Superior Manufacturing Co.

– Case Analysis

By- Group 9

(Dhiraj Agarwal, Akshay Sharma, Harish Vijayan, Soumitra Dubey,

Hiteswara T.)

Submitted To-
Dr. T.P. Ghosh
About the Company:

Superior Manufacturing Company dealt in three industrial products, i.e, product 101, product
102 and product 103. These goods were used as crude material by other assembling
organizations. The whole of the company’s sales force used to work towards selling these
products, but in varied quantities. The organization operated in New England with seven other
competing firms with a similar product line. Amongst the eight manufacturers, Samra Company
was the potential dominator of the market. Owing to its large market share Samra used to affect
the development in market price of the item very often. The market in which the company
operated, price cutting technique was not appreciated at all and its only advantage was the cash
discount offered on the quoted selling cost. Eventually, any price cutting used to last only until
the Samar Company entered the market, to put an end to it. After Samar’s entry, the concept of
price cutting would escape. Waters through his experience very well knew that ascent in the
costs wasn't possible exclusively by Superior Manufacturing since customers could shift to other
firms in the market who offer homogeneous products.

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

Introduction to the Case:

Back in 2005, Herbert Waters was delegated as the General Manager of the organization named
Superior Manufacturing Company. Waters was chosen for the post because he had a deep
understanding of manufacturing companies since he had worked in organizations dealing in
items which were same as Superior Manufacturing. Before Herbert Waters joined the
organization, it was stuck with the issues which emerged after the demise of the Richard Harvey,
the founder of the organization. After the death of his father, Paul Harvey took up the role of the
leader of the organization. His experience with the company was very restricted. Probably this is
why, at times he used to settle on some poor choices which drove the organization towards a
yearly loss of around $688000. The yearly loss was why Waters was pulled in by offering him
the stock creative in addition to his salary. Consequently, in addition to the monetary benefits
Waters demanded for the full authorization and direction to Paul in the matters related to the
management. No sooner was he incorporated in the company, he ordered the accounts
department to give nitty gritty report on all costs and income of the company.

Defining the problem:

The given case study on Superior Manufacturing Company talks about the issues looked by
Herbert Waters, the General Manager and Paul Harvey, the President of the organization. The
focal issue, because of which different issues and side effects multiplied, was that:

Superior Manufacturing Company had to take some decisions with respect to their products and
its pricing strategies so as to be competitive in the market.

For a considerable span of time, one of the products of the company, the Product 103 had not
been generating positive cash flows for the company. The cost system of the organization was
not good enough therefore offering their products at competitive costs to make sure that they
don’t lose on their market share was getting difficult for the company.

The company, however, couldn't forecast the price reduction its competitors are looking forward
to capture the large chunk of the market share. And therefore, the company ended up being
disappointed because of the sudden price reduction for product 101 from its competitors, since
even after a downfall in the cost price of the inputs the company would not make profits if it
accepted the price reduction, and it could lose its market if they didn’t abide by the competitive
prices.

Discussion and Analysis:

1. Based on the 2004 statement of profit and loss data presented in exhibit 1 and exhibit 2, do
you agree with Waters decision to keep product 103?
Solution –
Variable Costing
Sales (Net) $27.03
Less: Variable Costs
Material $4.91
Direct labour $6.97
Repairs $0.46
Compensation insurance $0.10
Supplies $0.36
Power $0.31
Total $13.11
Contribution Margin/unit $13.92
 Fixed costs $15,988,000.00

