Hilton Manufacturing commenced business in 1976 and now operates from a modern factory of 10,000 square meters, located in Dandenong, in the South East area of Melbourne. To meet increased business demands of our customers in Queensland, Hilton Manufacturing has recently established a second manufacturing plant of 4000 square meters in size, in the South West region of Brisbane. Hilton is now the preferred supplier fuel tanks and associated mounting component to companies including Volvo & Mack, Kenworth, Mercedes, Iveco and Western Star.
Hilton Manufacturing also supplies all of the Australian truck companies with aftermarket products and is a major supplier to truck aftermarket of its own unique fuel tank products via its distributors located around Australia. Hilton has used the skills it has developed for the local truck industry to gain export orders to Tata/Daewoo in Korea, Hino, Nissan and Isuzu in Japan, Scania in Sweden and Westport in Canada. (www. hiltonmanufacturing. com) Problem Statement
In February 2004, Paul Hilton, President of Hilton Manufacturing Company, hired a professional manager, George Weston, with wide executive experience in the manufacturing industry after he realized he made poor decisions due to lack of training and experience. His father, Richard Hilton, who was the president until early 2003, died prematurely before he could teach his son Paul the necessary tools needed to run the company. When Weston and Hilton reviewed the financials for 2003 (See Exhibit 1 in the case study) they noticed a loss during an otherwise good year.
One product appears to be unprofitable (Product 103), whereas the product sold in highest volume was under competitive price pressure. A crude cost accounting system fails to reveal appropriate actions to correct the problems. Hilton Manufacturing made only three industrial products: 101,102,103. These products were sold throughout New England where, Hilton Manufacturing Company (HMC) was one of eight competitors in the market. The dominant company was Catalyst Company.
Catalyst, taking the lead in the market, announced prices and typically other producers followed the leader due to the cartel characteristics of the market. The eight companies sustained themselves, while they shared profits with highly undistinguished products. The companies in the market kept around the same amount of market share, but when prices were reduced, contributed margin figures decreased and each company took less net profit with each price reduction. After reviewing the financials, Mr. Hilton stated that he thought product 103 should be dropped.
In reviewing the statement for the period of January 1, 2004 to June 30, 2004, this idea is not supported. Even though product 103 continued to be unprofitable in 2004, Hilton Manufacturing Company did realize a profit of $158,000 for the first half of the year by keeping it in production. Weston and Hilton discussed the product-pricing problem. Hilton determined that since Catalyst, the market leader, announced a price drop of product 101 from $9. 41 to $8. 64 in early 2005, HMC would not do well to follow suit with its competitors and lower its price to such a level.
Such a level would be unprofitable for the company, but Hilton believed that the company would loose profits, although sales volume would increase from 1 million cwt (100 weight = 100 pounds) from the previous 0. 75 million cwt. How can HMC show profitability, while restoring confidence in the Paul Hilton’s management and remaining competitive in the highly standardized market? Data Analysis A day does not go by without managerial accounting being utilized in this capitalistic world we call America. Whether we recognize it or not, it is in our lives everywhere we turn.
Managerial accounting is the process of identifying, measuring, analyzing, interpreting, and communicating information in pursuit of an organization’s goals. Managerial accounting provides internal decision-making data and information to managers of organizations, in order for them to make critical decisions for the goals of profit maximization and cost reduction. There are tons of research showing that total quality management is the predominant factor to remain business organizations’ sustainable competitiveness and generate the best result (e. g. , Easton & Jarrell, 1998; Hendricks & Singhal, 1997; Lemak et al. 1997; Samson & Terziovski, 1999; Shetty, 1993). The standard costing system used in HMC in 2003 was also used in the first quarter of 2004 to price the production expenditures of products 101, 102, and 103. These figures, computed by the accounting department, gave Weston and Hilton a fairly accurate estimate of the costs of these products and how profitable each product was at the market prices of $9. 41, $9. 91, and $10. 56, respectively. Questions If the company had dropped product 103 as of January 1, 2004, what effect would that action have had on the $158,000 profit for the first six months of 2004? See exhibit 2) The exhibits provided in the case study provided a great backdrop for helping Weston and Hilton make the correct decisions. From analysis of the exhibits and further calculations, it was determined that by keeping product 103 in production, Hilton Manufacturing Company was able to spread out its fixed costs over three products instead of just two. Furthermore, dropping product 103 or any of the products for that matter would not have necessarily translated into increased sales for the other two products.
Realistically, dropping product 103 would have a negative effect on the contribution margin of the company, reducing the amount of margin available to handle fixed costs. Fixed costs remain regardless of which product is produced or dropped and HMC must be aware of these costs. Even if a product is unprofitable, if it can swallow some of the fixed costs of the company, it is helpful to the overall health of the company. Only when a product cannot cover the variable costs association with its production is it necessary to cease manufacturing of that product.
Total actual cost is the amount paid for an asset; not its market value, insurable value, or retail value. It generally includes freight-in and installation costs, but not interest on the debt to acquire it. Total Cost = $21,244,000 Variable Cost are the expenses that change in proportion to the activity of a business. It is the sum of marginal cost (change in total cost that arises when the quantity produced changes over one unit) over all units produced Variable Costs of Product 103 = Compensation Insurance + Direct Labor + Power + Material + Supplies + Repair – Other Income Total Cost (after 103 is dropped) = $18,712,000
Total Revenue is the total money received from the sale of any given quantity of output. Total Revenue (after 103 is dropped) = $16,179,000 Loss = 16,179,000 – 18,712,000 = 2,533,000 = $2. 533 million loss Exhibit 1. 4. 1. 1 shows three ways to evaluate whether product 103 should be dropped. In January 2005 should the company reduce the price of product 101 from 9. 41 to 8. 64? The case states that Weston forecasted that if Hilton Manufacturing Company held to the $9. 41 price during the first six months of 2005, its unit sales would be 750,000 cwt. He felt that if Hilton reduced its price to $8. 64 per cwt. the six months’ volume would be 1,000,000 cwt. Although HMC, could reduce the price of product 101 to gain a competitive advantage, the company could also hold on to the $9. 41 and come up with a value proposition analysis to keep the current price but offer an incentive to overpower its competitors, such as introducing a first to market technology, such as an advanced manufacturing technique aimed at reducing variable costs. The company could leverage its direct and indirect labor for capital substitutes in the form of automation or even outsourcing of certain components that the company finds is costly to product itself.
