Blackheath Case Study

The Case

Blackheath Manufacturing Company, is a company that manufactures a single product named ÐŽ§Great Heath.ЎЁ The company recently hired a new cost accountant, Lee High, who intends to conduct a new cost analysis over a period of three production weeks. Lee wanted to better identify the fixed, variable, and semi-variable costs associated with production of ЎҐGreat Heath.ÐŽ¦ Once these costs were categorized Lee could determine how this would effect the cost of goods sold. Lee could then develop what the break- even volume that could be generated from a changing volume of sales. The case shows the assumptions that Lee High made with respect to variable as versus fixed costs in determining the cost of goods sold per unit . Lee High was able to develop decision rules for use by the companyÐŽ¦s owner for management decision-making purposes. Based upon Lee HighÐŽ¦s data, Charlton Blackheath, the owner, dictated a management decision that sales could not be less than a $7.00 per unit order. The case then introduces a series of sales possibilities that are accepted or declined based essentially on these decision rules. However, a young file clerk decided to take an under-bid proposal at $5.50 for an order of 100 units of ЎҐGreat HeathÐŽ¦ based upon her own assumption that such a volume order would be profitable. A subsequent sales-cost report was developed by Lee High showing cost per unit based upon his predetermined analysis of costs and including profit per unit. Data showed the file clerkÐŽ¦s order generated a subsequent loss because the price per unit was so low. Based upon this data, Blackheath then fired the clerk for this error and readjusted the per unit price to $8.00 to generate a higher profit.

Executive Summary

Lee High had made calculations based upon a static volume of sales and production. He was also calculating only the cost of goods sold and did not take into consideration the respective amounts of fixed versus variable costs. While the fixed costs remain constant in total, when the volume of goods produced and sold increases, the amount of fixed cost attributed to each individual unit goes down. Following this logic the variable cost per unit will remain constant on a per unit basis, assuming a constant level of efficiency of production. This leads us to the inevitable conclusion that as production increases, the cost of goods sold will increase overall, but will decrease on a per unit basis. Thus Blackheath can maintain a healthy profit margin, charging a lower price, assuming that the volume increases accordingly.

With respect to the situation that has been defined in this case study; we have drawn the following conclusions. Lee HighÐŽ¦s decision matrix was fundamentally flawed since he had based everything upon an assumption of 500 units per week sales (p.35), not taking into account the cost fluctuation if production deviates. Lee High also calculated fixed costs incorrectly (p.34) grossly understating them. Mr. Blackheath would lose money in the long run by adopting the new sales strategy of 15% commission for the salesmen who sold Great Heath for a price of $8.00 (p.37). Mr. Blackheath should have promoted, or at least congratulated Adelaide Ladywell on her sales to Maze Woolwich as the added volume increased the Net Profit.

Body

The primary mistake that Lee High made was assuming that fixed expenses were $781. While the President had given him this figure, he should have reviewed the available cost information and come up with his own calculation of fixed costs. The miscalculation of the $781 of fixed costs also led to errant calculations in the variable cost per unit. We are unable to determine how this figure of $781 was reached, therefore we can best assume this figure was arbitrary. The chart below shows the original costs provided in the case. In this chart we have surmised which costs should be labeled as variable, mixed and fixed.

Week

Week 1

Week 2

Week 3

#Units

400

500

600 Direct

Materials

Variable

300.00

375.00

450.00

Direct Labor*

Variable

550.00

625.00

750.00 Indirect Labor

Mixed

180.00

200.00

220.00 Indirect Materials

Fixed

300.00

300.00

300.00 Electricity

Mixed

115.00

125.00

135.00 Factory Insurance

Fixed

125.00

125.00

125.00 Other Overhead

Mixed

310.00

360.00

410.00 Total

1880.00

2110.00

2390.00

The correct figuring of costs are essential in determining the correct pricing for goods. We noted that the original data provided did not properly account for Direct Labor. We can see this in the change of production unit between week 2 and week 3, which clearly shows that the direct labor change is $1.25 per unit (or a $125 difference between weeks.) Thus, the correct direct labor figure for week 1 should be $500*. From this raw data Lee High created income statements for these three weeks (p.35).

Sales

Cost of Goods Sold

Gross Margin

Less: