The Birdy Company is a multidivisional company and its managers have been delegated divisional profit responsibility. Each division produces and markets its own products. Divisional managers are accountable also for inventory levels. The corporate head office provides common administrative services. Actual costs for these services are allocated to all divisions based on their budgeted sales and are included under divisional operating costs as administration expenses. Annually, all divisions prepare their operating budgets and present these for review to the corporate head office. During the review process, additional information is often requested to explain major changes from past trends in sales, costs, or expenses. Final budget approval is given when the proposed return on the assets employed by the division is satisfactory.

Divisional performance is monitored monthly and any significant difference from the approved budget is to be documented and explained by the divisional manager. The submission of a revised budget along with details of specific action to be taken is required when any significant difference from the approved budget is expected to continue. A formal review of divisional performance and of any revised budget submission is held each quarter at each division with senior corporate executives.

The Eagle Division has shown acceptable profits for a number of years. However, during the most. recent quarter, particularly during the month of September, major problems appeared.

The division produces electrical switches which are sold to electric supply dealers. Eagle's sales personnel work on a commission basis. Products are advertised monthly in trade magazines. Until recently, the dealer price had been $13.50 per switch. Quality and timely deliveries were factors which had contributed to the division's success.

During the last few months, a new brand of switches had entered the market rather unexpectedly. Backed by full page advertisements in trade magazines and lower dealer prices, the new competitor had gained a significant share of the market within a three-month period. A sample of the new competitive switch had been examined and tested, and it was found to be of the same quality as the Eagle switch. The manager of the Eagle Division suspects that the current low prices may continue for another three months and then slowly return to the normal price level of $13.00 to $14.00.

During the last month, September, the Eagle Division had reduced production from its normal level of 30,000 units to 22,000 units. Sales, on the other hand, were only 14,500 units leaving the division with an inventory at September 30 of 50,000 units. The annual operating budget for the division included an inventory target of 20,000 units at year end, December 31.

The following standard manufacturing costs per switch were used for the annual operating budget and will remain in effect for the budget year.

Cost Component	per unit
Direct materials	$2.40
Direct labor ($9.60/hour)	$3.20
Variable overhead ($3.60 /DLH)	$1.20
Fixed overhead ($6.60 DLH)	$2.20
TOTAL	$9.00

DLH = Direct Labor Hours

The standard overhead rate per unit of $3.40 is based on normal annual production volume of 360,000 units or 30,000 units per month. The maximum production capacity without increasing the fixed manufacturing overhead is 35,000 units per month or 420,000 units per year.

The actual results for the nine-month period ended September 30 are as shown in Exhibit I.

Early in September, the Eagle Division manager had asked his plant supervisor to check with engineering for any possible cost savings in production to minimize losses from budget. The supervisor made the following proposal:

"During the switch assembly, eliminate an alignment and an adjustment operation which will reduce the production time by four minutes per switch. This will result in producing some defective switches, but they will be detected during the final inspection and discarded immediately.

Based on several tests, the average number of defective switches were 50 for every 1,000 good switches produced."

Some rough calculations done by the plant supervisor indicated a net saving in the unit production cost. The divisional manager would like to have this verified.

Exhibit 1

Eagle Division

Statement of Results for the Nine Month Period Ended September 30

Actual	Budget	Variances
Sales (units)	252,000	270,000	18,000 U
Revenue	$3,333,500	$3,645,000	$311,500 U
Cost of goods sold*	2,297,900	2,430,000	132,100 F
Gross margin	1,035,600	1,215,000	179,400 U
Expenses:
Advertising	191,500	189,000	2,500 U
Shipping/delivery**	151,200	162,000	10,800 F
Commission**	201,600	216,000	14,400 F
Administration	290,800	297,000	6,200 F
Total expenses	835,100	864,000	28,900 F
Eagle Division Profit	$200,500	$351,000	$150,500 U

*Actual production volume during the nine-month period was 262,000 units. Cost of goods sold for the nine-month period ended September 30 is detailed as follows:

Direct materials at standard	628,800
Direct labor at standard	838,400
Overhead applied at standard	890,800
Standard cost ·of goods manufactured	2,358,000
Less: Inventory increase (10,000 units@ $9)	90,000
Cost of goods sold at standard	2,268,000
Variances (unfavorable):
Labor and overhead efficiency	12,300
Overhead volume	17,600
Cost of goods sold	2,297,900

The variances were caused by lower production volume. The labour and overhead efficiency variance is not expected to recur.

**Variable with units sold

REQUIRED:

Prepare a report that addresses the following issues in the case.

1. Evaluate the plant supervisor's proposal by computing the annual effect on income for a normal year's volume.

2. Assume that the plant supervisor's proposal has been accepted and that the new ending inventory target for the fourth quarter is 10,000 units. Using the following 'independent market survey results for the fourth quarter, determine the optimum selling price, sales volume and production volume for the Eagle Division during the fourth quarter.

MARKET SURVEY RESULTS FOR THE FOURTH QUARTER

Selling Price	Eagle Division’s Expected Sales Volume
$12.00	60,000 units
$11.50	90,000 units
$11.00	130,000 units
$10.50	150,000 units
$10.00	170,000 units

3. The Eagle Division is regarded as a profit center. Should it be? Explain.

4. Evaluate the Birdy Company's approach to performance reporting, evaluation, and control. Make specific recommendations for improvement.

Answer rating: 100% (QA)

The Eagle Division should sell 60000 units at 1200 per unit to maximize its annual income The new ending inventory target for the fourth quarter shoul... View the full answer