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Chapter 11 – Decision Making with a Strategic Emphasis
Purchased Manufactured Manufactured
In-line Skates In-line Skates Snowboard
Bindings
Total Units 6,000 1,000 12,000
Per Unit Total Per Unit Total Per Unit Total
Selling price $98 $588,000 $98 $98,000 $60
$720,000
Variable costs
Material 75 450,000 20 20,000 20
240,000
Machine cost - - 24 24,000 8
96,000
Manufacturing overhead (1) - - 12 12,000 4
48,000
Selling & administrative cost (2) 4 24,000 9 9,000 8
96,000
Variable costs 79 474,000 65 65,000 40
480,000
Contribution margin 19 114,000 33 33,000 20
Profit $13 $78,000 $21 $21,000 $12
$144,000
Machine hours per unit - 1.5 0.5
Contribution per machine hour - $22 $40
Supporting calculations:
(1)Manufacturing overhead
Manufactured in-line skates
Machine hours = $24.00 per pair ÷ $16 per hour = 1.5 hours per pair
Manufacturing capacity = 5,000 pairs × 1.5 hours per pair = 7,500 hours
Overhead per machine hour = $18.00 per pair ÷ 1.5 hours per pair = $12.00 per hour
Fixed overhead per pair of skates = 1.5 hours × $4.00 per hour = $6.00 per pair
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Chapter 11 – Decision Making with a Strategic Emphasis
Snowboard bindings
Machine hours = $8 per board ÷ $16.00 per hour = 0.5 hours per board
Variable overhead per snowboard = $8.00 per hour × 0.5 hours per board = $4.00 per board
Fixed overhead per snowboard = $4.00 per hour × 0.5 hours per board = $2.00 per board
(2)Selling & administrative cost
Each unit has $6.00 allocated fixed cost. Variable cost = total cost – fixed cost
Case 11-5: Garden Patch Foods
Required: Assume that you are a staff accountant at Garden Patch Foods and CFO Ty Brown has
asked you to help him prepare the requested report for the president. Specifically, he wants you to
run the numbers that have been gathered by him and Bill to estimate the financial impact of the
options available to the company (remember that status quo is always an option). Additionally, he
wants you to identify any nonfinancial issues that need to be considered, especially in light of the
fact that the company intends to continue growing through acquisition. Information systems and
internal control issues should be considered as part of these nonfinancial issues to the extent you
believe they are relevant.
Decisions in practice are determined by a combination of financial and nonfinancial factors, the most
critical of which may be managers’ interpretation of, and willingness to accept, risk. For example, in this
scenario risks include: (1) the long-term viability of the business process outsourcing provider; (2) the
ability of new technology solutions to function as planned, for either shared-services or outsourced
arrangements; and (3) the lack of employee acceptance of the shift in corporate culture from a
alternative. Students may present similar analyses using different numbers if their assumptions about cost
savings percentages differ from those we made in developing the suggested solutions. Significant
consideration should be given during the grading process to the justifications the students present for their
assumptions. It is possible that the greatest learning from this case will not be in correctly laying out cash
flows, but rather in learning to deal with the ambiguity of projections.
When used in the undergraduate cost accounting course, a grading scale was developed by first weighting
three components of the report: financial analysis, nonfinancial analysis, and written communication.
Grading of the financial analysis, weighted 40 percent, concentrated on the reasonableness of the
assumptions, accuracy of the calculations, and presentation format. The nonfinancial analysis, weighted
50 percent, focused on the clarity and completeness of the discussions regarding outsourcing and shared-
services arrangements and identification of benefits and risks associated with GPF’s implementation. The
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Chapter 11 – Decision Making with a Strategic Emphasis
All suggested analyses include only the first year’s results because the financial results are compelling
after just one year. Other analyses such as payback period, net present value, and return on investment
would also be acceptable. Such analyses would require attention to additional areas of uncertainty such as
the appropriate discount rate, the length of the PayOut contract, future increases in invoice volume and
related volume-based PayOut fees, future increases in PayOut’s base service fees, and future
technological advances influencing hardware replacement.
OPTION #1: MAINTAIN THE STATUS QUO
This option does not result in increased costs to the company except for the opportunity cost of not
choosing the other options.
Nonfinancial Issues
Advantages
It is the easiest to implement.
Disadvantages
It leaves all of the current redundancies in support functions unchanged.
Any future expansions by GPF will increase the redundancies.
OPTION #2: IMPLEMENT A SHARED-SERVICES ARRANGEMENT
The numbers provided in the case make it impossible to calculate a precise financial impact of
this option. Exhibit 1 provides one solution for the first two years. For the cost savings on purchases,
three different base numbers could be used: (1) $3,234,883.the total of the 15 categories of analyzed
purchases that are common between the three divisions; (2) $8,021,576.the total of all nonstrategic
to analyze the remaining purchasing categories, but that is not likely to happen in the near future due to
their lack of experience with this type of arrangement. Students may point out that over time GPF may
develop the expertise necessary to expand the arrangement to other expense categories.
