LEARNING OBJECTIVES The specific learning objectives for the simulation are to develop students’ ability to: (1) Understand the various functions in a simple manufacturing environment. (2) Determine...

LEARNING OBJECTIVES

The specific learning objectives for the simulation are to develop students’ ability to:

(1) Understand the various functions in a simple manufacturing environment.

(2) Determine product cost in a job cost environment.

(3) Analyze the effectiveness of a costing system.

(4) Recommend an alternative to the existing costing system.

CASE SCENARIO

Company Background

The Paper Pepper 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.

The PPF is a family owned company that employs approximately 100 people. The owner and CEO of the company is Brian Clark. At this time 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. We’ll also have to lease a bit more space.”

Brian Clark though 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 investigated 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. A description of each department and a diagram of the factory floor is included in Figure 1 (Appendix) - Description of Manufacturing Departments Panel A and Panel B.

The 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 Sheet. See Figure 2 (Appendix) – Blank Job Cost Sheet. 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 in order to cover our product costs and meet 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 costs keep rising.”

The Manufacturing Process

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 in order to manufacture these products: colored paper, staples, tape, and stickers. The following “manufacturing equipment” is used in this factory simulation: stapler, tape dispenser, and scissors. Assume that you are responsible for Job 101 that includes 15 paper hats and 10 paper chains.

Assignment:

a)
Identify the major elements of the value chain for the Paper Pepper Factory.

b)
Identify the various costs involved in making the products. (Do not concern yourself with dollar amounts at this point.)

c)
Separate the list of costs identified as product or period costs. Further classify product costs as direct material, direct labor, and manufacturing overhead.

d)
Trace the direct material and direct labor amounts used for each job and mark it on the Job Cost sheet. (These amounts have already been input onto the Job Cost Sheet for you. See Exhibit 2 – Partially Completed Job Cost Sheet. Complete the Job Cost Sheet using information from Exhibit 1 – Cost and Assumptions)

e)
Using one overhead cost pool and units as the cost driver, allocate the overhead to each job.

f)
Complete the Job Cost sheets by identifying the total product cost for each job. Next compute the cost for a unit of paper hats and a unit of paper chain.

g)
What do you think is the cause of the increase in unit costs for paper hats?

h)
Matt Brady has asked you help him identify some other methods for allocating overhead in the determination of product cost. Identify at least two other possible ways of allocating the overhead to each job. Recalculate the product cost and targeted selling price of each job and each unit using one of the two methods of allocating overhead that you just identified.

i)
What are the advantages and disadvantages of the methods identified? Which method would you recommend?

j)
Write a memo to Brian Clark summarizing your findings and recommendations.

APPENDIX

Figure 1

Description of Manufacturing Departments and Building Layout

Panel A - Description of Manufacturing Departments

Panel B - Building Layout

Figure 2

Blank Job Cost Sheet

Exhibit 1

Costs and Assumptions

Costs for the Month of September

Direct Material

Direct Labor

Manufacturing Overhead (TOTALS)

Exhibit 2

Partially Completed Job Cost Sheet