Case Scenario – Company Background – Homework

CASE SCENARIO

Company Background

The Paper Products Factory (PPF) is a local manufacturer of a single product: paper party

hats. They sell primarily to specialty stores in the Mid-Atlantic region of the United States.

There are several other national and international manufacturers of similar products; therefore it

is a very competitive marketplace. The market is very price sensitive, small increases in price

can result in large decreases in product demand.

PPF is a family-owned company that employs approximately 100 people. The owner

and CEO of the company is Brian Clark. Currently, no other family members are involved in

the business. The company employs administrative staff including the president, vice presidents,

and support staff; engineers who design and develop the products; sales representatives;

manufacturing labor; distribution center employees; and customer service representatives.

Patrick Clark, the owner’s son, recently completed his M.B.A. Wanting to impress his

father with his newly acquired skills, he presented his father with a business proposal to add a

second product line – paper chains. “Dad, by adding paper chains, we can expand our product

line to our existing customer base. For the most part, our current sales and customer service

structure can remain as is since we will be selling more products to our existing customers. We

would need to add an additional Production Manager to oversee the new product line. We have

excess manufacturing capacity, skilled labor, and almost all of the manufacturing equipment

necessary to make the chains. We can offer our hourly employees more steady work. The only

additional costs will be the additional capital investment involved due to the purchase of some

specialized cutting machines, which will cost $180,000 and can be expected to last about five

years with no salvage value. We’ll also have to lease a bit more space.” Brian Clark thought it over for a few days. “Patrick, your proposal makes sense to me. By adding a product line, we should be able to decrease our unit product costs because our fixed costs will be spread over many more units. This should be good for the new chain product line and the hat product line. I can get additional manufacturing space by moving our administrative offices out of our manufacturing site and into an office complex nearby. This will free up more space in the factory. I looked in to the purchase of the cutting machines and it seems that we will be able to finance the purchase at a low interest rate. There’s only one more thing to consider. I will implement your idea only on the condition that you will join the company as the production manager for paper chains.” Patrick agreed and is now the Paper Chain Production Manager reporting to the Director of Manufacturing.

There are a variety of manufacturing departments that are involved in producing the

products including: Warehouse, Materials Handling, Cutting, Assembly, Finishing, Quality

Control, and Factory Supervisor. Supervision is provided throughout the process. Quality

Control is provided at the end of the manufacturing process.

PPF utilizes job order costing by assigning direct material, direct labor, and

manufacturing overhead to each individual job. The costs are accumulated using a Job Cost

Given the simple, one-product nature of the manufacturing and cost environment in the past, they have always used the following method for determining job costs: (1) Direct material and direct labor are traced to each job based on timecards and materials requisition requests. (2) Manufacturing Overhead is applied using the total actual manufacturing overhead cost for the month divided by the number of units produced in the month. The selling price of each job is determined using a cost-plus pricing method. The final selling price is 115% of the cost determined on the job cost sheet.

The introduction of the paper chain product line has been a great success. During the six

months that the company has offered the paper chains, demand has exceeded all of the initial

projections. During September, PPF made and sold 80,000 paper chains, which is 50% higher

than their initial projections. Brian Clark is thrilled with his son’s performance, but has been less

impressed with the Paper Hats Product Manager, Matt Brady. Mr. Clark remarked, “Brady —

what is the problem with the sales for hats lately? Your sales have been down for the past five

months. Maybe I should go out and hire another M.B.A. like Patrick. He sure knows how to

bring in the sales and some fresh ideas.”

Matt Brady has been an excellent and loyal employee for over ten years. He has become

frustrated with the decline in the sales of paper hats too. During September, PPF made and sold

only 160,000 hats, which is far below their planned sales of 300,000 hats. “I just can’t compete

in the marketplace anymore. My unit costs keep rising, and corporate forced us to raise prices to

our customers to cover our product costs and meet the targeted selling price. My unit costs

were always around $0.75 per unit and now they are over $0.80 per unit. My previously loyal

customers have switched to other lower cost providers. I need to better understand the

manufacturing process and talk to the cost accountants to see if they can help figure out why my department’s costs keep rising.”

At the beginning of each day, the Factory General Manager consults with the sales

department and determines which jobs will be completed for the day. The General Manager

forwards the Job Cost Sheet and the materials requisition to the Materials Handling Department.

Materials Handling obtains the materials needed for each job from the Warehouse stockroom and

brings the materials to the appropriate department for the day’s manufacturing.

Paper Hats are manufactured as follows:

(1) Paper is delivered by Materials Handling to the Assembly Department.

(2) Paper sheets are folded into a cone shape, taped and stapled in the Assembly

Department. Finished hats are moved to the Finishing Department.

(3) Hats are decorated in the Finishing Department using four stickers per hat.

(4) Hats are placed on a table for inspection by Quality Control. Quality control also

checks to ensure that the proper items are included in the order.

The manufacturing process for paper chains is as follows:

(1) Paper is delivered by Materials Handling to the Cutting Department.

(2) Links are cut in to 2”by 8.5” strips. Five strips can be made from one sheet of paper.

Cut strips are moved to the Assembly Department.

(3) Each link is connected to the previous link and then taped and stapled in the

Assembly Department. Completed chains are moved to the Finishing Department.

(4) Chains are decorated in the Finishing Department using eight stickers per completed

chain.

(5) Chains are placed on a table for inspection by quality control. Chains are then

inspected by Quality Control before being packed for shipment with the completed job.

The following raw materials are used to manufacture both products:

• Colored paper
• Staples
• Tape
• Stickers

The following “manufacturing equipment” is used in this factory simulation:

• Stapling machine
• Tape dispensing machine
• Cutting machine

Department responsibilities:

• Receiving / Warehouse is responsible for storing and distributing raw materials used in the manufacturing process
• Materials Handling is responsible for requesting materials from Warehouse for the day’s jobs. They are also responsible for moving items in-process between departments and keeping the factory clean during downtime.
• Cutting is responsible for cutting the paper sheets used in products.
• Assembly is responsible for fastening the product parts.
• Finishing is responsible for decorating the products.
• Quality Control is responsible for ensuring that products are made according to specification and checking the accuracy of the final jobs.
• General Manager is responsible for setting the manufacturing schedule after consulting with the Sales Department, coordinating materials ordering with the Purchasing Department, and supervising the manufacturing process.

Written Assignment

1. Identify the major elements of the value chain for Paper Products Factory.
2. Identify the various costs involved in making the products. (Don’t worry about dollar amounts for this question, just identify and list the cost elements.)
3. Separate the list of costs identified as product or period costs. Further classify product costs as direct material, direct labor, and manufacturing overhead.
4. Trace the direct material and direct labor amounts used for each job and mark it on the Job Cost sheet. Your job consisted of 15 Hats and 10 Chains. The labor hours used for each product have been input onto the Job Cost Sheet for you.
5. Using one overhead cost pool and units as the cost driver, allocate the overhead to each job.
6. Complete the Job Cost sheets by identifying the total product cost for each job.
7. Next compute the cost for a unit of paper hats and a unit of paper chain.
8. What do you think is the cause of the increase in unit costs for paper hats?
9. Matt Brady has asked you to help him identify some other methods for allocating overhead in the determination of product cost. Identify at least oneother possible way of allocating the overhead to each job. Recalculate the product cost and targeted selling price of each job and each unit using this alternative method of allocating overhead.
10. What are the advantages and disadvantages of the methods identified? Which method would you recommend?