Reference no: EM13372804 , Length: 2278 Words

Advanced  Management Accounting Questions:

Q1) (ACTIVITY BASED MANAGEMENT)Seneca Foods is a regional producer of low-priced private-label snack foods. Seneca contracts with local supermarkets to supply good-tasting packaged snack foods that the retailers sell at significantly lower prices to price-sensitive consumers. Because Seneca's production costs are low, and it spends no money on advertising and promotion, it can sell its products to retailers at much lower prices than can national-brand snack food companies, such as Frito-Lay. The low purchase prices often allow the retailer to mark this product up and earn a gross margin well above what it earns from brand products, while still keeping and selling price to the consumer well below the price of the brand products.

Seneca has recently been approached by several large discount food chains who wish to offer their consumers a high-quality but much lower-priced alternative to the heavily advertised and high-priced national brands. But each discount retailer wants the recipe for the snack foods to be customized to its own tastes. Also, each retailer wants its own name and label on the snack foods it sells. Thus, the retailer, not the manufacturer, would be providing the branding for the private-label product. In addition, the retail chains want their own retailer-branded product to offer a full snack product line, just as the national brands do.

Seneca's managers are intrigued with the potential for quantum growth by becoming the prime producer of retailer-brand snack foods to large, national discount chains. As they contemplated this new opportunity. Dale Williams, the senior marketing manager, proposed that if Seneca enters this business, it can think of even higher growth opportunities. Seneca does not have to sell just to the discount chains that have approached it. Local supermarket chains may also be attracted to the idea of having their own brand of high quality but lower-priced snack products that could compete with the national brands, not just be a low-priced alternative for highly price-sensitive consumers. Perhaps Seneca could launch a marketing effort to regional supermarket chains around the country for a retail-brand snack food product line. Williams noted, however, that the local supermarket chains were not as sophisticated as the national discounters in promoting products under their own brand name. Each supermarket chain likely would need extensive assistance and support to learn how to advertise, merchandise, and promote the store-brand products to be competitive with the national-brand products.

John Thompson, director of logistics for Seneca Foods, noted another issue. The national-brand producers used their own salespeople to deliver their products directly to the retailer's store and even stocked their products on the retailer's shelves. Seneca, in contrast, delivered to the retailer's warehouse or distribution center, leaving the retailer to move the product to the shelves of its various retail outlets. The national producers were trying to dissuade the large discount chains from following their proposed private-label (retailer-brand) strategy by showing them studies that the apparently higher margins they would earn on the private label would be eaten away by much higher warehousing, distribution, and stocking costs for these products.

Heather Gerald, the controller of Seneca, was concerned with the new initiatives. She felt that Seneca's current success was due to its focus. It currently offered a relatively narrow range of products aimed at the high-volume snack food segments to supermarket chains in its local region. Seneca got good terms from its relatively few supplier because of the high volume of business it did with each of them. Also, the existing production processes were efficient for the products and product range currently produced. She feared that customizing products for each discount or supermarket retailer, plus adding additional products so that they could offer a full product line, would cause problems with both suppliers and the production process. She also wondered about the cost of providing new services, such as consulting and promtoins, to the supermarket chains and of developing some of the new items required for the proposed full product line strategy. Heather was attracted to the growth prospects offered by becoming the preferred supplier to major discount and supermarket chains. But she was not as optimistic as Dale Williams that these retailers truly believed that selling their own private-label foods would be more profitable than selling the national brands. Perhaps they were only using Seneca as a negotiating ploy, threatening to turn to private labels to increase their power in setting terms with the national manufacturers. Once production geared up, how much volume would these retailers provide to Seneca? How could Seneca convince the large retailers about the profitability associated with the new private-label strategy?

Gerald knew that Seneca's existing cost systems were adequate for their current strategy. Most expenses were related to materials and machine processing, and these costs were well assigned to products with the conventional standard costing system. But the new strategy would seem to involve a lot more spending in areas other than purchasing materials and running machines. She wished she knew how to provide input into the strategic deliberations now under way at Seneca, but she didn't know how to quantify all the effects of the proposed strategy.

REQUIRED:

a)      How can activity-based costing help Heather Gerald assess the attractiveness of the proposed policy?

b)      Assuming that Seneca starts to supply new customers-large discounters and supermarkets outisde its local region-what ABC systems would be helpful to guide the profitability of the strategy and assist Seneca managers in making decisions?

