Individual Written Cases Part 2 (50 Marks)
Due Thursday April 10th
Instructions:
· A Hard copy of the report should be submitted at the beginning of the class.
· You are required to complete both of the following cases:
Quality Treats, Inc. Case
(24
Marks)
Milton University Bookstore Case (26
Marks)
· Font type should be Arial and the font size should be 12 points.
· Line spacing should be 1.5 lines.
· Follow the required page limits as stated for each requirement.
· Marks for professional presentation are integrated with the marks of each requirement.
· The assignment should be done independently by each student.
· It is the students responsibility to ensure that the assignment is completed when due.
· The Business Faculty requires the Harvard style of referencing for academic papers. Please see Quote, Unquote Referencing, and a Speedy Guide to Harvard Referencing at http://www.viu.ca/business/resources.asp.
· Errors happen in the real life every day, so if you see an error in the cases. Note the error in your report and use your best judgment to continue your analysis.
Quality Treats, Inc. Case (24 Marks)
INTRODUCTION
Nicole Molson is the manager of Strategic Marketing Unit Two (SMU2) at Quality Treats, Inc., a provider of branded, high-quality food products. Molson is unhappy with what she perceives to be unfair and inappropriate product costing for her unit, especially for what Quality Treats considers to be special orders. Molsons education, experience, and expertise as a food scientist and process engineer have earned her considerable respect at Quality Treats, but she has limited accounting knowledge, which holds her back from expressing her serious concerns. Therefore, Molson asked you, soon to be an accounting graduate, to develop a memorandum and a glossary of terms to help her make her case more forcefully to top management.
QUALITY TREATS, INC.
Quality Treats, Inc., rooted in the upper Midwest United States, produces a wide range of food products in a competitive industry. Almost all of its products are sold under the Fine n Fast brand name, which is
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widely recognized for its high quality and has a loyal customer following. Most products are packaged in sizes for end-consumption and are sold through supermarkets, convenience shops, and similar outlets. Depending on the nature of the product and consumer preferences, products are sold frozen, refrigerated, canned, boxed, or packaged in other ways. Some items, such as individual packets of ketchup, mayonnaise, and mustard, are sold to fast food restaurants and similar outlets. The company also sells half-gallon containersbranded with the company logoof salad dressings, ketchup, mustard, and similar items with a plastic pump so that restaurant customers can serve themselves at salad bars and similar places. Other products are sold, often in bulk, to institutional users, such as large food service groups, caterers, and the like. These products may or may not be branded. A small portion of sales is made to other food producers, for example, salad dressing packets are sold to producers of packaged fresh salad greens; Quality Treats does not deal with fresh products.
Quality Treats is owned by Jordan Meadows Group, a private equity firm. Jordan Meadows Group gives Quality Treats almost complete freedom and control over management, product selection, performance evaluation, and so forth. Because it is privately owned, external financial reporting is not mandatory, nor is there any obligation to use any set of financial accounting standards for internal reporting. Any external financial reporting is on a group or consolidated basis and performed by Jordan Meadows Group.
Jordan Meadows Group also owns Quality Treats Canada, Ltd., which sells products almost exclusively in Canada, with primary operations nearby in the prairie provinces. There is no mutual ownership or management connection between Quality Treats and Quality Treats Canada. Because the two companies produce many identical products using the Fine n Fast brand, they do share recipes and process technology. Quality Treats also produces some products for Quality Treats Canada that do not have sufficient market size in Canada to justify separate production. Jordan Meadows Group also owns smaller companies with the Fine n Fast name that are mostly importers of Fine n Fast products in countries outside of the U.S. and Canada where high-quality, branded North American food products have niche markets. These products are produced by Quality Treats.
Quality Treats is organized into three Strategic Marketing Units (SMUs) based on the markets they serve. SMU1 serves supermarkets and similar outlets. SMU2 serves mostly institutional customers who order in large volumes and often in bulk quantities. SMU2 also sells special orders from time to time that involve unbranded bulk products that are exported. SMU3 serves affiliated Quality Treats companies in other countries, mostly for import into those countries; governmental organizations that sell food and have food service facilities, such as military organizations; and similar customers that have special contracting requirements.
