20

29,05

$
-8,91

20.266,13
$

1000

$
-10,68

18.915,05

29,90

$
-12,73

17.563,98
$

950

Profit(Loss) p. unit

$
1,18

$
35.127,95

$
1,67

Profit(Loss) total
$
-7.640,11
$
-6.939,00
$
-6.237,88
$
-5.536,77
$
-4.835,66
$
-4.134,55
$
-3.433,44
$
-2.732,33
$
-2.031,22
$
-1.330,11
$
-629,00
$
72,11
$
773,23
$
1.474,34
$
2.175,45

It is obvious that for volumes higher than 1 150 000 product 103 is actually
profitable. These calculations are made without taking into consideration the
expected 5% diminishment of the prices of materials and supplies in 2006.
(did not take into consideration the change of price of sales, admin, indirect
labor)
Sensitivity analysis
In order to make recommendations for a possible strategic course of actions we
need to take in consideration the variance of some key indicators.
These are:
1. The operating capacity of the facility and the level at which it operates
now.
2. Possible changes on the market volume and companys market
share(expected reactions from the competitors)
3. Potential savings
4. Inventory costs
Strategic scenarios

Having in mind the analysis of the current situation we could offer some
scenarios for strategic actions to the management of Superior Manufacturing.
Referring back to the first paragraph we can explore the following options:
Stop the production of product 103:
1. Stop production and any business related to product 103.
2. Stop production but outsource it to another company and continue the
distribution.
3. Stop production and use the available production capacity in order to
produce product 101 or 102.
1. Stopping the production of product 103 in the current situation would
mean that the company will no longer produce a non profitable product.
This will bring to avoiding a possible potential loss of at about 2.2 million $
assuming expected sales of 1million units.
On the other hand it will bring as a loss all the non variable, fixed
expenses, missed sales profit, restructure of the workforce etc. To calculate
these we assume that in short term, i.e. for the next operating cycle (year
2005) the company will:
a. continue to pay all the fixed expenses
b. not sell the machinery
c. totally reduce the directly occupied working force
d. still need at about 10% of the indirectly occupied workforce and
general administration in order to secure and maintain the
operations still related to the rented and possessed property.
$
Rent(non v)

1.882,00

Property Taxes(almost non v.)

401,00

Property Insurance(non v)

534,00

Compensation Insurance(v)

45,80

Direct Labor(v)

Indirect Labor

230,90

$
1.882,00

$
401,00

$
534,00

$
458,00

$
6.879,00

$
2.309,00

$
Power(v)

$
302,00

$
Light & Heat(almost non v,fuel dep.)

$
106,00

$
Building Sevice(non v)

$
75,00

$
Materials(v)

$
4.851,00

$
Supplies(v)
Repairs(v)

$
350,00

104,00
$

Total

3.093,70

$
18.249,00

$
Selling expenses(non v,changeable) General
Administrative(non
v,changeable)
178,30

$
4.701,00

$
1.783,00

$
Depreciation(non v,changeable)

3.658,00

Intereset(non v,changeable)

539,00

Total Cost
Less:Other
v,changeable)

7.469,00

$
3.658,00

$
539,00

$
Income(non

$
28.930,00

$
-

$
51,00
$
28.879,00

$
Sales (Net)

Total loss

7.469,00

$
26.670,00

$
2.209,00

It is obvious that at least in short and mid-term period stopping the production
would bring much bigger losses than continuing it. Therefore we cant
recommend this as a good solution of the situation
2. Knowing the current state and especially how specific is the industry it is
highly unlikely that outsourcing can be an option.
3. Using the existing production capacity in order to produce one of the other
products that are known to make money for the company (product 101) or
at least not such big losses (product 102) is also not a solution. We know
that the market is very rigid and it is pretty much impossible to double the
market share without any substantial price changes.
Taking into consideration all of the above said continuing the production of
product 103 is the viable option. When exploring however this option we need
to take into consideration the production capacity of the facility and the
level to which it is exploited. For instance in the document it is mentioned
that the factory is working under capacity, but this could mean that it is working
as well as on 40% of capacity as well as on 90%. Another consideration would be
the financial health of the organization. This is necessary as any of the scenarios
would require a period of losses or increased expenses. We need to know how
much of these the company could support financially from a strategic point of
view.
1. Lowering the volume of production is obviously not the worst solution but it
is a bad solution. Strategically it could serve as to soften the period of
transition towards stopping the product 103. From table xxx and yyyy(to
number the tables and graphics) is obvious that lowering the production
level to less than 700 000 units is economically a worse decision than
stopping the production immediately

