Reference no: EM13878901
Case Study: The Odd-Job Manufacturing Company
The Odd-Job Manufacturing Company (OJMC) produces toolboxes from plastic and metal in a single plant. The basic product is made from strong 5 mm plastic with a plas- tic handle and metal hinges and wheels. The company has a good reputation in the market because the standard toolbox is a high-quality item, has been well-produced and has sold well for many years.
Two years ago the company decided to expand its product line and produce bespoke boxes for the different retail outlets, usually those that specialise in do-it-yourself supplies. These boxes differ from the standard because they are produced in a range of sizes, they have a metal handle and carry the logo of the specific retail outlet. The standard one-size toolboxes are simply imprinted with the company's initials, OJMC.
In order to reduce the labour cost of the speciality toolboxes, much of the assembly work is done by automated machines. These machines are used to a much lesser degree in the production of the standard toolbox. With the lower cost of labour, the accounting depart- ment has determined that the speciality toolboxes are less costly to manufacture than the standard toolboxes. This is shown in the summary data below. Because the bespoke tool- boxes are special-order items, they are priced at a higher level than the standard toolbox. The managing director of OJMC, T.E.N. Onsaw, exploded when he saw the above figures and demanded, ‘Why do we produce the standard item? It seems time to cut back, cut the standard, just produce the special lines and see if we can grow them more.' The company's marketing director, Pierre Lasterboard, commented, ‘I agree that the bespoke business is working better and there seems to be plenty of work out there, particularly as the competition has not been able to touch our price. Our biggest com- petitor charges £15 for bespoke items.'
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Per unit
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Standard (£)
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Bespoke (£)
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Selling price
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9.00
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10.00
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Manufacturing cost
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8.94
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6.10
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Gross profit
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0.06
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3.9
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However, the finance director, Dee Rill, is not as easily convinced. She observes that, ‘Since we introduced the bespoke lines, our annual net profit has fallen by £350,000. This business has produced sales but it has also required investment and other costs.' The Managing Director responds, ‘Dee, that's all very well but the unit gross profit figures tell their own story! Your argument just seems to be suggesting that neither line makes a profit - yet the company makes a profit so we must be doing something right. As chief accoun- tant, Dee, I suggest that you sort this out as soon as possible and let me have something definitive before we move any further on this issue.'
Dee begins her investigation and first obtains a breakdown of the manufacturing cost of each of the company's product lines as follows:
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Standard
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Specials
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Units produced each month
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10,000
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5,500
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|
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Per unit
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Per unit
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|
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£
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£
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Direct materials
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5.00
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4.13
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Direct labour (at £4 per hour)
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0.80
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0.40
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Prime cost
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5.80
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4.53
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Manufacturing overhead (£15.69 per hour)
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3.14
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1.57
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Note that the manufacturing overhead is absorbed via direct labour hours and the absorption rate of £15.69 per hour is obtained from the budgeted manufacturing over- head (£40,012) divided by the budgeted direct labour hours (2550 hours).
Further investigation reveals that standard toolboxes are produced in batches of 200 units, whilst speciality toolboxes are produced in batches of 25 units. In conse- quence, in each month the company makes 100 set-ups for the bespoke items and 50 set-ups for the standard products. Each machine set-up requires 1 hour for the standard product and 2 hours for the bespoke product.
Each standard toolbox requires 0.5 hours of machine time but, due to its higher level of automation, each bespoke toolbox requires 2 hours of machine time.
At the end of the production process all toolboxes are inspected to ensure that qual- ity standards are met. The standard toolbox requires little inspection time as the workers correct for any quality problems as they process the units. In total the standard toolbox requires 300 hours of inspection per month, and the speciality toolbox 500 hours of inspection time per month.
Dee also has access to results of a consultant's recent study of monthly overheads. The consultant's report includes the following summary:
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Overhead activity (cost driver)
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Overhead cost £
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No. of events
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Standard products
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Specialty products
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|
Purchasing (no. of orders)
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3,000
|
60
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48
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12
|
|
Material handling (no. of receipts)
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3,750
|
60
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52
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8
|
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Production orders and set-ups
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5,062
|
150
|
50
|
100
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(set-up time)
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|
|
|
|
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Inspection (inspection hours)
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4,000
|
800
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300
|
500
|
|
Frame assembly (assembly hours)
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10,200
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2,550
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2,000
|
550
|
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Machine-related (machine hours)
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14,000
|
7,000
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2,000
|
5,000
|
|
Total
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40,012
|
|
|
|
Complete Dee Rill's investigation and write a report to the managing director that examines the strengths and weaknesses of the existing costing system, examines the consequences for the company of continuing with it and evaluates an alternative system. You should illustrate how an alternative system should work and explain its significance for the company's production and marketing strategies.