A start-up company struggles to understand its operating margins. How much of the large monthly fluctuations in margins is real and how much is caused by its costing system? Skim the section on The Genomics Analysis Market on pages 1-3 of the case but pay attention to the information on competitive position.
1. Work the Youngstown Products numerical example on the following page. (This should take only a few minutes and is basically a short refresher on a phenomenon we saw in the Bridgeton case.)
Answer is inline in Youngstown case question.
2. The cartridge margins shown in Tables A and B vary from 17% to 65%. What elements of cost account for the difference between the 2000 Actual and 2001 Budget margins in Table A? What elements of cost account for the difference between the margins in the original 2001 Budget in Table A versus the revised 2001 Budget in Table B? For each element, why do you think costs changed between 2000 and 2001 between the original and revised budgets in 2001? What would you predict for each cost in the long-run?
The elements account for the difference between 2000 Actual and 2001 Budget are the estimated material and scrap cost, overhead cost based on cartridge production volume. Revised material and scrap cost, overhead cost account for the difference between original and revised 2001 Budget in Table B. The estimated and actual production volume affects each element of cost. Larger volume means lower per unit cost. In long-run, the cost should approach to a steady level.
3.Kelly, Puleski, and Yeltin meet to discuss concerns about both “long-term profitability of the business” and “short-term profitability.” Discuss how well the current standard cost systems helps the board and analysts distinguish and understand these two issues. The current system doesn’t do well at estimating the cost. The estimated material and scrap cost, overhead cost depends on estimated production volume rather than capacity. The system can explain short term profitability but has difficulty to explain long term profitability.
4. Suppose sales in 2001 equal 26,000 units, as budgeted in January, and that actual manufacturing expenses turn out to equal budgeted expenses. What should Daniel Yeltin do to “devise a better way to calculate product costs and gross margins for management decision-making purposes”? (Hint 1: What are the decisions facing management and the board? Hint 2: Consider the suggestion in Activity-Based Costing and Capacity to allocate costs based on capacity, rather than based on production. What is current cartridge manufacturing capacity according to the information in Exhibit 8? What are the costs of providing that capacity according to Exhibit 7? What should Daniel Yeltin do with the cost of unused cartridge manufacturing capacity?)
Basically calculating the cost based on production capacity rather than production volume. The current manufacturing capacity is 65000, while the cost of such capacity is $1,299,581. The unused cartridge manufacturing capacity should be written off as an expense. 5.Anagene expects demand for 95,000 cartridges in 2002. What changes can Anagene make to increase capacity to meet higher demand? (See information in the comments column of Exhibit 8 about additional capacity that can be added to the various manufacturing steps.) Assume employees added to increase capacity at any of the various steps cost $100,000 per employee, and assume these costs are treated as part of the overhead cost pool because they are costs of increasing capacity. Under these assumptions, how will the cost of adding capacity affect the overhead component of cartridge manufacturing costs?
Youngstown Products, a supplier to the automotive industry, had seen its operating margins shrink below 20% as its OEM customers put continued pressure on pricing. Youngstown produced four products in its plant and decided to eliminate products that no longer contributed positive margins. Details on the four products are provided below:
Production Volume (units)10,0008,000 6,000 4,000
Selling Price$15.0018.00 20.00 22.00
Materials/unit$ 4.00$ 5.00 $ 6.00 $ 7.00
DLH/unit0.240.18 0.12 0.08
Total DLH2,4001,440 720 3204,880
Plant Overhead $122,000
Youngstown has a traditional cost system. It calculates a plant-wide overhead rate by dividing total overhead costs by total direct labor hours. Assume, for the calculations below, that plant overhead is a committed (fixed) cost during the year, but that direct labor is a variable cost. 1. Calculate the plant-wide overhead rate. Use this rate to assign overhead costs to products and calculate the profitability of the four products. Product
2. If any product is unprofitable with this cost assignment, drop this product from the mix. Recalculate the overhead rate based on the new total direct labor hours remaining in the plant. Apply the new overhead rate to the remaining products. A is not profitable, after dropping out A, the new overhead rate will be 122000/(4880-2400) = 49.19 Product
4. What is happening at Youngstown and why?
The total plant overhead is fixed, and when a product line is dropped, each product line has higher overhead allocated, and eventually Youngstown becomes unprofitable. 5. What does the situation at Youngstown (a low-tech manufacturing firm making decisions to shrink sales over time) have to do with the situation at Anagene (a high-tech firm making decisions to grow sales over time)? Anagene is facing a similar situation. If Anagene continues to use budgeted manufacturing volume when determine the cost, Anagene might have a risk to run into the death spiral as Youngstown (dropping unprofitable product until nothing is profitable).