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G.G.Toys has been a leading supplier of dolls (premium and high quality dolls) to almost all
the major retail stores across United States. The company’s USP had been highly durable
dolls made of vinyl and resin.
Off late, the company’s gross margins on its standard dolls had registered a decreasing trend
falling from 25% to 9%. The case is to discuss on how can the company turn this around and
make more profitable business once again. The company has two plants namely Chicago
Manufacturing Plant where all varieties of dolls are being manufactured and a Springfield
Assembling plant where only assembling of cradles is done.
Answer to Question 1:
For Chicago Plant: The existing cost system at the plant is that of traditional cost estimation
where apart from the direct material and direct labour the overheads of the plant are applied
uniformly over production basis the direct labour hours incurred. This does not give a true
representation of the overhead to be allocated to both the production lines: Standard Geoffrey
Dolls and Doll#106 as both of them uses different production runs, different setups time and
different number of shipments.
The company should consider changing the cost system from traditional to ABC (Activity
Based Costing) system. ABC system will allocate the overhead of the plant to the production
lines based on the actual usage and not uniformly based on production alone. ABC will
allocate the overhead based on each activity usage be it production runs or machine set up
time or number of shipments. This will enable the company allocate overheads accurately and
equalise the contribution margins.
For Springfield Plant: Here, the company has only one activity and that is assembling of
cradle with no machine hours or machine set up time. So, for this the company should still
stick to the traditional costing system.
Answer to Question 2:
The cost of the dolls and cradle under ABC system can be calculated as below:
We have first calculated the per unit rates for each heads of the manufacturing overhead
being incurred. With these rates, we can calculate the overheads cost per unit for each
product as below:
Thus, we see that the actual costs of the products under ABC for Geoffrey dolls is $15.21 as
opposed to the earlier computed cost of $19.19 based on traditional costs. This is because the
product was actually using less of resources but because of the policy of allocating the
overheads uniformly, the costs of the doll was shooting up.
Answer to Question 3:
The comparison of the profitability of each doll under both the system of costs is presented as
below:
From, the above we clearly see that against the original 9% profit of Standard doll, the actual
margin is computed as 27% under ABC system of costing. The ABC system presents a
dramatically different picture regarding the profitability of the products. According to the
margin statement as per the ABC system, the management of the company should:
1. Direct the marketing efforts to the sales of Geoffrey dolls because of the huge
contribution margin that it brings to the company.
2. Consider increasing the selling price of the speciality dolls to ensure a decent
contribution margin.
3. They can consider bundling the cradle with doll as the cradles are also high
contribution margin product for the company.
The additional information which would help make these recommendation more strongly are
reports on industry growth indicating demand of the doll and future projection on sale prices.
Answer to Question 4:
The company is creating excess capacity and that capacity will only be used for only 3
months (July, August and September) and will remain unutilized for a larger span of the year.
This would lead to large volume variances for the company where the reports will show large
failure to utilise the installed production capacity and these will be built in the overhead rates.
It is recommended to use an opportunity cost approach to account for this unused capacity,
wherein the lost profits are traced to the underutilized capacity of the manufacturing
establishment. This is achieved by estimating the total cost of unused capacity and avoid it
for decision making purpose.
There can be two situations when the holiday reindeer is under production:
a. If the holiday reindeer dolls do not use any resources like production runs, setup, or
the shipments of the facility, then the final costing of all other dolls will not be
affected.
b. But, if the production lines share similar cost pools, it will obviously affect the
manufacturing overhead cost which is to be allocated to Specialty-branded #106 and
Geoffrey Dolls.
The method to be employed in the case will be similar to the one we have used above,
wherein we will recalculate the total cost per activity and divide it by the increased activity
levels to recompute the cost per unit for different products.
Answer to Question 5:
The difference between the forecasted and actual revenue during March 2000 in Chicago
plant can be explained using the variance analysis.
Variance Analysis
Particulars Budgeted Actual
No. of units (A) 24,900 24,000
Revenue (B) $7,65,000 $7,86,000
Price (B/A) $30.72 $32.75
With the above information, we can calculate the Price and Quantity variance as below:
Through this, we can interpret that the reason for higher revenues in spite of reduction in no.
of units produced from budgeted 24,900 to 24,000 only is the increase in per unit prices of
the product. It was due to favourable price variance that the revenues were higher than
budgeted.
The other information that would help me assess the difference more accurately is the exact
information about the budgeted units to be produced for each type of doll. Through this
information I would have explained exactly the product line which is contributing to the
favourable variance in revenue.
Answer to Question 6:
The company in order to produce Romaine Patch doll, has two options:
Option 1: Buying Materials from an external Source:
The contribution margin in this case can be computed as below:
From the above analysis, we see that the company should produce the Romaine Patch doll
only when the company uses scrap material from the Chicago plant. Production only from
scrap material is recommended because of the following reason:
To utilize the scrap materials resulted from making the pyjamas of the current
production units.
This will enable the firm produce a low range variant of the doll making it affordable
for all categories of buyers.
This will also help the company advertise the company as an environment-friendly
venture as they are using scrap for something creative.