2. Maintaining the same level of production can be again a good mid-term

approach serving as a transitional period towards increasing the level of
production. We say this because as we know the market is quite rigid. This
means that it will take quite some time for the company to increase its
market share. Probably this could happen if some of the other players on
the market vanish or the company takes an aggressive price policy. In this
case increasing the production volume would bring to building of inventory
in the amount of 200 000 to 500 000 or more units. For the scale of the
company this is a huge inventory. That is why as a short or even mid-term
solution it would be better to maintain the same volume of production. This
of course requires calculating and comparing the current losses of sales to
the expenses for inventory or a very aggressive pricing policy.
Another key factor needs to be taken into consideration here as well. This
is the production capacity of the factory. We know that the factory is
working under capacity but if this means that it is currently exploiting 85%
or 90% of it, then the factorys production capacity is not higher than 1,
1.1 million units. In this case obviously the best long-term solution is
maintaining the pretty much same level of production as it will spare us
from incurring a loss of 7 million $.
3. Increasing the production volume is obviously the best solution. This is
possible only if the factory is working on a grave under capacity regime.
For example if it is exploiting only 40%-50% of the machine productivity. In
this case the full economies of scale potential could be exploited. A good
prediction could be that producing 1,4 or eventually even 1,5 million units
annually could give the company the price flexibility in order to take
aggressive price positions and eventually gain an additional 5%-6% market
share. With this market positions it will sell all of its production and be
making at about 2-2.5 million of profit from product 103.

Q2. Should Superior lower as of January 1, 2006 its price of

product 101? To what price?
Analyzing the future scenario of the company and of the whole market on the
basis of the price variations applied by the competitors on the product 101,
Waters made two forecasts of the company sales of first semester 2006. The first
one was done maintaining the original price of 24,5 $ while the second one was
realised 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
units sales.
First of all the forecasted balance sheet for the first semester 2006 has been
calculated reallocating the costs using the given allocation basis, starting from
the total costs to the total department costs, then to the unitary costs.
The assumptions made in order to calculate the budget for the first semester of
the year 2006 were:

The amount of unit sales of products 102 and 103 will remain the same
unless the decreasing trend of the market described in the case, thanks to
the company cash discounts which will remain the same.

The unitary costs of direct labour and repairs will remain the same.
The unitary cost of materials and supplies will be lowered of 5% as
described in the case.
The total non variable costs having a fixed allocation basis will remain the
same (rent, property taxes, property insurance, power, light and heat,
building service, depreciation, interests).
The total non variable costs depending on a variable allocation basis have
been recalculated and reallocated (compensation insurance, indirect
labour, selling expense, general administrative, other income).
Setting a price of 24,5 $ corresponding to a sales of 750.000 the calculated loss
reaches 2.207.000 $ as show in the following table :

PRICE = 24,50
Prod 101
std. per
100 lbs.

Prod 102

Prod 103

total
std.

std. per
100 lbs.

total
std.

std. per
100 lbs.

total
std.

