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UV1726
LAMBETH CUSTOM CABINETS (A)
Jack Lambeth, a master cabinetmaker, owned and operated a shop where he sold custom- made cabinets. At the beginning of September, he had no outstanding debts, and the following amounts were on his books:
1. Raw-materials inventory, $2,150
2. Supplies inventory, $620
3. Work-in-process inventory, $5,650
Job
Materials
Labor
Overhead (50% of
labor)
A-3
$ 750
$1,100
$ 550
A-4
900
650
325
A-5
325
700
350
Total
$1,975
$2,450
$1,225
$5,650
4. All other assets as of September 1, $16,890
During the month, Lambeth’s woodworking crew finished jobs A-3, A-4, and A-6, but did not finish A-5. Job A-7 was started but not finished during September. Overhead costs (pertaining primarily to equipment and shop depreciation, cleaning supplies, and insurance) were applied to every job at the end of the month unless the job was finished during the month, in which case overhead was applied when the job was finished.
This case was prepared by Professor Francis J. Spreng of McKendree College, with minor revisions by Professor Mark Haskins of the Darden Graduate School of Business Administration, University of Virginia. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2004 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies ,send an e-mail to
[email protected] No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means— electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
-2- UV1726
During September, the following direct-materials and direct-labor costs were incurred:
Job
Direct Materials
Direct Labor
A-3
$ 280
$ 750
A-4
350
1,300
A-5
180
550
A-6
375
490
A-7
590
370
$1,175
$3,460
Other important financial factors in September were as follows:
1. Raw materials costing $1,675 were purchased during the month.
2. Supplies costing $580 were purchased, of which $490 were used and thus transferred to the manufacturing-overhead account.
3. Total increases to the labor-general-ledger account were $5,460 (apparently, $2,000 of indirect-labor costs were charged).
4. General and administrative expenses for the month were $3,420.
5. Collections received from customers on jobs A-3, A-4, and A-6 amounted to $6,125,
$8,600, and $1,750, respectively, for a total of $16,475.
6. At the end of the month, Lambeth Custom Cabinets had no outstanding debts.
While Lambeth was reviewing the September data, he became concerned about the manufacturing-overhead variance (MOV). Because he never wanted to lay off an employee, the MOV was always large in months when business was slow. (Lambeth assigned idle workers to general cleanup and repair work, and charged their wages to indirect labor.) Of course, Lambeth realized why the MOV was so large. What he was worried about, however, was Mrs. Carter.
Mrs. Carter, a neighbor, had stopped by the shop one day in early September to get a price on some cabinets she wanted built. Lambeth’s son, Jack Jr., spoke with her. Jack Jr. was working in the shop while on summer vacation between his first and second year of graduate business school. He studied Mrs. Carter’s plans, and estimated the cost of building her cabinets to be $1,625. His job-estimation sheet showed the following:
Lumber $590
Finishing materials 75
Direct-labor cost 640
Overhead
320
$1,625
-3- UV1726
When Jack Jr. quoted a price of $1,900 ($1,625 cost plus $275 profit) to Mrs. Carter, she said that she could get the same thing built by Walworth Custom Kitchens for $1,500. Furthermore, she informed him, “I would throw the dumb economics books away before I would pay a penny more than $1,500 for book cabinets to store them.”
Jack Jr. simply told her that his best price was $1,900. He explained all about labor, materials, profit, overhead, and competitive capitalism. In addition, he told Mrs. Carter that Walworth could not make money on a $1,500 price, and if Walworth was really willing to build the shelves for $1,500, she would be stealing from Mr. Walworth!
Mrs. Carter was very angry when she left. Jack Jr. later told his father the whole story, and laughed as he said, “Heck, we can’t build stuff that costs $1,625 and sell it at a price of
$1,600, let alone $1,500, can we?” At the time, Lambeth did not think much about the incident, but he began to wonder whether Jack Jr. had learned anything at graduate business school. Lambeth became especially concerned when he saw Bob Walworth, who said, “Mrs. Carter saved me last month.” Walworth had just delivered Mrs. Carter’s new cabinets, for which she paid $1,500. Lambeth wondered who was right: Jack Jr. or Walworth?
