ACCT2102 Case Study |Accounting Assignment

BACKGROUND

Understand company is a family-owned business started in the 1980s. They are into manufacturing metal sunshades for domestic as well as for commercial use. Their core business is to make metal sunshades for domestic people.

Previously they were into the production of only domestic sun shades but with the emerging markets and seeing the growth opportunity they started making metal sunshades for commercial use as well. Their main clients for the commercial segment is luxury hotels and motels.

The domestic products are made in large batch sizes and as they have been doing it for so many years they have specialized in the domestic segment. But the newly introduced commercial segment for luxury hotels and resorts are made on a made-to-order installation basis. Made to order installation basis means that the production of the sunshades will start once the order is placed and will be made according to their specialization required. These will be custom-made sunshades made according to the demands of the customers. Commercial products are considered to be high-end products and domestic products are considered to be low end products.

As understand company was a family owned company therefore the management of the company was the family members who were into production and looked after the whole business. They were experienced and had hands on experience of the production process but didn’t have any formal professional qualification. They followed a cost plus pricing system adding a 50% markup on the manufacturing cost arriving at the sales price for both the domestic and commercial products.

The company was established in 1980 and has been running their production and selling their products for the last 40 years. It’s very certain that they had built upon a goodwill and is a known household name as metal sunshades is very common and is used by all the houses. But the current situation doesn’t seem to be favorable for understanding the company. They have faced some difficulties in running their business efficiently and has experienced a decrease in sales and gross profit as well. So they have hired a new CEO John sticks who is a Chartered Accountant by profession and has knowledge and experience in manufacturing and costing in both management and service organization. He has an impeccable record and is believed to be very capable of making UNDERSTAND Company profitable and return its glory.

PROBLEM AND ISSUES

The first and foremost problem they are facing is the entrance of new companies who are eating up the market share of UNDERSTAND companies in the domestic product segment. The entrance and making of commercial products by UNDERSTAND has also led them to shift their focus towards commercial products and thus deviating them from what they do the best. They are very experienced in the domestic segment and thus can make the products more efficient. But due to making commercial products and shifting their focus from the core product, this has a dent in their pocket. They saw a reduction of sales in their domestic products which has led to a reduction in their gross profit as well.

They have also introduced the made-to-order installation system for commercial products. This means that the company will start their production once the order has been and the products will be custom-made according to their wish. They also introduced JIT which has increased the ordering cost.

The other backdrop of commercial products is that as they are custom made they are produced in small batches and thus incurs a huge cost in set up. For commercial products the cost of quality control has also increased as they are checked 1 at a time to ensure uniformity in quality whereas domestic products are sent 100 at a time. Domestic products require 6.6 mines per unit to be made compared to 102 mins or 1.7 hours for commercial products. Commercial products require 15 soldier points for 1 product compared to 4 points for domestic products. If we compare shipments then also it has huge variation. 1 shipment for 1 commercial product whereas 1 shipment for 500 products.

This shows us that for making 1 commercial product it requires a lot of money that needs to be invested for set up, quality control and raw materials. But we should also keep in mind that the sale price is also higher than domestic products.

All these problems can be handled by taking some proper measures. The management of the company should give more importance on product mix and should do a cost benefit analysis of which are the profitable products that should be sold most to increase and maximize the profitability.

THEORETICAL ANALYSIS

Quantitative aspects are used in analyzing a company’s overall business model, quality of management and governance of the business (Runfola et al. 2017). With respect to the business model, making metal sun shades has a great opportunity as it is one of the essential goods while constructing a house. Metal sun shades are used by households as well as luxury hotels and resorts as well. It is a profitable business as it has a high margin but the volume of sales is likely to be less.

As it is a family owned business and they have been running this business for over 40 years they are very experienced and they are best at what they do. With the diversification of the business and bringing new products into their revenue stream it seems that the company has good long term prospects (Siano and Wysocki, 2018).