TOTAL
STD

NON
Var.

rent

1,25

936

1,10

785

1,88

941

2.662

2.660

property taxes

0,42

314

0,36

254

0,40

202

770

770

property
insurance

0,35

262

0,28

203

0,53

267

732

732

compensation
insurance

0,41

310

0,40

288

0,48

239

837

917

direct labor

6,06

4.54
5

5,92

4.216

6,97

3.494

12.255

DIRECT

indirect labor

2,22

1.66
3

2,17

1.543

2,55

1.279

4.485

4.485

power

0,16

123

0,20

140

0,34

169

432

432

light and heat

0,11

80

0,09

66

0,11

54

200

200

building service

0,06

44

0,05

33

0,06

30

107

107

materials

3,41

2.55
8

4,35

3.098

4,66

2.338

7.994

DIRECT

supplies

0,24

178

0,44

311

0,34

171

661

DIRECT

repairs

0,08

60

0,15

107

0,10

50

217

DIRECT

18,42

9.234

31.352

TOTAL

14,76

11.0
74

15,51

11.04
4

selling expense

4,79

3.59
5

4,99

3.556

5,34

2.679

9.830

9.830

general
administrative

1,60

1.20
3

1,67

1.190

1,79

896

3.289

3.289

depreciation

3,78

2.83
8

3,01

2.144

3,66

1.835

6.817

6.817

interest

0,35

260

0,28

203

0,53

267

730

730

TOTAL cost

25,29

less: other income

0,05

18.9
70
40

25,47

18.13
6

0,06

29,75

40

0,06

14.91
2
30

52.018

110

25,24

18.9
30

25,41

18.09
6

29,69

14.88
2

51.908

actual sales (net)

24,24

18.1
77

25,25

17.97
9

27,02

13.54
5

49.701

profit (loss)

-1,00

-0,16

-117

-2,67

-1.337

-2.207

unit sales (100

lbs.)

-753

750.000

712.102

110

501.276

Considering the second forecast the setting price was 22,50 $ corresponding to
1.000.000 unit sales; also in this case there is a loss but lower than before:
649.000 $. The following table listed the losses of each product:

PRICE = 22,50
Prod 101
std. per 100
lbs.

Prod 102
total
std.

std. per 100

lbs.

Prod 103
total
std.

std. per 100

lbs.

total
std.

TOTAL STD

NON Var.

Rent

0,94

936

1,10

785

1,88

941

2.662

2.660

property taxes

0,31

314

0,36

254

0,40

202

770

770

property insurance

0,26

262

0,28

203

0,53

267

732

732

compensation
insurance

0,40

402

0,39

279

0,46

232

913

917

direct labor

6,06

6.060

5,92

4.216

6,97

3.494

13.770

indirect labor

1,97

1.974

1,93

1.373

2,27

1.138

4.485

4.485

Power

0,12

123

0,20

140

0,34

169

432

432

light and heat

0,08

80

0,09

66

0,11

54

200

200

building service

0,04

44

0,05

33

0,06

30

107

107

Materials

3,41

3.411

4,35

3.098

4,66

2.338

8.847

DIRECT

Supplies

0,24

238

0,44

311

0,34

171

720

DIRECT

Repairs

0,08

80

0,15

107

0,10

50

237

DIRECT

13,92

13.922

15,26

10.865

18,13

9.087

33.874

selling expense

4,07

4.068

4,61

3.286

4,94

2.476

9.830

9.830

general
administrative

1,36

1.361

1,54

1.100

1,65

828

3.289

3.289

depreciation

2,84

2.838

3,01

2.144

3,66

1.835

6.817

6.817

Interest

0,26

260

0,28

203

0,53

267

730

730

TOTAL

DIRECT

TOTAL cost
less: other income

actual sales (net)

profit (loss)
unit sales (100 lbs.)

