CASE 38 Upper Canada Wood Stoves This is your first assignment as a consultant with the prestigious McHenry Consulting firm. You want to do well. Three years ago you graduated with business degree, and last month you earned your CPA designation. McHenry hired you last week and after getting familiarized with McHenry's business model and practices, you have been assigned to a new client, Upper Canada Wood Stoves. Upper Canada Wood Stoves was established in 1810 as a family business. It was a booming business for its first century, but during the 20th century sales declined with the replacement of wood stoves with oil, natural gas, electricity, and central heating. Actually, the company nearly disappeared on more than one occasion. For the last two decades, the company produced only one model, called the Traditional Canadian wood stove. With this improvement in business, the owners saw an opportunity for a more contemporary model, called the Airtight Canadian. This new model is focused on cus- tomers using wood, at their cottages and country homes, as an alternative source of energy for cooking and heating. In each of the first three years on the market, Airtight's sales met expectations. Company profits were, however, less than expected. It was unclear if the Airtight stoves were really profitable. Sales for the latest year, shown in Exhibit 1, were for 15,000 traditional stoves at $1,000 each and 1,000 airtight stoves at $3,500 each. The company had calcu- lated profitability in its normal method, as shown in Exhibit 2. The new airtight stoves were, accordingly, an outstanding success. On the other hand, profitability of the traditional stove had become dismal, which was difficult for the CEO to under- stand as it had been considered a successful stove up until the introduction of the airtight stove. The results, in Exhibit 2, were being questioned by the CEO. She recognized that profitability per stove had always been determined by gross profits per slove, i.e., by dividing the company's gross profits by the number of stoves sold The CEO had considered raising the price of the traditional stove to improve profits, but had delayed that decision for two reasons. First, the traditional stove was already competitively priced in its market Market research had indicated that price increases would be met with even larger declines in units sold. Second, she wanted to get advice on product costing and product profitability. In the past, with one product it was obvious that product profitability was synonymous with the company's profits 144 CASE UPPER CANADA WOOD STOVES 145 However, with two products the CEO thought that a new method might he needed for product costing and for determining product profitability. Consequently, your consulting firm was engaged After reviewing Exhibits 1 and 2 and understanding the CEO's concerns, you real- ized that more cost information is needed, and you in detail asked for and received the information contained in Exhibits 3. 4. 5. Exhibiti Income Statements for Traditional and Airtight Stove June 30 ($ 0001) 518.500 REVENUE COST OF GOODS SOLD Direct materials Direct labour Factory overhead 6.800 2,400 SO 15,000 3.500 GROSS PROFIT SELLING AND ADMINISTRATION Selling Administration 1200 1.000 NET INCOME BEFORE TAXES Exhibita Profitability Analysis, Per Store Traditional Stone $1,000,00 93750 562.50 Revenue Cont of goods sold" Grosmarin * $15,000,000/6.000 Airtight Slove $3,500.00 937.50 5256250 Exhibit Direct Costa Per Stuwe Traditional Stove Airtight Stove Direct materials Direct labour $100 8 hours of skilled labour at $15 per hour $300 24 hours of skilled labour at 525 per hour 16/SECTION IN ACCOUNTING MANAGEMENT CASES Exhibit Yay Owed by Arth Activities Costa Cost Driver Material related $1.500,000 Labour related 1.200,000 These costs are mainted with the admission and physical movement of parti mund the factory The mumber of parts in ench stove, traditional and wintight, was 2 and 40, respectively Overhead costs suchwilities, depreciation, etc.) that are incurred to support the time consuming stivities of cutting, weliling sanding assembly, and packaging Traditional stoves were made in butches of 3,000 sirtight stoves were made in hetches of 200 stoves. The number of setupe drove the cost Painting costs were incurred equally per stove Nutter af poople employed in production de human resource administration and benefits Paint Setup 800,000 1,000,000 Painting Human races 55.800,000 Exhibit 5 Other Overhead Activities Costs Cos Driver Selling 51.200,000 It was estimated that 10 percent of these costs were incurred for the traditionnistoveswhile 90 percent were curred for the sirtight soves I wis estimated that each brand-traditional and Airtight-- 10 percent of these resources. The remaining 80 percent supports the well com Administrations $1,000,000 Required Use the cise approach to address the CEO's requirements. Be sure to explain your analyses and recommendations