The governance has also been good for the company as they are transparent in their accounting. With the new CEO John sticks on board and with the expertise that the CEO brings in the table it is likely that the company will see great operations and the revenue are also likely to rise.

 

QUANTITATIVE ANALYSIS

COST ITEM
UNIT COST	COMMERCIAL	DOMESTIC
Materials	$6,000.00	$200.00
Direct Labor	$2,000.00	$150.00
machine cost	$2,000.00	$100.00
manufacturing overhead	$8,500.00	$550.00
cost/unit	$18,500.00	$1,000.00
no of units	$1,000.00	$10,000.00
total of unit cost	$18,500,000.00	$10,000,000.00
batch cost
purchase order	$1,333.30	$6.67
machine set up	$1,454.50	$14.55
shipping	$1,764.70	$3.53
total batch cost	$4,552.50	$24.74
total order cost	$18,504,552.50	$10,000,024.74
Markup (50%)	$9,252,276.25	$5,000,012.37
bid	$27,756,828.75	$15,000,037.11
bid per unit	$27,756.83	$1,500.00

 

					units of cost allocation base
activity	annual cost	cost driver volume	activity  cost rate	type of  activity	commercial	domestic
purchase orders	$    1,400,000	no of orders	$ 1,333.3	batch	1000	50
soldering	$    4,000,000	no of soldier points	$      72.7	unit	15000	40000
machine power	$    3,000,000	machine hours	$ 1,071.4	unit	1700	1100
quality control (inspect incoming parts)	$    2,200,000	no of inspections	$ 2,000.0	unit	1000	100
machine setups	$    1,600,000	no of setups	$ 1,454.5	batch	1000	100
shipments	$    1,800,000	no of shipments	$ 1,764.7	batch	1000	20
	$ 14,000,000

 

 

	Units for every activity
	COMMERCIAL	DOMESTIC
purchase orders	1	200
number of soldier points	15	4
machine hours	1.7	0.11
machine set up	1	100
shipments	1	500
quality control	1	100

 

Interpretation of the above calculation

From the above calculation we can conclude that it takes more time and process for making a single commercial product compared to 1 product of domestic sun shades. For making a commercial product we require 15 soldier points compared to 4 for domestic. Commercials need to be produced in smaller batch sizes and need to be checked very properly as they are custom made to ensure quality of the product, which has led to a reduction of production and sales of the domestic product. But at the same time there is huge variation in selling price as well. From the above calculation we see that the bid price for commercial products ought to be 27756 but they are selling it at 27750.

There is a huge variation on the no of products sold. Commercial products comprises 64% of the total sales whereas domestic products comprises 34%. Therefore it is right to conclude that a reduction of demand for the commercial products would likely hit the company’s revenue and profitability more.

RECOMMENDATIONS

From the above calculation we can conclude that the cost of making a product and time to produce a commercial product is higher than the domestic product but at the same time the selling price is also higher. But as we all know that UNDERSTAND Company specializes in making domestic metal sun shades and they have the highest market share compared to their competitors, therefore they should focus on their domestic products as well.

They have planned their diversification by producing and focusing on commercial products which has a higher selling price but requires a lot of time. The major backdrop is that they are not specialized in commercial products and cannot work as efficiently as they can in domestic products. The entrance of new market players can also be considered dangerous as they would eat the market share of UNDERSTAND.

Therefore we would recommend producing domestic products at a larger scale and at the same time should slowly and steadily make some progress in the commercial products as well.

With the new CEO John Smith on board who is a CA (chartered accountant) by profession, we are extremely optimistic about the long-term vision and execution of the company.

References

Runfola, A., Perna, A., Baraldi, E. and Gregori, G.L., 2017. The use of qualitative case studies in top business and management journals: A quantitative analysis of recent patterns. European Management Journal, 35(1), pp.116-127.

Siano, F. and Wysocki, P.D., 2018. The primacy of numbers in financial and accounting disclosures: Implications for textual analysis research. Available at SSRN 3223757.