Products sold by all three SMUs are manufactured by the same production facilities, including warehouses, food preparation and cooking facilities, and packaging facilities. The SMUs also share most headquarters activities, such as information technology, accounting and other administration, human resources, and similar activities. SMU1 and SMU2 have their own marketing and sales departments, while SMU3 does not have separate departments for these tasks. Figure 1 shows an organizational chart for Quality Treats.
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COST ALLOCATION
Molson strongly and persistently tells you that she believes her unit is being treated unfairly in the way costs are allocated to products. In particular, she has a problem with the product cost allocation for special orders of product MP, a basic product that is widely consumed in North America. SMU2 is the only unit filling special orders, and almost all of the special orders are for product MP. While all three units sell product MP, it represents a significantly larger percentage of total sales for SMU2 than it does for the other two units. SMU1 and SMU3 do not perceive a product costing problem because a substantial portion of their sales come from other products, which means the product costs for product MP are not a major part of their cost of sales.
After talking with Molson, you review what you learned in your accounting classes about product costing and special orders. With this knowledge, you set out to conduct an in-depth look at product costing and accounting for special orders at Quality Treats, especially in SMU2.
THE PRODUCTION PROCESS
In order to learn about product costing at Quality Treats, you decide that first you need to understand the physical flow of products through production lines. A simplified diagram of the product MP production process, which is typical of many of the companys products, is shown in Figure 2.
Basic raw food items begin production with preliminary inspection, sorting, and so forth. The raw material then goes to the first stage of preparation, which can involve chopping and peeling, as well as some preliminary cooking. After possible temporary storage, additional ingredients are added, such as seasonings, flavorings, and so on, and then the final cooking and processing occurs. The prepared product is then packaged, frozen, stored temporarily (if necessary), and then shipped to the customer.
PRODUCT COSTING
The management of Quality Treats believes that it must allocate all costs to its products in order to get a true and accurate measure of each products profitability. Here is a look at the product costing procedure that would apply to product MP, as well as virtually all other products. Product MP is one of several different products that comes from the same initial raw material but are then processed and sold in different configurations and package sizes.
Raw material, packaging material, and direct production salaries are added to determine what Quality Treats calls direct calculated costs. Electricity, steam, water, and warehouse costs are then allocated based on estimates and a mark-up to cover spoilage and other incalculable costs. This calculation gives an amount the company calls variable manufacturing costs. Material costs are determined based on the cost required for one unit of product. Direct salaries are determined by the amount of time normally required for one unit multiplied by the hourly labor cost.
Quality Treats allocates what it considers to be fixed production costs in a complicated process. A list of what Quality Treats considers to be fixed production costs is shown in Table 1.
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Costs for production management, steam boilers, and quality are shared by different factories. Estimates are made about usage of these activities, and costs are allocated to factories based on these estimates. If only one factory uses a service, the entire cost of the service is allocated to that factory. When these and other costs are assigned to factories, two approaches are used for further allocation to product groups (such as salad dressings, canned soups and vegetables, and puddings) and products:
All costs for steam boilers, building maintenance, vehicles, and sanitation are allocated directly to products using net weight or gross weight.
Remaining factory costs are first allocated to product groups. One allocation is a fixed percentage based on estimates that do not change for each product group. Other costs are allocated based on the weight, labor time, and production time of the product produced. If the allocation of remaining factory costs is a fixed percentage, then allocation to products is based on production time.
For special orders (virtually all product MP), the total freight out is accumulated for a month and then allocated based on the weight of product shipped. The estimated freight cost is included in the sales price. Similar procedures are followed for other products, for which Quality Treats pays the freight.
Media and sales promotion costsfor SMU1 and SMU2 are allocated to product groups and to individualproducts based on weight of product sold.