Assignment
1. Show, in a series of ledger accounts, the transactions for September (you may use the T- accounts below).
2. In the greatest detail possible, prepare balance sheets as of September 1 and September 30 and an income statement for September (do not consider taxes).
-4- UV1726
Raw Materials Work-in-Process Finished Goods
Manufacturing Expense &
Supplies Inventory Overhead Inc. Summary
Labor All Other Assets
9-192-063
R E V: O C T O B E R 19, 2004
Hilton Manufacturing Company
In February 2004, George Weston was appointed general manager by Paul Hilton, president of Hilton Manufacturing Company. Weston, age 56, had wide executive experience in manufacturing products similar to those of the Hilton Company. The appointment of Weston resulted from management problems arising from the death of Richard Hilton, founder and, until his death in early 2003, president of the company. Paul Hilton had only four years’ experience with the company, and in early 2004 was 34 years old. His father had hoped to train Paul over a 10-year period, but the father’s untimely death had cut short this seasoning period. The younger Hilton became president after his father’s death and had exercised full control until he hired Mr. Weston.
Paul Hilton knew that he had made several poor decisions during 2003 and that the morale of the organization had suffered, apparently through lack of confidence in him. When he received the 2003 income statement (Exhibit 1), the loss of almost $200,000 during a good year for the industry convinced him that he needed help. He attracted Weston from a competitor by offering a stock option incentive in addition to salary, knowing that Weston wanted to acquire financial security for his retirement. The two men came to a clear understanding that Weston, as general manager, had full authority to execute any changes he desired. In addition, Weston would explain the reasons for his decisions to Mr. Hilton and thereby train him for successful leadership upon Weston’s retirement.
Hilton Manufacturing Company made only three industrial products, 101, 102, and 103, in its single plant. These were sold by the company sales force for use in the processes of other manufacturers. All of the sales force, on a salary basis, sold the three products but in varying proportions. Hilton sold throughout New England, where it was one of eight companies with similar products. Several of its competitors were larger and manufactured a larger variety of products. The dominant company was Catalyst Company, which operated a plant in Hilton’s market area. Customarily, Catalyst announced prices, and the other producers followed suit.
Price cutting was rare; the only variance from quoted selling prices took the form of cash discounts. In the past, attempts at price cutting had followed a consistent pattern; all competitors met the price reduction, and the industry as a whole sold about the same quantity but at the lower prices. This continued until Catalyst, with its strong financial position, again stabilized the situation following a general recognition of the failure of price cutting. Furthermore, because sales were to industrial buyers and the products of different manufacturers were similar, Hilton was convinced it could not unilaterally raise prices without suffering volume declines.
HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 1991 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
192-063 Hilton Manufacturing Company
During 2003, Hilton’s share of industry sales was 12 percent for type 101, 8 percent for 102, and 10 percent for 103. The industrywide quoted selling prices were $9.41, $9.91, and $10.56, respectively.
Weston, upon taking office in February 2004, decided against immediate major changes. Rather, he chose to analyze 2003 operations and to wait for results of the first half of 2004. He instructed the accounting department to provide detailed expenses and earnings statements by products for 2003 (See Exhibit 2). In addition, he requested an explanation of the nature of the costs including their expected future behavior (see Exhibit 3).
To familiarize Paul Hilton with his methods, Weston sent copies of these reports to Hilton, and they discussed them. Hilton stated that he thought product 103 should be dropped immediately as it would be impossible to lower expenses on product 103 as much as 83 cents per hundredweight (cwt.). In addition, he stressed the need for economies on product 102.
Weston relied on the authority arrangement Hilton had agreed to earlier and continued production of the three products. For control purposes, he had the accounting department prepare monthly statements using as standard costs the actual costs per cwt. from the 2003 profit and loss statement (Exhibit 2). These monthly statements were his basis for making minor marketing and production changes during the spring of 2004. Late in July 2004, Weston received from the accounting department the six months’ statement of cumulative standard costs including variances of actual costs from standard (see Exhibit 4). They showed that the first half of 2004 was a successful period.