The Profit & Loss statement for year ended on 31 December 2004, showed that the product 103
is incurring substantial losses. The calculation shows the overall substantial loss of $2.209
million on total sales and loss of $2.16 per unit.
Exhibit 1 in appendices is referring the above data.
It can be noted that the size of the indirect cost has been ever increasing. It sums up to be 28% of
the total expenses. If the above table and management’s word are to be considered, then the
production facilities of product 103 is under its full capacity, then in conclusion there is a chance
of economies of scale, which is probably feasible.
Herbert Waters wanted to continue the production of product 103. To have a detailed analysis of
whether Herbert should have taken this step, let us assume that the production has been already
stopped and see what will the result of this.
Now, when the production of product 103 will be stopped, it will not generate profit. This will
lead to the company saving about $2.209 million from loss with expected unit sale of 1 Million.
Whereas on the other side, if the production is continued, the company will have to bear all the
costs related to the production of product 103, for example: all variable and non-variable cost,
fixed costs, costs related to restructuring of the workforce and reduction in the unit sales. The
table given above is representing all the cost under dropping the production of product 103.
Stop vs Continue
Stop Production Continue Production
Particulars ($) ($) Difference ($)
Sales(net) 0 26,670 26,670
Variable Expense
Direct labour 0 6,879 6,879
Material 0 4,851 4,851
Repairs 0 104 104
Power 0 302 302
Supplies 0 350 350
Compensation Insurance 0 458 458
Total Variable Expense 0 12,944 12,944
Contribution Margin 0 13,726 13,726
Fixed Expenses
Rent 1,882 1,882 0
Property Taxes 401 401 0
Property Insurance 534 534 0
 Electricity and heat 106 106 0
Indirect Labour 0 2,309 2,309
Selling expense 0 4,701 4,701
Building Services 75 75 0
General Administration 0 1,783 1,783
Depreciation 3658 3,658 0
Interest 539 539 0
Total Fixed Expense 7,195 15,988 8,793
Net Loss -7,195 -2,262 -4,933
In appendices, calculation is given in Exhibit 2.
Thus, it is not at all a good idea to stop the production of the product 103 is not a good as it will
result in more losses than continuing its production. Apart from this it would also affect the
employee morale.

2. Should Superior lower as of January 1, 2006 its price of product 101? To what price?
Solution –
Variable Costing
Sales (Net) 24.24 22.26
Variable Expense:
Direct labour 6.06 6.06
Material 3.41(5% below the 2005 standard) 3.41
Supplies 0.24(5% below the 2005 standard) 0.24
Power 0.11 0.11
Repairs 0.08 0.08
Compensation
Insurance 0.40 0.40
Total 10.30 10.30
Contribution
Margin/unit 13.94 11.96
Fixed costs 1,23,21,000 1,23,21,000
Cash Discount = 1.08%
After working on how the future of the company would look like keeping in mind the price
deviation made by the competitors, two forecasts could be made on the company’s sales in the
first quarter of 2006. The first forecast was made on retaining the current price of $24.5 while the
second forecast was made on decreasing the price $22.5 as the competitors intend to do.
Herbert Waters forecasted that 750,000 units would be sold on a price of $24.5 and if the
company abided by the price reduction, the sales was forecasted to be of 1 million units.
The forecasted balance sheet for the first six months of 2006 has been calculated through
allocating the costs using assumptions and the given information by the management.
Assumptions made to calculate the budget for first quarter of 2006 are given below:

 Cash discount and unit sales of product 102 and product 103 will remain the same while
following the declining trend of the market.
 Unit cost of direct labour and repairs will be constant.
 Non variable costs on the basis of fixed allocation will remain the same (e.g. rent,
property taxes and insurance, power, light and heat, building services, depreciation and,
interest).
 As described in the case, cost of materials and supplier will decrease by 5%.
At price of $24.5, around 7,50,000 units were sold with a loss of about $18,66,000 which has
been calculated and shown in the table given below.
Please see the calculations in Exhibit 3.
The second forecasted price was $22.50 and the recorded sales was of about 1,000,000 units; this
forecasted price also incurred the loss of about $3,61,000 which is lower than the previous case.
The following table represents the losses of each product:
Sales Projection
Price (Net Price) Unit Sales Profit (Loss)
20.0 (19.78) 13,12,500.00 1,21,500.00
20.5 (20.28) 12,50,000.00 1,54,000.00
21.0 (20.77) 11,87,500.00 1,12,125.00
21.5 (21.27) 11,25,000.00 20,250-.00
22.0 (21.76) 10,62,500.00 -1,44,750.00
22.5 (22.26) 10,00,000.00 -3,61,000.00
23.0 (22.75) 9,37,500.00 -6,36,375.00
23.5 (23.25) 8,75,000.00 -9,82,575.00
24.0 (23.74) 8,12,500.00 -13,90,600.00
24.5 (24.24) 7,50,000.00 -18,66,000.00
Profit = Quantity*[Sales Price (1- Cash Discount %) – VC] – FC
6 Months FC = $1,23,21,000; VC/unit = $10.29
In order to know the price that the company can go to, for the production facility to be continued
profitably, an assumption was made by increasing the demand by 62,500 units for every varying
price value. Once we got the different pricing values and sales unit, the profit/loss for every price
value was calculated according to the above stated formula. And from our calculation we could
conclude that the company would benefit if it reduces the price of the product 101, since they
would have to incur less losses at this price level.
And reducing the price of product 101 to $20.5 would be the most beneficial for the company
since it would fetch a profit of $1,54,000 for the company. This is said to be the optimum price
level because going below this price level would fetch lesser profits for the company.
In the short run, the company should thus adjust its expenses and try to match the market prices.
And it the long run, if the country is not willing to reduce the sales price, it can try to increase its
sales volume.

