G.G.

TOYS
Written Analysis of the Case
Prepared by: Adjarani, Alberto, Andalahao, Palma, Wee J., Yap

I. STATEMENT OF THE PROBLEM

In the light of increasing production costs and diminishing profit margins for its products, what
actions should G.G. Toys (The Company) take to improve its profitability over the next twelve
(12) months?

II. OBJECTIVES

The primary objective of this paper is to formulate a recommendation that is in the best interest
of The Company given existing and potential circumstances. Specifically, this paper aims to:
 To recommend a costing system that would better reflect the contribution and profit
margin of The Company’s products than the existing system.
 To compare and contrast the profit margins computed using old costing system and the
proposed costing system.
 To recommend marketing strategies (e.g. pricing matrix, advertising strategies) that
would help increase revenues and profits based on the new analysis of costs and profits
 To address the issue of excess capacity from October to June due to the seasonality of
The Company’s ‘Holiday Reindeer’ doll
 To provide an analysis that would help The Company decide on whether to produce the
Romaine Patch Doll
 To identify potential problems that may arise from the recommended course of action
III. AREAS OF CONSIDERATION

SWOT Analysis – The Company

STRENGTHS
 Leading and established supplier of
high quality dolls
 Unique and durable design of products
 High demands for products from retail
outlets
 Separate manufacturing plants (for the
dolls and its cradles) which contributes
to ease of managing production and
efficiency
 Supplies of raw materials come from
accessible sources
WEAKNESSES
 Misleading cost system which distorts
profit margins of each product
 Separate manufacturing plants (for the
dolls and its cradles) which can be a
reason why overhead costs are high
 Multiple set-ups required for each
product line
 Failure to adjust prices in spite of
increasing production costs
 Static marketing strategies
 Idle capacity

OPPORTUNITIES THREATS
 New product lines (e.g. Holiday  Rising production costs (especially raw
reindeer dolls, Romaine dolls) materials)
 Production of dolls made from scrap  Competition from other doll
and recycled materials manufacturers
 Partnership with complementary  Uncatered demand that may lead to
businesses customer dissatisfaction and low
 Innovation in product lines retention
 Unutilized capacity that may be used
for current operations

ABC Costing
PHASE 1: Computation of OH Rate per Cost Driver
Total Capacity Rate per unit of
Overhead cost pool Cost driver
cost* (A) Levels* (B) cost driver (A/B)
Machine Related Machine hours $112,000 11,200 hrs. $10
Setup Labor Related No. of production set-ups $13,333 160 setups $83.33

Production Order $63,000 161 runs $391.30

No. of production runs
Related

Packaging and Shipping No. of shipments $53,000 350 shipments $151.43

Plant Mgmt. & Facilities Production units $40,000 27,000 units $1.48
*total cost and capacity levels is obtained from the Exhibits (March 2000 Production Data)
PHASE 2: Allocation* of OH Costs to the Products
Overhead costs Geoffrey Doll Specialty Branded # 106 Cradles
Machine runs $37,500 $12,000 $0
Facilities 11,111.11 5,925.93 4,444.44
Setups 833.31 8,333.13 0
Production runs 3,913.04 39,130.43 391.30
Number of shipments 1,514.29 33,314.29 7,571.43
Total allocated OH $54,871.75 $98,703.77 $12,407.17
Divide: Units produced 7,500 4,000 3,000
Cost of OH per unit $7.32 $24.68 $4.14

*allocation is done by multiplying the rate per cost driver (A/B, computed in Phase 1) by the level of activity for
each product (shown in Exhibit 4)

PHASE 3: Computation of Gross Margins using Unit Costs

Specialty Branded
Costs Geoffrey Doll Cradles
#106
Direct Labor cost $3.00 $3.75 $7.50
Direct Materials cost 5.00 6.00 12.00
Manufacturing Overhead (ABC Costing) 7.32 24.68 4.14
Standard Unit cost $15.32 $34.43 $23.64
Selling Price 21.00 36.00 30.00
Gross margin $5.68 $1.57 $6.36
Gross margin % (ABC Costing) 27.05% 4.37% 21.20%

Comparative Analysis of Gross margins: Traditional vs. ABC Costing

Geoffrey Doll Specialty Branded #106 Cradles

Traditional
(Single-allocation 9.00% 34.00% 21.00%
base)
Activity Based
27.05% 4.37% 21.20%
Costing (ABC)
No significant
Traditional costing has
Traditional costing has difference between the
resulted to the over-
Analysis resulted to the under- two cost systems due to
costing of Geoffrey
costing of Geoffrey dolls. the same allocation
dolls
bases
Rationale behind ABC Costing
In the Chicago plant, The Company should modify its existing cost accounting system from
traditional costing to activity-based costing (ABC). In allocating overhead as a percentage of
direct labor cost, the resulting margins for the product lines do not properly reflect the overhead
costs attributable to the same. Using one cost driver distorts the allocation of overhead costs. The
effects are pervasive since manufacturing overhead at the Chicago plant is very high (about 95%
of the overall GG Toys manufacturing overhead). Each doll requires different amounts of
machine hours and other variable costs. By using ABC Costing, each specific category of doll
would have a different manufacturing overhead (and consequently, a different contribution
margin) allocated to it. The more accurate allocation shall be used in measuring profitability and
in decision making for production levels. For the Springfield plant, there is no significant benefit
in changing the cost system since the traditional system yields almost the same cost allocation.
Therefore, the new system shall only be used for the Chicago plant to minimize implementation
costs.