During the latter half of 2004, the sales of the entire industry weakened. Even though Hilton retained its share of the market, its profit for the last six months would be small. For January 2005, Catalyst announced a price reduction on product 101 from $9.41 to $8.64 per cwt. This created an immediate pricing problem for its competitors. Weston forecast 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 dropped its price to $8.64 per cwt., the six months’ volume would be 1,000,000 cwt. Weston knew that competing managements anticipated a further decline in activity. He thought a general decline in prices was quite probable.
The accounting department reported that the standard costs in use would probably apply during the first half of 2005, with two exceptions: materials and supplies would be about 5 percent above standard; and light and heat would increase about 7%.
Weston and Hilton discussed the product 101 pricing problem. Hilton observed that especially with the anticipated increase in materials and supplies costs, a sales price of $8.64 would be below cost. He therefore wanted to hold the price at $9.41, since he felt the company could not be profitable while selling a key product below cost.
Questions
1. 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?
2. In January 2005, should the company reduce the price of product 101 from $9.41 to $8.64?
3. What is Hilton’s most profitable product?
4. What appears to have caused the return to profitable operations in the first six months of 2004?
2
Hilton Manufacturing Company 192-063
Exhibit 1 Hilton Manufacturing Company, Income Statement for Year Ending December 31, 2003.
Gross Sales
$40,690,234
Cash discount
622,482
Net sales
40,067,752
Cost of sales
25,002,386
Gross margin
15,065,366
Less: Selling expense
$7,058,834
General administration
2,504,597
Depreciation
5,216,410
Operating income
285,525
Other income
78,113
Income before interest
363,638
Less: interest expense
555,719
Income (loss)
$ (192,081)
3
(
.
)
192-063 Hilton Manufacturing Company
Exhibit 2 Hilton Manufacturing Company, Analysis of Profit and Loss by Product, Year Ended December 31, 2003
Product 101
$ per
Product 102
$ per
Product 103
$ per
Total
Thousands
Cwt.
Thousands
Cwt.
Thousands
Cwt.
Thousands
Rent
721
0.3383
603
0.5856
718
0.7273
2,042
Property taxes
240
0.1125
192
0.1862
153
0.1555
585
Property insurance
201
0.0941
153
0.1486
202
0.2047
556
Compensation insurance
317
0.1486
167
0.1620
172
0.1747
656
Direct labor
4,964
2.3282
2,341
2.2740
2,640
2.6746
9,945
Indirect labor
1,693
0.7941
814
0.7903
883
0.8947
3,390
Power
86
0.0403
96
0.0929
116
0.1171
298
Light and heat
57
0.0269
49
0.0472
39
0.0392
145
Building service
38
0.0180
30
0.0288
28
0.0288
96
Materials
2,935
1.3766
1,809
1.7572
1,862
1.8862
6,606
Supplies
201
0.0941
183
0.1774
135
0.1363
519
Repairs
68
0.0319
57
0.0557
39
0.0396
164
Total
11,522
5.4036
6,493
6.3059
6,986
7.0787
25,002
Selling expense
3,496
1.6397
1,758
1.7069
1,805
1.8286
7,059
General administration
1,324
0.6209
499
0.4850
681
0.6904
2,505
Depreciation
2,169
1.0172
1,643
1.5955
1,404
1.4223
5,216
Interest
201
0.0941
153
0.1490
202
0.2043
556
Total cost
18,711
8.7755
10,546
10.2423
11,078
11.2243
40,338
Less other income
39
0.0184
20
0.0192
19
0.0192
78
18,672
8.7571
10,526
10.2231
11,059
11.2051
40,260
Sales (net)
19,847
9.3084
9,977
9.6900
10,243
10.3784
40,068
Profit (loss)
1,175
0.5513
(549)
(0.5331)
(816)
(0.8267)
(192)
Unit sales (cwt.)
2,132,191
1,029,654
986,974
Quoted selling price Cash discounts taken,
percent of selling price
$9.41
1.08%
$9.91
2.22%
$10.56
1.72%
Note: Figures may not add exactly because of rounding.
