Case 7 BLACKHEATH MANUFACTURING COMPANY eee Week Wed Wess a Blackheath Manufacturing produced a single product called the Great Heath. During the past three weeks Lee High, the new cost accountant, had observed that production ‘tficency and input prices were constant but that output varied considerably. These three ‘weeks were thought of as typical by the salesman who said that they could be taken a5 average. Production costs were accumulated and accounted for under seven diferent _70up listed below. Units of Direct Direct Indirect Indirect Factory Other Output _Matericls Labor Labor MolerialsElectcity Insurance _ Overhead 400 «S300~=«$550=«SIRDSsS300= SUS. S125 $310, 500 375 «625.200 300 125 135 360 600 450 «750220300. BS 13s ‘410 [Lee High thought that this would be an ideal time to do some cost analysis onthe Great Heath. Based on the data for three weeks' production cost he felt it would be possible o identify fixed costs, variable costs, and semivariable costs. Furthermore, Lee ‘wanted to develop some equation which might be useful for managerial decision making From such equations it seemed that break-even volume could be generated. Since ‘reduction was usually based on orders actually received and since produets were shipped immediately upon completion, inventories of work-in-process and finished goods were practically nonexistent. When talking to the salesman Lee discovered that on typical ‘orders the selling price of Great Heath was $7.00. During lunch one day, Lee was told by the president that office expenses including certain selling items were fixed at $781 per week. [Lee High decided to begin his analysis with income statements forthe three weeks: ‘PART 2: PRODUCT AND SERVICE COSTINGet Week? eats Sale sao sys $4200, (Coat of gots ld in su kaw Gros Ma 370 1390 10 ese ober expenses st 4 Netinome ay ae From hse sttemens Lee relia ht eling mare aot profit, He alo read ‘that cot of goods sold per wt seemed ofall as output rose ‘when sles were 400 then ot of gods sod per unit was $457 “won sles were $00 then oe of goods ol er unit was $422 ‘when sls were 600 thon costa gods sod per wit was $3.98 Lee wasn't sre why cost of goods sod per unit shoud fal, betas afr al the fieny an np! pices had emaiod the sbne, He eased tht here was something ‘oi about the data and decided woul be god io work with some average. Sine the hee weeks for which Le ad data were thought tobe typical he decided th some "standardized cot information” based on sles of 500 uns per werk woud be very pl. He derived the flowing chart ‘Us Daten Gre Heth Average vil cos pr wit sce 0 ‘Averaged con pr nit proce 12 Average id lminisive and sing cos pr sit 16 ‘Commun peri 2 Addl anoint runing evr en soe fey revaindate an a ‘The filamin shi be hepa mind when ling Great Hex 1 Mesut 600 aver aif Gre Heo we make ely 0 cents pr ui 7.00 seling ie 22 Desi al for alee on te oa), Neve Gc Het fr kes in $6.0 po alt arp sas a 60 we ust ek even 3. Beste db lerco wich no comic i pai): Never ll Great ‘wh estan 550 plas pf pn bce a 50 weit rea een ‘EASE T-LACRTERTH MANUFACTURING COMPAR sLee was very pleased with his chart, particularly the part about different decision rules, When the chart was fnishod Loe pasod it onto Mr. Charlton Blackheath, who was the owe, president and chief decision maker at Blackheath Manufacturing. Chariton, ‘who was skeptical of "scientific analysis," studied Lee High's chart and underying data, “That night Chariton sai to his lnwyer, with whom be was heving dinner, “have finally found the kind of practical fast-track analyst I need. This kid, Lee High, has just developed a set of decision rues which will solve all my pricing and profit problems." ‘The nextday Charlton Blackheath sent a memo tothe salesman and others who were ‘involved in pricing Great Heath. Among other things the memo stated, "Everyone should study Mr. Highs chart, especially the decision rules he has generated through complex ‘ost accounting procedures. From nov on, all pricing decisions will follow these rules and under no condition will we pric at less than 10% above our delivery cost. Therefore, the lowest prices that can be quoted by the salesmen and office force ae $7.26/anit and $6.49/unit, respectively. This new policy means the salesman had better stop taking orders at $7.00 per unit" ‘When he ead the memo Lee was bth pleased and abit disturbed, Inthe first place, be didnt expect Mr. Blackheath to ak his chart so seriously; inthe second place, he knew intuitively tha any price higher than $7.00 per unit for Great Heath was too high. Lez explained his poston to Mr. Blackheath who in tum informed the salesman that orders $7.00 would be OK but nothing less would be accepted ‘After this revision in policy Lee felt better, Blackheath went on vacation, the salesman was confused, and the members of the office force, who could take orders by phone, were pleased with their new role ting the next week the folowing four sles prospects were available to Blackheath Manufacturing for Great Heath 1, The salesman sold 450 units at $7.00 per unit. 2 The salesman turned down a request fom an imegular customer for $O units at $6.50 per unt because ofthe $7 00 rule. 3. One telephone order was accepted for $6.50 per unit for 80 units but another order was rejected at $5.75 per unit for 50 units because of the $6.49 ue. 4. Ms Adelaide Ladywel a ninctee-year-od file clerk, received a phone call from Maze Woolwich wien noone else was in the office. Maze said that he had seen Lee Hiahis data on costs and since Blackheath could produce more economically than Wootwiches, he wanted to order 100 units at $5.50, Furthermore, Maze ‘explained that since he was going out of business this would be his only order. Adelaide said that $6.50 was the minimum price, but Maze responded that that ‘as just Blackheath doublet. Ms. Ladywel looked over the data and realized that on a special order like this $5.50 would be a good price considering that cherie Maze Woolwich would produce the 100 units himself. She accepted the order and anticipated a promotion when Mr. Blackheath returned, ‘At the end of the week Lee High prepared the following sales-cost report for Mt Blackheath, PART 2: PRODUCT AND SERVICE COSTINGSou HofUnis_Price/Unit__ConvUnit__ProfUnit (Onder We Accepied From salesman 450 $700 ‘$6.60 $40 Office manger 80 650 590 ra ‘Adelaide Ladywell 10 350 590 (40) Onder we Rejected ‘From salesman 30 650 6.60 9) Office manager 50 515 590 as) ‘After Ms, Blackheath looked over the report he did two things: 1, He called inthe salesman and explained that it would be better for the company to sell 350 units at S8.00/uit than the 450 at $7,00/unit. He went onto say that st $8,00/unit he would pay a commission of 15% instead of 10%. His reasoning was as follows: $8.00 Revenue $7.00 Revenue (Cost per unit per Lee's (Cost per unit per Lee's $90 chart 5.90 chart 210 Contribution 1.10 Contribution 120 Commission 70 Commission 20 Clear profit per unit 4 Clear profit per unit 30 units times 90 per 450 units times 40 unit ‘unit equals $315 profit ‘equals $180 profit per per week work ‘The salesman was instructed to sell at $8.00 and guaranteed at least a commission of 15% on the sales of 350 unit. 2. Blackheath fired Adelaide Ladywell over the Maze Woolwich mess, He suid, "No ‘one is going to cause me to lose 40 cents per unit.” ‘What do you thnk about the whole situation? Develop a proper st of decison rules. ey ‘CASET: BLACKHEATH MANUFACTURING COMPANY a