Well, we can’t change our prices, at least not this year, so the question now is are we making money on the Nimbus 2000 or not? Until today, I thought it was a profitable model, but now I’m not so sure.
The speaker was Harry Potter, COO of Wizard Manufacturing, Inc. (WMI), who had just been told by his accountant that, with revised overhead allocations, the profitability on two of his broom models might be different from what he had thought it was, and that one, the Nimbus 2000, might not even be covering its full manufacturing costs. He continued:
When I was at HBS [Hogwarts Business School], I focused most of my attention on operations and marketing. I was convinced that they were the keys to a successful career. Cost accounting was always a drag, but now I’ve got my accountant telling me that I need to think about a different way to assign manufacturing overhead to products, and I don’t even know where to start. I never dreamed that some day my career would come to this!
WMI manufactured seven different models of brooms that it sold to hardware stores and other retail outlets throughout the United States. The company prided itself on the strength and durability of its brooms, and in particular on the ability of its straw to make full floor contact on each sweep (called “spiffling” in the broom industry). It was superb spiffle ratings that WMI claimed distinguished its brooms from those of its competitors.
WMI purchased its wood and straw in units that were precut to the desired length and, in the case of straw, the desired quantity. It used a single factory to manufacture all its brooms. The factory workers operated three kinds of machines. Cutting machines trimmed the wood into the rough diameter for the handle. Sanding machines then sanded the handle into the desired shape (which varied slightly by broom model) with tolerances measured in millimeters. Assembly machines attached the straw to the handle with a special translucent fiber.
About 40 percent of WMI’s manufacturing overhead was for depreciation, maintenance, and repairs on the cutting, sanding, and assembly machines. The rest was in receiving and handling the raw materials, in adjusting the machine to set them up for each batch of brooms, and in inspecting the finished brooms and packing them for shipment. The actual manufacturing effort (cutting, sanding, and assembly) was mainly automated, and WMI used little direct labor. The company also operated on a just-in-time (JIT) manufacturing basis, such that there were almost no inventories at the end of each month.
Most of the brooms sold in large quantities. However, the Nimbus 2000 did not. It represented a recent effort by WMI to enter a new market: high-end hardware stores in wealthy communities. As a result, the quantity manufactured and sold was expected to be much lower than the other . . .
- Using the existing product costing system, determine the full product cost and selling prices of one Firebolt and one Nimbus 2000.
- Using the product costing system being proposed by the accounting, compute the full production cost for one Firebolt and one Nimbus 2000. What accounts for the differences between the two systems?
- Suppose absorbed manufacturing overhead (MOH) in 1999 was $300,000 more than budgeted MOH. What are three potential causes for the $300,000? Use machine adjusting (one of the MOH accounts) as an example for your explanation.
- What should Mr. Potter do? Specifically, what action should he take this year? Next year?