Being the first company to offer an incentive on the product could boost unit sales. For product 101, a 1. 08% cash discount is given to customers who pay cash rather than pay with credit. The original price without the discount is $9. 41 cwt, while the price with the cash discount is $9. 3084 cwt. The proposed cost price reduction without the cash discount is $8. 64 per cwt and is $8. 55 per cwt with the cash discount. In 2005, the costs of materials and supplier were projected to increase by 5% above standard from $1. 3766 per cwt to $1. 4454 per cwt (materials) and $0. 0941 per cwt to $0. 881 (supplies) and the cost of light and heat are projected to increase by 7% from $0. 0269 per cwt to $0. 0288 per cwt. Light and heat are relatively fixed and do not change with production. The variable costs include materials, direct labor, power, compensation insurance, repairs and supplies. The following calculations are the variable costs, revenue, and contribution margin figures for product 101. Price = $9. 41 Old Variable Cost (750,000 cwt) $1,372,000 + 2,321,000 + 40,000 + 148,000 + 32,000 + 94,000 = $4,007,000 Total Fixed Costs (Remains constant) = $4,723,000 Revenue at P = $9. 41 x 750,000 = $7,057,500
Contribution Margin = $7,057,500- $4,007,000= $3,050,500 Price = $8. 64 New production numbers = 1,000,000 cwt Assuming that the current period is 2005, Catalyst has already lowered its price to $8. 64 and the new fixed costs have already taken effect. New Variable Cost (1,000,000 cwt) $1,440,600 + 2,321,000 + 40,000 + 148,000 + 32,000 + 98,700 = $4,080,300 (Fixed Costs) $4,723,000 (Total Revenue) $8. 64 x 1,000,000 = $8,640,000 Contribution Margin = $8,640,000–$4,080,300= $4,559,700 The contribution margin is higher with the lower price point, so HMC would do better to offer the lower price for Product 101.
Exhibit 1. 4. 2. 1 shows a spreadsheet that evaluates whether or not the price of product 101 should be dropped to $8. 64. What is Hilton’s most profitable product? Profit is dependent on total contribution, because a product with higher contribution margin but lower sales will not be able to profit the company. Actual total contribution decides profitability of the product {101} is Hilton’s most profitable product. Exhibit 1. 4. 3. 1 shows an analysis of the most profitable product What appears to have caused the return to profitable operations in the first six months of 2004?
The rent, property taxes, property insurance, indirect labor cost, selling expenses, general admin expenses, depreciation & interest are the fixed costs that were appropriated to all three products based on the production to get the standard costs. However, the actual fixed costs were the same irrespective of the production (which you can see by comparing the total cost for 6 months in 2004 and the total costs for 12 months in 2003 as it relates to the above stated fixed costs. This resulted in a variance of the expected costs. Thus, the total cost turned out lower than the standard cost, which then caused the profit.
The standard costing system is only used as a guide to help management make internal assessments of profit and loss. Actual product costs are nearly impossible to accurate predict 100% and variances always appear. Using accounting and finance technology can help a company make sound business decisions, but should not be taken at face value due to the chaos that is the external market. Events such as supplier shortages and surpluses, changes in interest rates, stock market prices, inflation rates, or even the profits of competitors can have any number of effects on the operations of HMC.
No accounting model today can accurately predict the effects of external factors on a company’s profitability. There is always some speculative risk involved in doing business in the economy. Generating Activities An organization needs resources and people to carry out the activities. The management team of the organization must achieve the goals with the resources, people and activities. The four important roles of a management team is decision making, planning, directing operational activities, and controlling. Recommendations
Make sure that there is an effective activity based management accounting system in place to match the expenses to the proper account that causes those expenses. Conduct a Total Cost of Ownership (TCO) analysis to provide the company with a better understanding of the true cost associated with making better decisions to help make the company most cost competitive. Many business people look at to gauge the profitability of a company. While important, the bottom line doesn’t always provide the entire picture. HMC should also evaluate the ratios and analytical procedures listed below to determine how their business is performing.
A properly conducted profitability analysis provides invaluable evidence concerning the earnings potential of a company and the effectiveness of management. Profitability ratios provide a definitive evaluation of the overall effectiveness of management based on the returns generated on sales and investment. The adequacy of your company’s earnings can be measured in terms of the rate earned on sales; the rate earned on average total assets; the rate earned on average common stockholders’ equity; and the availability of earnings to ommon stockholders. The most widely used profitability measurements are profit margin on sales, return-on-investment ratios, and earnings per share. Ratios Gross Profit on Net Sales Net Profit on Net Sales Management Rate of Return Net Profit to Tangible Net Worth Rate of Return on Common Stock Equity Analytical Procedures Comparative Statements Index-Number Trend Series Common-Size Statements Analysis of Financial Statement Components Exhibit 1. 4. 1. 1 Exhibit 1. 4. 2. 1 Exhibit 1. 4. 3. 1