Once the students select a base for nonstrategic purchases, they will have to decide what level of cost
savings can be achieved. Five percent savings results in an incremental cost in the first year, but would be
positive in the future as the outlay for the systems upgrade would not occur. Net present value analysis is
not necessary since recovery of the investment would presumably happen before the end of the second
year. With respect to labor savings, the numbers in Exhibit 1 use the greatest number of people required
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Chapter 11 – Decision Making with a Strategic Emphasis
Nonfinancial Issues
Advantages
It provides leverage for negotiating prices with larger consolidated volume and supplier
concentration.
GPF retains control over these operations and does not have to rely on outside parties.
business process outsourcing options.
Disadvantages
GPF retains technological risks associated with hardware and software obsolescence.
Personnel will have to be let go. There will likely be an additional financial impact of severance
packages.
If personnel are not let go, the labor savings will not be achieved.
Ongoing maintenance of hardware and software must be performed.
Longer lead times may be experienced when local vendors are not used.
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Chapter 11 – Decision Making with a Strategic Emphasis
Some students may consider the implementation of a shared-services arrangement without the investment
in a systems upgrade. The cost incurred would be only the $45,000 in consultant fees.
However, it is unlikely that the company could achieve the efficiency necessary to implement the
arrangement without a common information system for the three divisions.
OPTION #3: OUTSOURCE THE PURCHASES-THROUGH-PAYABLES PROCESS
Based on the financial analysis in Exhibit 1, this option provides the greatest potential financial impact for
the company. Among the many nonfinancial issues students may identify are the following (other relevant
courses and topics are included in parentheses).
Nonfinancial Issues
Advantages
Technological risk is passed to PayOut.
Savings and lack of capital investment can be directed toward the company’s core processes.
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Chapter 11 – Decision Making with a Strategic Emphasis
GPF obtains additional processing capacity for the future.
Management time is freed up to focus on strategic purchases and operations.
Disadvantages
GPF may end up paying for excess capacity if invoices are collapsed across GPF subsidiaries and
result in total volume of less than 30,000.
Unforeseen difficulties may be experienced in integrating PayOut and GPF information systems.
Longer lead times may be experienced when local vendors are not used (integrate performance
measurement, contracting, and community involvement).
Other Potential Concerns
What recourse does GPF have for late or missed payments by PayOut? (integrate service level
(integrate accounting information systems contingency planning and auditing)
Does PayOut have a SAS No. 70 Service Organizations review report available from a reputable
auditor? (integrate audit special reports and SAS No. 70)
What internal controls are in place to segregate GPF.s data from data of other clients? (integrate
auditing and design of effective internal control systems)
CONCLUSION
In teaching the case, one of the issues that might be raised is why GPF should focus on improving the
bottom line through cost efficiencies instead of focusing on the customer and increasing revenues. Such a
question may be even more meaningful if the concept of the balanced scorecard has been discussed. First,
the internal process of purchasing nonstrategic items is not one at which the company must excel to
Finally, if time allows or other directions are desired, the instructor may choose to point out the various
areas of accounting and business knowledge that are needed for such a decision. For example, the
decision to outsource should lead GPF to require a service level agreement with PayOut. Such an
agreement would specify acceptable levels of performance, so the discussion could move to performance
metrics and measurement. With these items being specified in the outsourcing contract, there is the
opportunity to address legal issues involved in such contracting arrangements, including penalties for
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Chapter 11 – Decision Making with a Strategic Emphasis
Case 11-6: Pop’s, Inc.
Targeted Courses/Prerequisites
The case is targeted for use in a upper-level Managerial/Cost Accounting Course, but could also be used
in an Introductory MBA-level course in Managerial Accounting. Because the case is designed for
beginning managerial accounting students, there are no formal pre-requisites for completing the case.
However, a background in cost allocation, mark-ups, and spreadsheets would be useful in finishing the
case.
Case Summary and Objectives
The attached case is based on cost analysis techniques used by finance managers working in the consumer
products industry. While the sensitivity of strategic positioning and cost structures prevented us from
utilizing actual product information, the attached case is based upon a real world situation in the beverage
industry. The case is designed to challenge students to think beyond the numbers and encourage them to
integrate cost accounting into some basic strategic business concepts normally covered in Marketing and
Policy & Strategy Courses.
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Chapter 11 – Decision Making with a Strategic Emphasis
The case requires students to engage in the process of finding the total cost associated with producing and
selling a new product. While students are required to utilize cost accounting skills in solving the case, the
main focus is on the strategic analysis of the situation. A critique of the cost summary requires students to
engage in the discussion of several strategic decisions embedded in the case. The case discussion should
lead students to begin generating many important questions that should be asked in this type of business
situation. Questions such as: (1) What assumptions are we making?; (2) How reliable are the data?; (3)
Are we thinking myopically?; (4) What are we missing [what data do we still need]?; (5) Are the numbers
actionable?
Specific case requirements include performing the basic cost procedures of accounting for direct costs,
allocating manufacturing overhead and period costs, and determining margins to develop a “cost +
margin” pricing analysis. Upon completion, students should be able to think through the production
process, identify key cost drivers, and understand the role cost accounting plays in the introduction of
new product initiatives.