22,45

22.450

24,71

17.598

28,91

14.493

54.540

0,05

46

0,05

37

0,06

28

110

22,40

22.404

24,66

17.561

28,86

14.465

54.430

22,26

22.257

25,25

17.979

27,02

13.545

53.781

-0,15

-147

0,59

418

-1,84

-920

-649

1.000.000

712.102

501.276

The sales of the product 102 enable the company to have profits, anyway in the
second semester there will be a huge loss due to the allocation of costs; during
the first semester in fact there is the production of the main part of the yearly
sales unit so the costs could be spread on a large number of product while in the
second one they will be divided on few units (these calculations were done
assuming that the demand of 2006 will be closer to the demand of the previous
year).
The difference between the forecasted profits in these two solutions highlights a
loss in both the cases; for sure, the best solution is the second one which
guarantee a lower loss (1.558 $ difference).
Considering the huge losses related to these two alternatives, merged the need
to identify a function describing the relation between the demand and the price
in order to find if there are any intermediate solutions which allow to have reduce
the losses.
In order to evaluate the dependence between demand and price, it's necessary
to make an assumption regarding the nature of this dependence. Two different
assumptions were been made: a linear trend of the function (constant elasticity)
and a non linear one.
In the first case the linear trend of the function has been identified starting from
the two points forecasted by Mr. Waters, that allowed to trace a straight line
representing the function. The best demand/price combination calculated in order
to maximize the profit has a price of 20,36 $ with a related demand of 1.267.367
units. This solution, which is the best one, generates a loss of 148 $ and this
result highlights the fact that in the first semester of 2006, for sure, it will not be
a positive profit.
This solution is not applicable because the company can't make a price lower
than the price maker's one, so the best solution with the linear dependence is to
set the price at 22,50 $.
In the second case (non linear dependence), a function has been created by
increasing the demand of a variable value. This alternative has been analyzed
only in the price interval between 22,50 $ and 24,50 $, which are the two
forecasted prices, and generated this result:

110

Price

Units

Profit

$24,50

750

-$2.207

$24,40

772

-$1.972

$24,30

793

-$1.755

$24,20

813

-$1.557

$24,10

832

-$1.376

$24,00

850

-$1.213

$23,90

867

-$1.066

$23,80

883

-$937

$23,70

898

-$824

$23,60

912

-$727

$23,50

925

-$674

$23,40

937

-$581

$23,30

948

-$532

$23,20

958

-$497

$23,10

967

-$477

$23,00

975

-$471

$22,90

982

-$480

$22,80

988

-$502

$22,70

993

-$538

$22,60

997

-$587

$22,50

1000

-$649

The best solution found with the assumption of non linear trend in order to
maximize the profit is a 23,00 $ price with a demand of 975.000 units; the result
of this alternative is a loss of 471 $.

Q3. 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?
We are convinced that the costing system Superior Manufacturing used to
register the results of the first semester of 2005 was very imprecise further than
useless to check the performances of the different units.
To demonstrate this we are going to compare it with the system we suggest,
showing how the first semester was really quite profitable even if it would have

been followed by a worst second semester that would bring at the end of the
year losses comparable to those of 2004. In fact, without making any calculations
it seemed so strange that with the same period costs (that are in large part nonvariable or fixed), the same direct costs for products, the same annual sold
quantities, and the same prices, the company was able to significantly improve
its performances.
So from the beginning we looked with suspicion at the results of the first
semester, immediately finding out that if product 101 and product 102 sold
respectively the 46,75% and the 50,79% of the annual quantity, it is almost clear
how non balanced are the sales of product 102; after only 6 months the 69,26%
of 102 sales were already registered.
In the following paragraphs we are going to make some hypotheses, trying to
explain the reasons for all the significant variances we found. Since it is a
problem of profitability, we first look at revenues and costs nature and then we
show where the data reported in exhibit 4 are misleading.