*NOTE: Make sure to think about the totality of Seneca's operations, including its relationships with both supplier and customers. (i) Discuss how ABC can be used to manage and controls costs for Seneca's manufacturing operations. The "whale curve" and some of those concepts can apply to this company. (ii) ABC can be used to measure profitability: internal to the companyand external by modeling the customer. (iii) Finally, use ABC to manage the company's relationship with suppliers. 

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Q2) (COST-BASED DECISION MAKING)

COST COMMITMENT

Using published sources, identify the process of cost commitment during various phases of some product's life cycle. Try to find several  examples so that you can contrast the rate of cost commitment for different products.

*Note: Provide a minimum of two examples and document the process of cost commitment

during various phases of these products' life cycles. In particular, indicate what

percentage of the costs will be committed at the design stage.

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Q3) (FORMAL MODELS IN BUDGETING AND INCENTIVE CONTRACTS)

THE REVELATION PRINCIPLE IN BUDGET SETTING

Kentville Orchards grows and sells a wide variety of fruits. Norm Wilson, the vice-president-controller of Kentville Orchards, is responsible for all aspects of budgeting and forecasting in the firm. Norm has becoming both disillusioned and dissatisfied with the traditional approach that Kentville Orchards has taken to budgeting. Norm summarized his concerns as follows:

"The traditional approach, where we set budget objectives and then evaluate performance relative to those objectives, is not working well. First, the budget is focusing attention on the wrong things. The managers are interested in making short-run profit as large as possible and are not doing things to improve long-run profitability. Second, I do not think that the model of evaluating performance based on profits has the scope to evaluate the jobs that the managers are doing. Their jobs are much more complicated than a simple profit measure implies, and we need a more accurate picture of how well they are doing. Finally, the existing system is motivating the managers to build slack into both their standards and performance targets so that they can make budget and earn bonuses. As a result, our forecasting system is unable to predict either sales levels or input usage accurately."

Norm went on to indicate that he was considering recommending to the senior management committee at Kentville Orchards that the current budgeting system be replaced with a new system using participative budggeting techniques. Specifically, the new system would require that the objectives for each management job in the organization be defined relative to the organization's strategic goals by negotiations between the job's incumbent and incumbent's supervisor. From these general objectives, specific performance objectives would be set for each job each year through negotiations between the incumbent and the incumbent's supervisor. The objectives would be multidimensional and would include performance objectives for all attributes of the job that are considered important.

The annual evaluation would reflect two dimensions of performance appraisal. First, the incumbent would be evaluated for innovation in developing ways of carrying out assigned responsibilities. Second, the incumbent's performance would be evaluated relative to the targets that were negotiated with the supervisor. Norm summarized his feelings as follows:

"The only thing that is holding me back is that I do not think that the proposed changes go far enough. The proposed system deals with the problem of inadequate performance measurement but still provides managers with the incentives to understate their potential, since their performance will be evaluated relative to the targets that each manager negotiates with his supervisor. Moreover, the planned system, like the old system, still has the aspect of checking up on people rather than relying on them to do their jobs. Perhaps we should go even further and implement the proposed system but evaluate managers only on their ability to be innovative in undertaking the tasks that they have been assigned. If they are not evaluated relative to the targets that they set jointly with their supervisors, they will be motivated not to understate their potential. The bottom line is that I think that we should get rid of the concept of standards altogether, irrespective of who sets the standards. As a result of eliminating the concept of standards, the budget will serve to communicate and coordinate rather than be a threat and a means of checking up on the managers."

REQUIRED:

Evaluate the initial proposal for the revision of the budgeting system as well as the proposal that would eliminate the use of standards.

*Note: Start by identifying the problems with the current budgeting and performance

system. Then, comment on the advantages and disadvantages of the proposed new

systems: one in which evaluation is based on participative budgeting and innovation

and the other in which evaluation is based solely on innovation.

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Q4) (FINANCIAL MEASURES OF PERFORMANCE-Internal Transfer Pricing with an Outside Market)

BACKGROUND

The New Brunswick Company is a midsized subsidiary of the Sun Corporation, which manufacturers various textile and similar material composites. Sales are made to affiliate companies within the Sun Corporation, as well as to external companies. Approximately one-half of New Brunswick's sales are to affiliated companies.

New Brunswick's formal mission statement reads as follows:

"New Brunswick's mission is to develop and supply unique, cost effective fabrics and related nonconventional structures to proactively support the Sun Corporation's worldwide consumer and professional markets. An extension of New Brunswick's mission is to capitalize on the resultant unique product and fabric capabilities by developing profitable franchises in slective growth-oriented consumer and industrial markets. This will be accomplished while satisfying the expectations of the company and fostering commitment, challenge, and reward for our employees."