Quality Treats allocates what it calls other fixed costs in two ways:
Sales and marketing costs, which are incurred only in SMU1 and SMU2, are allocated to products based on sales volume.
Costs for top management, business administration, information systems, human resources, supply management, and logistics are allocated in two steps. Costs are first allocated to cost centers based on number of employees, labor time, production time, or set percentages. Then costs are further allocated to products based on gross sales, amount of time spent on internal reviews, number of marketing campaigns, quantity sold, number of orders, net weight of product delivered, or equally to each product.
Molson is concerned that the amount of costs allocated to special orders for product MP is excessive and therefore causing her unit to be viewed less favorably than the other units. Among other things, she believes allocations based on weight are unfair because product MP is a relatively dense, bulky, and heavy product that, while profitable, has a relatively low profit per pound compared to other products.
SPECIAL ORDERS
Because of Molsons concerns, you further explore what Quality Treats considers to be special orders. According to Molson, a special order is one in which the contract specifies that it can be rejected within one year before delivery, otherwise it is not special. Such special orders constitute 2% of total revenues for Quality Treats.
Virtually all of the special orders are for product MP and for a food distributor in Mexico. Product MP is not a normal part of the diet of Mexican people, but there is a niche market for it. The market is not
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large enough to motivate a Mexican food production company to produce the item, but Quality Treats is motivated to provide the items to Mexican food suppliers as so-called special orders because the company is already producing the product for a variety of customers in the U.S. and Canada. It is packaged unbranded for sale in Mexico because it will be used primarily by institutional food preparers; it is shipped frozen in 10-pound packages.
The raw material used to make product MP can be kept in storage for a fairly long time under proper conditions, and there is always a ready stock on hand because it is used in many other products. Once product MP is produced, it can be kept frozen for up to one year. These factors provide a high degree of flexibility in scheduling production to meet such special orders. Production of product MP can be readily scheduled when there is idle production capacity. Sometimes requests for these special orders come unexpectedly; other times, SMU2 approaches the customer to indicate that idle capacity is planned. Typically, orders are in relatively large quantities.
SMU2 accepts special orders when the contribution margin (CM1) is positive. Quality Treats defines CM1 as net sales minus variable manufacturing costs, fixed manufacturing costs, and freight out (see Table 2). Molson is convinced that decisions to accept the special orders are good for the company and contribute to Quality Treats overall profitability, but she is frustrated at the impact on the results of her units operations.
PERFORMANCE EVALUATION IN QUALITY TREATS
Halfway through your project, you discuss it with friends and colleagues who are recent accounting graduates from VIU. As you describe Molsons concerns with Quality Treats product costing, as well as your frustration with analyzing and developing recommendations, one friend interrupts to say that the product costing problem appears to be only a symptom of a larger issue. Your friend had recently covered the issue of symptoms vs. underlying problems in her management control class, and it seemed to her that the major issue is performance evaluation of the SMUs, not just product costing.
Somewhat skeptical, you look at some of your textbooks and other sources to brush up on performance evaluation. Then you explore performance evaluation at Quality Treats. You begin by speaking to Davie Jacob, the controller of Quality Treats, who explains how the company computes CM1, CM2, CM3, CM4, and operating profit for each unit (see Table 2). Jacob says the SMUs have the ability to control the costs of their divisions, and other costs are allocated easily and fairly. Targets are established for CM1, CM2, CM3, CM4, and operating profit, and the numbers are reviewed monthly to see if corrective action is necessary. Evaluation of performance against the targets is made at the end of the year.
Molson, however, tells you that the primary evaluation for the SMUs is operating profit. Jacob and another unit controller confirm it. Molson feels the method used by Quality Treats to calculate operating profit does not reflect the true performance of the SMUs because unit management cannot control several of the cost elements included in the calculation. Further, she believes using operating profit as the primary indicator for evaluating units has a negative motivational effect on the employees of her unit.