Revenues
From an only superficial external analysis, thats to say how was it allowed by the
small number of data we have, in 2005 the market was not growing; so the good
results in term of quantity sold seem to show a very good semester for sales but
this is probably due to the natural cyclic proceeding of the sales of an industrial
good, such as the percentage showed before confirms; probably owing to
economies in the reordering process and the issues related to the dimensions of
lots of delivery impacting on logistics costs, customers are likely to buy a larger
amount of product 102 at the beginning of a new year, while at the end they try
to minimize values of finished goods and components stocks. This is a common
way of behaving in B2B markets, with different solutions that fit different goals,
like the minimization of inventory value or the lowering of net profit to avoid a
huge expense in taxes.
Larger quantities of products already sold at the end of June mean fixed costs
spread on a larger number of products and so an improvement in profitability;
however this appreciable gain is only temporary, because it will be balanced by
results of the second semester and thats why Waters expects a new worsening
of the situation (that is in reality physiological, such as we will show later
differently allocating the period costs). Even if we have no data about the actual
sales of the second semester of 2005, since the market is expected to be stable
or even decreasing, larger quantities in the first semester should correspond to
very low sales in the second one, with product 102 that will have to cover the
fixed expenses of the second semester of its factory with only the 30,84% of the
total annual sales.
Interesting would be to know something more about stock values that at the
beginning of the year should have been very high values, since customers buy

larger quantities in the first semester. If the way to account the stock is the same
of finished goods, stock can account for a considerable amount of money.
Costs
We already anticipated the main reason that stands behind the large part of
positive variances that the exhibit 4 shows between actual and expected results.
What is evident is that variable direct costs (Direct Labor, Materials, Supplies,
Repairs) were allocated by Superior in a correct way, calculating the unitary costs
and then multiplying it times the actual sales. No variances are reported on the
cost of components or raw materials, so that we can retain as reliable the actual
costing system, that, we have to remember it, uses the unitary costs of the
previous year. However exactly this feature of the costing system lets happen
some things: fixed or non-variable costs are allocated on the basis of the past
years results but also on a period shorter than the annual time horizon. This
means for example that if this year the company produces more than in the past,
it will spend more for the rent than the same contracted cost: this is an absurd
because it is a fixed cost for the following 12 years. In the 2005 first semester
documents we can see lots of these deviations, all the time that a cost fixed on
the annual time horizon is allocated on a semester sold quantity. We can say that
the principle of competence cost is totally violated. And this is the reason by
which actual registered costs are, for all those kind of costs but two voices, so
lower:

Rent (fixed allocated on cubic space)which is lower of 259 k$

Property taxes (almost non-variable allocated on the area): -69 k$

Property insurance (non-variable allocated on the value of equipment):

-61 k$

Indirect labor (almost non-variable allocated on the direct labor): -213 k$

Building services (non-variable allocated on the area): -40 k$

General administrative (almost non-variable allocated on the value of

sales): -125 k$

Depreciation (non-variable allocated on the value of equipment): -642 k$

Interests (almost non variable value of equipment): -63 only to semester

All these costs were expected to be higher because the unitary costs of the
previous year were multiplied times the actual sales but they dont depend on
the quantity sold.
A different explication has to be made for the other voices: the compensation
insurance remains practically indifferent because direct costs increased (owing to
increased quantities) while indirect ones are better distributed on the increased
quantities (obviously not according to the costing system used by Superior).

Power (variable cost, allocated on the machine horsepower and thus on the level
of activity) doesnt significantly change because on 4148819 units totally
produced in 2004, the 2210237 units made in the first semester of 2005
represent the 53% of total production and thus a little change in total activity
level. Light and heat costs (almost non variable, allocated on the area) were a
little bit higher than standard one probably because in the considered semester
there are more days of winter (valid explication only if the factories are located in
the north hemisphere). Last but not least, there was the role of selling expense
that increased considerably both considering the standard costs and the period
costs of competence.
In the tables below there are all the costs recalculated in two different ways: in
the column our suggestion there is a sort of budget, in which all the fixed or
non-variable costs are attributed to the production of the semester taking the
annual result of the previous year (divided by two, to assess the quota of the cost
for the semester) and the direct costs are calculated with the unitary costs of
previous years and the actual sales. In the hybrid column, we use the same
method but with actual sales and costs. The unitary costs relative to this second
column are those shown in the other columns; only direct variable costs present
the same unitary costs of previous year.

The difference between the final profit of our suggested method and the hybrid
one is mainly due to the increased cost of selling expenses: they had an
unexpected increase in costs so that we can think that the general bad and
worsening conditions of the market caused a more difficult costs management by
sales that had to increase their effort even only to maintain the same sales
levels.
The situation of the second semester shows how was right our hypothesis about
the unexpected profitability of the first semester of 2005.