Excess Capacity from October to June

The case stated that The Company acquired additional machines and leased space specifically for
the production of its seasonal product - “Holiday Reindeer Doll”, which is only saleable for three
months (July, August and September). This means that payments of rent and depreciation (which
are year-round expenses) do not generate any form of revenue for nine (9) months. The case is
silent as to whether these machines may be used for the production of other product lines and the
terms of the lease. Assuming the same, the Company can do the following to fully or partially
recover the costs resulting from the unused capacity:
a. Sublease the space to a third party
b. Use the excess capacity to produce other product lines in anticipation of high demand for
the same in the holiday season.

Romaine Patch Doll: To Produce or Not?

Based on the case, the computation of the Romaine Patch Doll’s expected contribution margin is
as follows:
Contribution margin (CM) = Sales Price (SP) –Labor Cost (DL) –Materials Cost (DM)
CM = $8.00 – 3.00 – 6.00
CM = $(1.00)

The negative contribution margin attributed to this proposed product may be a result of an
erroneous estimate in price, cost or both. The case mentions that the Romaine Patch Doll will be
manufactured using scrap or “leftover” materials from the doll pajamas of the regular and
specialty dolls. The decision of what should be done for this product line depends on the
assumption on whether the scrap costs were accounted for in the computation of direct materials
cost for the existing product lines as shown in Exhibit 3.

Assumption #1: The costs of scrap materials have been included in the allocation of materials
cost per unit to the regular and specialty dolls
Implication: This means that the direct materials cost for Romaine Patch Dolls is essentially
zero, giving it a positive contribution margin of $5.00 (i.e. $8.00 – 3.00).

Assumption #2: The costs of scrap materials have NOT been included in the allocation of
materials cost per unit to the regular and specialty dolls
Implication: This simply means that the estimated selling price of the dolls should be increased
to recover the costs of manufacturing it.

IV. ALTERNATIVE COURSES OF ACTION (ACOAs)

Using the new costing system (ABC), the following are the alterative courses of action that the
proponents have come up with. Each course of action is a combination of decisions and
approaches that address the multiple issues and concerns identified in this paper:

ACOA #1:
 Increase price of Specialty-Branded Doll #106 to earn a gross profit margin of at
least 15%
  Retain price of Geoffrey Dolls
 Use idle capacity to produce more regular dolls in anticipation of possible increase
in sales volume during holiday season
 Pursue with the production and sale of “Romaine Patch” Doll using the original
sales price of $8.00

Assuming that there will be price increases for the Specialty-Branded Doll #106, the price that
increase that would have to be suggested would be:

Cost per unit (ABC Costing) $34.43

Divide: Target cost margin __85%__
Target sales price $40.51
Current unit sales price __36.00__
Increase in unit sales price $4.51

Assuming that there will be no changes in cost structure and that the number of units sold and
produced is the same, this will increase total profits by $18,040 ($4.51 x 4,000 units).

ACOA #2:
 Temporarily discontinue the production of Specialty-Branded Doll #106
 Do not pursue with the production and sale of “Romaine Patch” Doll
 Focus on the marketing and innovation of Geoffrey Dolls
 Use idle capacity to produce more Geoffrey Dolls in anticipation of possible increase
in sales volume during holiday season

This course of action emphasizes on the development and marketing of The Company’s flagship
product which is the Geoffrey Dolls. In spite of the strong competition, the case makes it clear
the G.G. Toys has better market positioning and branding. What needs to be done

ACOA #3:
  Increase price of Specialty-Branded Doll #106 to earn a gross profit margin of at
least 20%
 Decrease price of Geoffrey Dolls to complement the increase in the price of Doll
#106
 Use idle capacity to produce more regular dolls in anticipation of possible increase
in sales volume during holiday season;
 Pursue with the production and sale of “Romaine Patch” Doll, with sales price
determined using a “cost + mark-up” approach instead of a predetermined sales
price
 Limit the variety of Specialty Doll #106 and impose a minimum order in units
 Improve efficiency in shipping to decrease shipping costs

V. RECOMMENDATION

ACOA #3:
 Increase price of Specialty-Branded Doll #106 to earn a gross profit margin of at
least 20%
 Decrease price of Geoffrey Dolls to complement the increase in the price of Doll
#106
 Use idle capacity to produce more regular dolls in anticipation of possible increase
in sales volume during holiday season;
 Pursue with the production and sale of “Romaine Patch” Doll, with sales price
determined using a “cost + mark-up” approach instead of a predetermined sales
price
 Limit the variety of Specialty Doll #106 and impose a minimum order of units
 Improve efficiency in shipping to decrease shipping costs

Rationale:
In spite of the low profit margins, it would not be advisable to discontinue the Specialty Branded
Dolls #106 product line. The positive margin still suggest that the product helps recover fixed
overhead costs and is contributing in the profits of the Company. Discontinuing the product line
would only decrease operating profits further since attributable fixed costs will not be avoided
but only redistributed to other existing products.

VII. ACTION PLAN

Time frame Department or
Activity Estimated Budget
Person in-charge
Apply the use of ABC Costing in
the Chicago Plant while retaining
the use of traditional costing in the
Springfield Plant

Assess current machinery to

determine efficiency lapses that
lead to long production runs; repair
or replace if necessary
Market

VII. POTENTIAL PROBLEM ANALYSIS

a. Due to changing production levels and shifts in practical capacity, it would be difficult
and costly for management to implement ABC Costing for its products, especially now
that it is proposing to introduce new products in the market.
b. There is no assurance that the market will respond to changes in the price since demand
elasticity cannot be derived from the information in the case.
c. Further increases in manufacturing costs, especially raw materials, may pose problems in
standardizing unit product costs for each product line.