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Unformatted text preview: 11-3 The Superior Valve DivisionIn 2009, the Superior Valve Division of the Able Corporation found itself in a position typical of fast-growing companies. Although sales revenues were increasing rapidly, capital equipment allocations from Able were less than desired, and profits were variable. Jerry Conrad, the general manager of the division, enrolled that year in a seminar on contribution margin income sponsored by the American Management Association (AMA). According to Conrad, "Before I went to that seminar, my knowledge of contribution margin income was limited to casual comments that I overheard at group general managers' meetings. A large acquisition in the automotive aftermarket industry had always used a contribution margin approach in its accounting systems. All other segments of the Able Corporation used the full costing method, but this company was allowed to keep its contribution margin cost system because a forced change of systems at the time of acquisition would have been too disruptive."Jerry believed that the full cost reports used in his division were accurate. He and Frances Kardell, the Division Controller, were confident they knew the total manufacturing cost of each of their products. However, Jerry did not have the same confidence in his staff's ability to determine how volume changes would affect profits. He was convinced that better utilization of plant and equipment and a more effective pricing structure would lead to substantially improved earnings. The division was not as profitable as others in the industry or other similar-size divisions in the corporation that had comparable manufacturing processes.A main point of the AMA seminar was that product lines do not produce profits; they produce contribution margin (sales revenue minus variable costs), which can become profits only after fixed costs are covered. The seminar also underscored not only the importance of cost behavior analysis but also the arbitrariness of many fixed cost allocations. Jerry immediately saw in contribution margin a new approach to solving Superior Valve's problems with both product mix and pricing decisions. Jerry discussed the subject of contribution margin with Todd Talbott, the Group Controller. After hearing the advantages and disadvantages of the approach, Jerry recommended that his division's product costing system be overhauled for the third time since Able Corporation acquired Superior Valve 20 years ago. Todd agreed to support a change in the management reporting system, but he pointed out that the contribution margin approach was contrary to the reporting philosophy of the corporation and, for external purposes, did not comply with GAAP, S.E.C. reporting requirements, and corporation and, for external purposes, did not comply with GAAP, S....
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