In the end, this is the situation for 2005; as we can see the losses are very similar
to those of 2004, with the difference mainly due to the previous underlined costs
of sales.

As regarding the usefulness of data from the exhibit 4, we will explain how
inaccurate it was in detail in the answer to the fourth question. Anyway, we
already said that, even considering the highly timeliness of this system that
allows to have results of the semester only one week later, the way to consider
full costs and allocate them on products was totally wrong and it doesnt seem
that can give some useful advice to the top management, except for the
evidence that a better use of the total capacity cant do nothing but improving
the total profitability of the company. In fact, higher quantities obviously would
help to cover the fixed costs, increasing the profitability of the single products.
This would be possible whether the logics of production are totally untied by
those of sales: if it is not possible to quickly improve sales results, it is useless to
produce at the maximum capacity, even if the benefits would be unquestionable.

Q4.Why is it important that Superior has an effective cost

system? What is your overall appraisal of the companys
cost system and its use in report to management? List
the strengths and weaknesses of the system and its
related reports for the purpose management uses the
systems output. What recommendations, if any, would
you make to Waters regarding the companys cost
accounting system and its related reports?
Why is it important that Superior has an effective cost system?
An effective costing system makes it possible for the management to follow their
processes/products and have a realistic understanding about the difference
between what was planned and how it is actually happening. It can help plan
further activities and course of action.
In the case of Superior Manufacturing Co it is critical for some reasons.
First of all theres been a recent change of management. In two consecutive
years two different managers take the lead of the company. It is understandable
that they more or less are unfamiliar with the exact way company operations are
lead. On the other hand the market situation is getting more complicated every
day and as well because of the major shift in management, the morale and
support of the employees drops drastically. In a case like this a good cost system
could be of great help as it can show to the new management the way operations
are lead historically and the position the company has benchmarked to its
competitors and on the market nowadays. It also can indicate the flaws and point
out a clear course of action for the new management to follow. Having an
effective costing system also shortens drastically the period of adaptation of the
new management.
Secondly the company operates in a really rigid, non growing market. It has
heavy competition, some of which is superior in terms of scale of operations and
therefore financially. Obviously in a situation like this the only flexibility in terms
of margin and strategic actions could come from lowering the cost of production.
Because of this it is critical that an exact and meaningful cost and expenses
control system is established. It should be used to identify the possibilities for
lowering costs, choosing alternative scenarios or different balance and
distribution of costs.
What is your overall appraisal of the companys cost system and its use in report
to management?
Overall we can conclude that the companys costing system is highly insufficient
for the managerial purposes it is intended to serve.
We know from the data provided that each from the dedicated factories has the
process horizontally integrated and therefore include raw material storage,

product-process facilities, finished-product inventories and shipping. The

information provided by the current costing system is quite brief, aggregated and
unpunctual to describe these in debt. More over the company is currently using
this system in order to do its strategic planning, product-line decisions,
identifying manufacturing process-improvement opportunities, to conduct
profitability analysis, performance evaluation, cost control, and inventory
valuation purposes.
As it appears the Superior Manufacturing Company is using the same costing
system in order to:

Perform planning & controlling activities and processes, like

identifying
manufacturing
process-improvement
opportunities,
performance evaluation, cost control

Take short-term strategic decisions, like product-line decisions,

conduct profitability analysis, inventory valuation, cost control

Take long term strategic decisions, like strategic planning

This is obviously impossible as the different audiences require different

information in order to make the decisions corresponding to their level. With
some assumptions (ex. If the system is applied in a correct way regarding the
period costs etc. ) we can say that the present system is fit in order to support
short-term decisions for marketing, product, business and senior managers. In no
way it can support planning and control, not to say about long-term strategic
decisions. If we go back to the previous analysis we can state that overall the
company has problems mostly on these levels.
Probably one of the things the new management noticed was the insufficiency of
the system and that is why from the beginning 2005 a new system was
introduced. This system was supposed to help focus on valuation of inventories,
budget preparation, performance analysis. It had a different model of cost
allocation but still could not support the necessary scale of managerial decisions.
List the strengths and weaknesses of the system and its related reports
for the purpose management uses the systems output.
Regarding to the previous paragraph we obviously can not evaluate the costing
system in absolute terms. IF we should speak about its strengths and weaknesses
it should be related to the purposes it was supposed to serve, served and could
serve.

