Morrissey Forgings, Inc The idea here is to take a closer look at the product

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Morrissey Forgings, Inc.

Teaching Commentary

OVERVIEW

This is a very rich case that will easily support a full class period (ninety minutes) of good discussion. On the surface,

the issue is “ABC.” The company proposes to drop the stoves product line for 1986 because their accounting reports

ANSWERS TO ASSIGNMENT QUESTIONS

Question 1

The idea here is to force students to estimate the financial statements for the year before the oven product line

was introduced. Exhibit A shows our estimate, with explanations. The conclusion is that the business was definitely in

trouble in 1983. It clearly needed some kind of major boost.

Question 2

The idea here is to take a closer look at the product line profitability breakdown from Exhibit 1 of the case using

ABC.

A. Activity Analysis of Manufacturing Costs

The cost system being used by MFI is a traditional full-absorption system in which all manufacturing costs are

treated as product costs. Fixed factory overhead costs are allocated equally over all production units. Within fixed

B. Activity Analysis of Nonmanufacturing Costs

A “full cost” approach to cost allocation considers all costs, manufacturing and nonmanufacturing. The latter

consists of operating expenses such as design, marketing, selling, distribution, service costs, and administrative costs. In

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and shipping costs. An estimation of the activities that

drive selling and shipping costs can identify a more

suitable base for assigning these costs.

In contrast to Exhibit 1 in the case, the profit and

loss by product line in Exhibit C shows ovens with a loss

of $752,000 and stoves with a $562,000 profit. This is a

direct reversal of profit and loss position between the two

Question 3

Morrissey believes this strategic change would

return MFI to profitability in 1986 based on the

information from Exhibit 1. He wants to drop the losing

line and expand the profitable line. But, as shown in

Question 2, he has the profit or loss position reversed.

Also, cutting back from 45,000 total units to 30,000 units

Question 4

In 1983, MFI shipped 30,000 stoves, all in the

to ship ovens in the core area as to ship stoves in the core

area. Ovens will just be added on to the same trucks

going to the same destinations. Total unit shipments in

allocation of shipping cost between stoves and ovens from

Question 2:

Per Question 2

Total

Stoves $.833 million

Ovens $1.667 million

Question 5

Total selling cost in 1983 was $1,250,000. Of

this total, $540,000 (6%  $9 million) was for the dealer

By subtraction, we can now calculate the total

cost of “order getting” outside the core area for 1985:

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Per Question 2

A Closer Look Outside

In the Core the Core

Stoves Ovens Ovens

Question 6

Let’s start this question by recalculating the

product line profitability numbers, under ABC, as refined

further in Questions 4 and 5:

Outside

In the Core the Core Ovens

Stoves Ovens Ovens Total

We can then convert all these costs to per unit

amounts before considering ordering costs, as follows:

Core Outside the Core

Stoves Ovens Stoves Ovens

Price $ 300 $ 350 $ 300 $ 350

COST PER ORDER: $142 $206

expect to get big enough orders to make it worthwhile to

do business there. This means we really should stop

trying to do business in the broader market area outside

line. This is a good idea.

Should we worry about cannibalization of stoves

in the core? Not really. If a customer who otherwise

would not buy a stove buys an oven, we have gained an

extra customer. If a customer switches from our stove to

our oven, we gain $18 per unit in net margin (before order

costs). Either way we win.

Some students will be inclined to stop here (if

they get this far). But, as is typical in this book, the

Promotional Allowance 315 (6% x 5,250)

Shipping 1,500

“Order Getting” 1,545

Variable Manufacturing 1,860 (124 x 15,000)

Factory Support 527 (1,170 x 60% x 3/4)

Revised PBT 569

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$341/15,300 = 2+% = dismal!

This looks a lot like the situation MFI faced in

1983. So, after all the adding and dropping of products

and market areas, we are right back where we started—in

deep trouble.

Based on case information, it really isn’t clear if

Maybe the best bet is a strategic “merger,” unless

Morrissey can come up with new products to make with

TEACHING STRATEGY

In class, we go through the assignment questions, one at a

time, trying to follow the logic outlined in the suggested

answers here. Students generally don’t have much trouble

getting through Questions 1, 2, and 3.

Question 4 is tougher, but not too bad.

Questions 5 and 6 are challenging and will cause

a lot of questions, disagreement, and confusion. They are

Question 7 is a “throw away” since we really

don’t have any rabbits to pull out of the hat! It is worth

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Exhibit A

1983

Estimated Financial Statement

(000)

Income Statement

Sales 9,000 30,000 x $300

Var. Mfg. Cost (3,420) $114 x 30,000

Depreciation & Rent (1,350) Same as 1985

Balance Sheet

Factory Equipment – Gross 12,000 800 x 15 yrs.

Return on Assets

Conclusion — The business was slowly “liquidating” in 1983 and definitely needed something new.

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Exhibit B

Activity Analysis of Manufacturing Costs

20,000 25,000

Ovens Stoves

Manufacturing cost per unit:

Variable costs:

Material 45 40

Per Exhibit 1:

Reported gross margin $170 $130

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Exhibit C

ABC Summary with

Activity Analysis of Nonmanufacturing Costs

Ovens Stoves Total

Sales $7,000,000 $7,500,000 $14,500,000

Cost of Goods Sold (Note a) 3,782,000 4,068,000 7,850,000

Note a: Using revised manufacturing unit cost from Exhibit 2:

Note b: It is stated in the case that the selling and shipping budgets have risen two and one-half times since 1983

USING THE REFINEMENTS FROM QUESTIONS 4 AND 5, ESTIMATED PRODUCT LINE PROFIT IS:

Exhibit D

An ABC Look at the Management Decision to Drop Stoves

Projected 1986 Profit or Loss – Ovens Only

30,000 Ovens

Sales revenue ($350 per unit) $10,500,000

Less manufacturing costs:

Gross margin (42% of sales) 4,377,000

Other expenses:

Selling (Note b) 2,885,000

Loss from operations $(1,773,000)

IN SHORT, A DISASTER!

Note a: Depreciation and rent ($800,000 and $550,000) remain the same. Factory support costs of $1,170,000 were