This statement has received wide approval from the corporate level and from the affiliate management boards. It serves as the driving force for New Brunswick's management and sets clear objectives.

THE PRODUCT

Fifteen years ago, New Brunswick research began evaluating a fabric formation technology (originally developed by the Smith Company, a competitor) called Super Weave. In this technology, fibers are entagled mechanically using water sprayed under high pressure. The resulting fabric is very clothlike in appearance, feel, and comfort. The Smith Company realized early on that this fabric would make an idea barrier in the operating room. The new fabric would provide an effective disposable replacement for operating room drapes and gowns, providing a greater degree of sterility than had been attainable in the past.

Within the Sun Corporation's family of companies, Sanitech is responsible for asepsis within the operating room. To this end, Sanitech markets operating room apparel, gloves, and disinfectants.

Ten years ago, Sanitech began marketing operating room packs and gowns using the Smith fabric. Although the franchise was successful, the relationship between supplier and customer did have drawbacks, which the Sun Corporation, Sanitech, and New Brunswick fully understood: 1) Product improvements made by Smith might not be exclusive to Sanitech in the future, because Smith could sell to Sanitech's competitors, 2) Smith's capacity versus Sanitech's demand, 3) Lack of a second source, 4) Fear of monopolistic pricing practices.

NEW BRUNSWICK'S ENTRY INTO THE MARKET

Six years ago, New Brunswick developed a material equivalent to the Super Weave fabric for sale to Sanitech. Entering this business required New Brunswick to make a significant capital investment in plant and equipment. The total investment would approach $30 million, the largest single investment in the company's long history. Given the Sun Corporation's policy of decentralized operating companies and New Brunswick's mission, New Brunswick's resources alone were used to fund the project. In addition, Sanitech as the marketing company was at liberty to select the fabric that, from its perspective, would best meet its customers' requirements at the lowest cost to Sanitech.

New Brunswick's proposal was presented to the executive committee of the Sun Corporation, who gave final approval for New Brunswick to proceed.

SMITH'S RESPONSE

Three years ago, New Brunswick began making fabric of a quality comparable to Smith's. However, New Brunswick found itself in a significantly changed market environment: 1) Concurrent with New Brunswick's entry, Smith's prices to Sanitech immediately dropped, 2) Smith introduced pricing strategies that rewarded Sanitech for high volume and provided multiyear incentives, 3) With the exception of price escalation, Sanitech and smith had developed an effective partnership since 1975, 4) After several years of manufacturing, Smith had been able to maximize manufacturing efficiencies and achieve lower cost. New Brunswick realized it was at a cost disadvantage and could not price on the basis of intercompany transfer formulas (normally, full cost plus a percent return on invested capital and working capital).

New Brunswick understood very quickly and clearly that, in order to be successful, it must beat Smith's pricing and in the long run minimize manufacturing costs or New Brunswick would have to be content as a secondary source of supply.

NEW BRUNSWICK'S PROBLEM

The vice president of affiliate marketing at New Brunswick requested the assistance of the chief financial officer in developing a plan that would enable New Brunswick to sell itsproduct to Sanitech while achieving the following objectives: 1) Establish a price that is competitive while recovering the capital investment in a reasonable number of years, 2) Establish the longer-term profitability for New Brunswick, 3) Provide the corporation with the lowest-cost product over the long run.

REQUIRED:

a)      How should New Brunswick develop its pricing strategy?

b)      How should the benefit to the Sun Corporation be measured?

c)       What might Smith's reaction be to your strategy?

d)      Should vertically integrated corporations be forced to procure raw materials from other divisions?

e)      Should intercompany pricing policy be inflexible?

*NOTE: This case involves a basic transfer pricing problem-an external supplier offers a

price that is lower than the full costs of producing the product inside. The questions

in this case are fairly straightforward. For (a), review the case and

recommend a pricing strategy. Provide clear reasons why your pricing strategy would

be most effective. For (b), comment on how each department should be

evaluated, and overall, how the company will be evaluated, based on the strategy

you suggested in (a). Consider whether the total company effect of a

transfer price is important, and think about the financial and non-financial benefits of

producing a product inside. For (c), describe how Smith will respond to the

the pricing strategy suggested in (a). Parts (d) and (e) are general

questions that can be applied to all vertically integrated companies.