Strengths: No matter that the costing system seems to have a lot of

imperfections it obviously served some purpose to the
management and was not a random casual one. If we take into
consideration the current company state and the continuously
increasing complexity of the market environment we could list
some points that support the relevance of such reporting system.
These are:

Timeliness in the paper is mentioned that the preliminary semestrial

statement for 2005 was issued at the end of the first week of July. Of
course the timeliness is a compensation for non punctualities on the
costing model but still when information is needed quickly it is better to
have some than none.

Low Cost obviously both the 2004 and the new 2005 systems does not
require a lot to prepare. They use mostly information that is available from
previous years and the sales force. Also because of its nature it is
prepared annually and only if explicitly ordered on the half year. In extreme
cases it might be prepared even quarterly (although it might not be very
indicative for short and long-term purposes) but in any case the price of
this report would on the scale of a simple bookkeeping report.

Simplicity another benefit of this costing system and its derivative

reports is the simplicity. The data is quite aggregated and straightforward.
For many purposes this would be inefficient but it might serve a new
manager to get the basic picture of the state of the company and give a
reference point for further actions.

Weaknesses: If w should take into consideration the purposes the

system was intended to serve as noted above we found it quite
weak as a managerial tool.

Incorrect allocation of costs on non full operating cycle, by which serves

more to confuse than to inform

Only straightforward data, which limits the possibilities of its use by the
superior management

Not enough detail in the data, which gives no possibility for low level
analysis on the real causes by mid level (product, marketing, sales) and
superior management. No possibilities for evaluation on cost control.

What recommendations, if any, would you make to Waters regarding the

companys cost accounting system and its related reports?

We would recommend a couple of things listed from the most tactical to most
strategic.
First and most urgent, the management should correct its current costing
systems to indicate the correct mid-term results and to make the relevant

conclusions. If they believe it might be more efficient (as they might decide to
implement a new costing system from the next year) they could disregard them
and consider the annual result which should be relatively correct.
In a mid-term (at about 1-3 year plan) we recommend to them to apply a set of
cost accounting systems that are to serve the respective audiences (low, mid, top
level managers) with the relevant for them information. Why would this be
necessary?

At planning & controlling activities and processes level we know

that the management is not being trusted and lacks support. Also we know
that it is critical that the company be as cost effective as possible. A
system that establish a process coherence with top management strategic
planning (which is financial and non comprehensible for the lowest levels
of the company) and a framework of specific goals, objectives and
procedures for control would give understanding about the mission and the
direction of the company. If applied with the correct system of control
(evaluation, feedback and coaching) this would raise morale and regain
trust for the management. Also is going to help the management perform
the necessary changes in an effective way.

At the level of short-term strategic decisions we could see that

these require much more information that is currently being provided. Not
only for the superior management but also for the sales, marketing,
operations and business managers, disaggregated, financial and nonfinancial information should be provided. For instance if a lifecycle of a
product is regarded using the principles of activity based costing or JIT this
could serve to a totally different approach to determining the production
process and therefore the price.

At a long-term strategic level we need a more complicated approach as

none of the so far suggested cost accounting systems support forecast of
scenarios and future cash flow. These however could serve as a basis for a
future analysis using elements of capital budgeting and investment
management.

Last we suggest that the company not only integrates the set of costing systems
recommended but continuously monitor the effectiveness of these systems, in
order to prevent extra and repetitive or useless reporting which would only add
another cost.