3. 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?
Solution -
The costing system of Superior Manufacturing was not appropriate and equipped enough to
record the varying unit costs of their productions. As far as 2005 results are concerned, it is
stated that Waters didn’t determine the actual product-line revenue, costs, and revenues. But
instead he calculated the cost of product line data from per unit standard cost and actual sales
made during the period. Calculating the costs and revenues in this way lead us to a situation
where we could see that variance in costs of Rent, Indirect Labour, General Administration,
Depreciation are the four main elements that lead to the major chunk of the favourable variance
in Total Cost of the three production.
Variances
General
Rent Indirect Labour Depreciation
Administration
Total Standard 2,919 4,968 3,414 7,459
Total Actual (6 months) 2,660 4,485 3,289 6,817
Variance +259 +213 +125 +642
% of Total Variance 18.53% 15.24% 8.94% 45.92%
Total Variance in terms of cost of the product = +1398
The results for the first six months were profitable, because in reality with the same fixed costs,
direct cost for the different products, with same annual sales quantities with similar prices, there
was a significant improvement in the company’s performances. The second table made below
shows that out of the total sales, the actual sale of product 102 is around 20% more than what
was expected based on the last year sales. Therefore, even this factor plays an important role in
the rising profitability of the company for the first half of 2005.
Sales Comparison
Units sold
Product 101 Product 102 Product 103
 Year 2004 21,28,412 10,29,694 9,87,984
First half of 2005 9,96,936 7,12,008 5,01,222
% of 2004 units sold 46.84% 69.15% 50.73%
The 2005 statement (exhibit 4) was useful because it provided feedback on Waters decision to
not make changes at the end of 2004. The statements were comparatively more detailed, showing
cumulative costs and variances of company’s total actual cost. These added details helped us in
knowing the major factors that lead to the decrease in the total cost of the products and therefore
the core reason behind the increased profitability. Despite all these, the major flaw of the 2005
statement, that they did not determine the actual product line revenues, costs and products.
Instead unit prices were predicted and were not tailored to the current market cannot be ignored.
Hence it can be said that the 2005 statement isn’t accurately determined

4. Why is it important that Superior has an effective cost system? What is your overall
appraisal of the company’s cost system and its use in reports to management? List the
strengths and weaknesses of this system and its related reports for the purposes
management uses the system’s output. What recommendations, if any, would you make to
Waters regarding the company’s cost accounting system and its related reports?
Solution –
It is important for the Superior Manufacturing Co. to have an effective costing system because it
will help the company to actively monitor and predict its finances and give current feedback on
whether its 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 acts
independently from the 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.

Allocation of Fixed costs Example

Total cost = 10000 Total Units = 1000 Standard cost/unit = 10
Half year (Sales) Standard Actual Variance
500 units sold 2,500 2,500 $0
600 units sold 3,450 2,500 $950
310 units sold 1,550 2,500 ($950)

The Strengths of using such a cost allocation system are:

 It enables simplification of book-keeping and helps the managers to focus on vital issues.
 It promotes efficiency and is economical in nature.
 Standard costs facilitate accountability and fit naturally in the integrated system of
responsible accounting.
 It covers the full-cost of the company.
Below mentioned are some of the disadvantages of standard costing method:

 Standard costing system makes the company to achieve the standards set, and thus misses
out on focusing on the objectives of the company.
 There are also instances where a standard costing system is misleading in nature.
 This costing may hamper the decision making of the company at times.
 It lacks details, and would benefit by creating monthly cost analysis with further
breakdown of costs.
It would be better for the company to implement the variable costing method for the cost
allocation of the product line.