John Krog owns and operates Krog's Metalfab, which manufactures metal products for construction. In January 2013, a fire destroyed the company's main Chicago plant. The company moved workers to its smaller Moline plant and incurred extra costs. While production was reduced, the company was able to rebuild. Krog now wants to settle the insurance claim, including compensation for lost profits during the year after the fire. The chief accountant estimates lost profits were $34,184, but Krog wants a second opinion from an outside consultant.
John Krog owns and operates Krog's Metalfab, which manufactures metal products for construction. In January 2013, a fire destroyed the company's main Chicago plant. The company moved workers to its smaller Moline plant and incurred extra costs. While production was reduced, the company was able to rebuild. Krog now wants to settle the insurance claim, including compensation for lost profits during the year after the fire. The chief accountant estimates lost profits were $34,184, but Krog wants a second opinion from an outside consultant.
John Krog owns and operates Krog's Metalfab, which manufactures metal products for construction. In January 2013, a fire destroyed the company's main Chicago plant. The company moved workers to its smaller Moline plant and incurred extra costs. While production was reduced, the company was able to rebuild. Krog now wants to settle the insurance claim, including compensation for lost profits during the year after the fire. The chief accountant estimates lost profits were $34,184, but Krog wants a second opinion from an outside consultant.
John Krog is president, chairman of the board, production supervisor and majority
shareholder of Krog’s Metalfab, Inc. He formed the company in 1991 to
manufacture custom- built aluminum storm windows for sale to contractors in the greater Chicago area. Since that time the company has experienced tremendous growth and currently operates two plants: one in Chicago, the main production facility and a smaller plant in Moline, Illinols. The company now produces a wide variety of metal windows, framing materials, ladders, and other products related to the construction industry. Recently the company developed a new line of bronze- finished storm windows, and initial buyer reaction has been quite favorable. The company’s future seemed bright. But on January 3. 2013, a light fixture overheated causing a fire that virtually destroyed the entire Chicago plant. Three days later, Krog had moved 50 percent of his Chicago workforce to the Moline plant. Workers were housed in hotels, paid overtime wages and provided with bus transportation home on weekends. Still, the company could not meet delivery schedules because of reduced operating capacity, and total business began to decline. At the end of 2013, Krog felt that the worst was over. A new plant had been leased in Chicago and the company was almost back to normal.
Finally, Krog could turn his attention to a matter of considerable importance:
settlement with the insurance company. The company’s policy stipulated that the building and equipment loss be calculated at replacement cost. This settlement had been fairly straightforward and the proceeds had aided the rapid rebuilding of the company. A valued feature of the insurance policy was ‘lost profit” coverage. This coverage was to ‘compensate the company for profits lost due to reduced operating capacity related to fire or flood damage. The period of ‘lost profit” was limited to 12 months. Interpreting the exact nature of this coverage proved to be difficult. The insurance company agreed to reimburse Krog for the overtime premium, transportation, and housing costs related to operating out of the Moline plant. These expenses obviously minimized the damages related to the 12 months of lost or reduced profits. But was the company entitled to any additional compensation? Krog got out the latest edition of Construction Today. According to this respected trade journal, sales of products similar to products produced by Krog’s Metalfab had increased by 7 percent during 2013. Krog felt that were it not for the fire, his company could also have increased sales by this percentage. Income statement information is available for 2012 (the year prior to the fire) and 2013 (the year during which the company sustained “lost profit”).The expenses in 2013 include excess operating costs of $250,000. Krog has documentation supporting these items, which include overtime costs, hotel costs, meals and such related to operating out of Moline.The insurance company is quite Willing to pay for these costs since they reduced potential lost profit. The chief accountant at Krog, Peter Newell, has estimated Iost profit to be only $34,184.Thus, he does feel that it’s worthwhile spending a lot of company resources trying to collect more than the $250,000. Peter at his calculation as follows: Sales in 2012 $5,091,094 Predicted sales in 2013. assuming a 7% increase $5,447,471 Actual sales in 2013 . $3,857,499 (A) Lost sales $1,589,972 (B) Profit in 2012 as a percentage of 2012 sales ($109,495 / 5,091,094) .0215 Lost profit (A X B) $34,184 Required: a) Mr, Krog is not convinced by Peter’s analysis and has turned to you, an outside consultant to provide a preliminary estimate of lost profits Using the limited information contained in the financial statements for 2012 and 2013, estimate lost profits. (Hint: You can proceed as follows.) STEP 1: Determine the level of fixed and variable costs in 2012 as a function of sales. You can use account analysis, the high-low method or regression if you are familiar with that technique. STEP 2: Predict what sales would have been in 2013 if there was no fire. Using this level of sales and the fixed and variable cost information from Step 1, estimate what profit would have been in 2013. STEP 3: The difference between actual profit in 2013 and the amount estimated in Step 2 is lost profit. b) Based on your preliminary analysis do you recommend that Mr. Krog aggressively pursue a substantial claim for lost profit? c) What is the fundamental flaw in Peter Newell’s analysis?
Stream Theory: An Employee-Centered Hybrid Management System for Achieving a Cultural Shift through Prioritizing Problems, Illustrating Solutions, and Enabling Engagement