4
Hilton Manufacturing Company 192-063
Exhibit 3 Accounting Department’s Commentary on Costs
Direct Labor: Variable. Nonunion shop at going community rates. No abnormal demands foreseen.
It may be assumed that direct labor dollars is an adequate measure of capacity utilization.
Compensation insurance: Variable. Five percent of direct and indirect labor is an adequate estimate.
Materials: Variable. Exhibit 2 figures are accurate. Includes waste allowances.
Power: Variable. Rates are fixed.
Supplies: Variable. Exhibit 2 figures are accurate.
Repairs: Variable. Varies as volume changes within normal operating range. Lower and upper limits are fixed.
General administrative, selling expense, indirect labor, interest: Almost nonvariable. Can be changed by management decision.
Cash discount: Almost nonvariable. Average cash discounts taken are consistent from year to year.
Percentages in Exhibit 2 are accurate.
Light and heat: Almost nonvariable. Heat varies only with fuel cost changes. Light is a fixed item regardless of level of production.
Property taxes: Almost nonvariable. Under the lease terms, Hilton Manufacturing Company pays the taxes; assessed valuation has been constant, the rate has risen slowly. Any change in the near future will be small and independent of production volume.
Rent: Nonvariable. Lease has 12 years to run.
Building service: Nonvariable. At normal business level, variances are small.
Property insurance: Nonvariable. Three-year policy with fixed premium.
Depreciation: Nonvariable. Fixed dollar total.
5
192-063 -6-
Exhibit 4 Hilton Manufacturing Company, Profit and Loss by Product, at Standard, Showing Variations from January 1 to June 30, 2004.
Product 101 Product 102 Product 103
Standard per
Cwt.
Total at
Standard
Standard per
Cwt.
Total at
Standard
Standard per
Cwt.
Total at
Standard
Total Standard
(thousands)
Total Actual
(thousands)
Variance
Rent
0.3383
337
0.5856
417
0.7273
365
1,119
1,021
+ 98
Property taxes
0.1125
112
0.1862
133
0.1555
78
323
307
+ 16
Property insurance
0.0941
94
0.1486
106
0.2047
103
302
278
+ 24
Compensation insurance
0.1486
148
0.1620
115
0.1747
88
351
348
+ 3
Direct labor
2.3282
2,321
2.2740
1,619
2.6746
1,341
5,281
5,308
– 27
Indirect labor
0.7941
792
0.7903
563
0.8947
448
1,803
1,721
+ 82
Power
0.0403
40
0.0929
66
0.1171
59
165
170
– 5
Light and heat
0.0269
27
0.0472
34
0.0392
20
80
83
– 3
Building service
0.0180
18
0.0288
21
0.0288
14
53
50
+ 3
Materials
1.3766
1,372
1.7572
1,251
1.8862
946
3,569
3,544
+ 25
Supplies
0.0941
94
0.1774
126
0.1363
68
288
288
—
Repairs
0.0319
32
0.0557
40
0.0396
20
91
88
+ 3
Total production cost
5.4036
5,387
6.3059
4,490
7.0787
3,548
13,425
13,206
+219
Selling expense
1.6397
1,635
1.7069
1,215
1.8286
917
3,767
3,706
+ 62
General administration
0.6209
619
0.4850
345
0.6904
346
1,310
1,378
– 68
Depreciation
1.0172
1,014
1.5955
1,136
1.4223
713
2,863
2,686
+177
Interest
0.0941
94
0.1490
106
0.2043
102
302
290
+ 12
Total cost
8.7755
8,748
10.2423
7,294
11.2243
5,626
21,668
21,266
+402
Less other income
0.0184
18
0.0192
14
0.0192
10
42
42
—
8.7571
8,730
10.2231
7,280
11.2051
5,617
21,626
21,224
+402
Actual sales (net)
9.3084
9,279
9.6900
6,900
10.3784
5,202
21,382
21,382
—
Profit or loss
0.5513
550
(0.5331)
(380)
(0.8267)
(414)
(244)
158
+402
Unit Sales (cwt.)
996,859
712,102
501,276
Note: Figures may not add exactly because of rounding.