Time Frame for Teaching the Case
This case has been classroom tested on four separate occasions in the lead author’s 300-level
managerial/cost accounting course. The lead author has found that introducing the case early in a
managerial/cost accounting class provides students with a basic understanding of key cost accounting and
manufacturing fundamentals that can later be leveraged when introducing more advanced topics. In fact,
the benefits of utilizing the case endure throughout the course by not only increasing student interest, but
also redefining student perceptions of the accountant’s expanding role in an organization.
A fifteen-minute introduction to the case is normally provided during the 3rd week of a semester course.
Historically students have spent between 3-5 hours in preparing the case, and the completed case and
discussion is normally required during the 5th week of the semester. After the students have finished the
case 30-35 minutes of class time is invested in discussing the case and the strategic implications.
Learning Outcomes
This case has been used in the classroom on several occasions, which has provided the opportunity to
improve several aspects of the case and obtain feedback on learning outcomes. While the breadth of
topics and the variance in student backgrounds make it difficult to pinpoint every learning objective, the
major competencies addressed include (1) Problem Solving and Decision making, (2) Strategic / Critical
Thinking, (3) Fundamental Cost Accounting Skills, and (4) Spreadsheet Development / Presentation.
Instructor's Solution/Discussion Items
Before beginning a discussion of the cost analyses, it is extremely important to remind the students of the
“big picture.” After completing the cost calculations, students tend to be very narrowly focused. It is quite
helpful to remind them of the following case facts: (1) Pop’s currently has a 4.7% share of the non-cola
market, (2) top management wants to accelerate growth, (3) the company is considering entering the cola
market and competing directly with Coke and Pepsi, (4) Pop’s Cola tested well in a national blind taste
test and in a Denver test market, (5) Pop’s has no manufacturing capacity, and (6) Pop’s has limited
distribution capabilities.
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Chapter 11 – Decision Making with a Strategic Emphasis
Question 1: Calculate the Full Product Unit Cost of both the 12 pack and 2-Liter products. Make
certain to round to four decimal places and include a detailed analysis by component (Raw
Materials, Packing Materials, etc.)
It is important that students understand that unlike this and other ‘textbook’ problems there is seldom one
single answer in any cost analysis project. Several iterations often need to be run using different volume
and mix scenarios to enable management to understand the sensitivity of these factors. These iterations
need to reveal how significantly fixed costs / unit changes with fluctuations in volume. Volume changes
may also influence other factors such as pricing tiers or volume penalties on Raw Materials, Packing
Materials, and even Contract Manufacturing activities.
While Pop’s Cola’s volume forecast comes from an actual test market (often an accurate volume
indicator), it is important to realize that the volume and mix forecasts provided are still only estimates and
there is a high probability that there will be fluctuations. Because Pop’s, Inc. did not test a specific price
point but merely matched the pricing of Coke and Pepsi, its volume forecasts are less reliable and
therefore require even greater analysis.
Additionally, the company needs to adjust its volume forecast to include a competitive response from
Coke and Pepsi. Otherwise, its volume assumption will likely be overstated.
When the cost model is set-up correctly (see Exhibit 1) it is easy to plug in different volume estimates and
observe that given the relatively low amount of incremental fixed costs, there is very little change in fixed
increase in cost / unit. This unusually low cost sensitivity is due to Pop’s, Inc. decision to outsource its
manufacturing process, which provides a more variable costing scenario and reduces the risk associated
with building a new manufacturing facility.
2. At what price would Pop’s, Inc. need to sell the 2-Liter and 12 pack to “the trade” in order to
provide a 25% profit mark-up for Pop’s, Inc. shareholders (Pre-Tax & Pre-Interest Expense)?
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Chapter 11 – Decision Making with a Strategic Emphasis
flows by determining revenue growth rates, estimating inflation of inputs and processing, and discounting
those cash flows at cost of capital that reflects the risk associated with the project. This model would treat
the capital investments as outflows in year zero and utilize depreciation to provide a tax shield.
3. At what Price would the trade sell the 2 Liter and 12-pack on-shelf to the final consumer
assuming on average “the trade” requires a 30% mark-up?
Trade Margin Discussion
It is important to emphasize that because of the risk involved in selling a new brand most retailers will
require a higher mark-up (return) for selling Pop’s Cola than other more established brands. This trade
disadvantage is compounded in the Cola Industry, where Coke and Pepsi have established such a large
consumer pull that retailers are willing to sell Coke and Pepsi at a loss in order to attract consumers
consume a $6 million promotional/advertising budget.
4. (Optional) Visit at least three different channels (i.e. Grocery, Mass/Club Stores, and
Convenience Stores) that distribute Coke and Pepsi products. For each location visited list the Store
Name, Location, Date, and the promotional pricing currently offered for both the 2-Liter and 12-
Pack products.
Note: If this question is not selected, students will need to be provided with the following on-shelf pricing
in order to properly answer questions 5 & 6. The following should be used with caution as actual pricing
will fluctuate depending on the product's location, promotions, and type of channel researched.
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