ACT 5060 (W4) - W (Weird MTSOLO 0 Timberland’s Overhead...

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Unformatted text preview: W (Weird MTSOLO 0 Timberland’s Overhead Allocation Problem Background Eastvaco recently purchased a pulp manufacturing company. Timberland, inc, located in Columbia, South Carolina. Eastvaco’s management is concerned about the current cost structure currently used by Timberland. The pulp industry' in general as been on an economic downturn but Timberland has historically shown below average net income and return on equity. Timberland produces four products. Each product is a variation of paper, for instance, difference thickness, color andlor width. Timberland supplies other Eastavco segments, in particular, the Charlotte plant, product A, a key raw material for their manufacturing process. Tile CEO of Eastvaco has dispatched several accountants from their corporate office to Columbia to review Timberland‘s cost allocation structure. Corporate accountants suspect that Timberland’s current overhead allocation. based on multiplying the overhead rate by material costs, is causing an over-allocation of overhead for some products. This leads to inaccurate product profitability analysis. It is believed that product changes and slitting are not being allocated co rrectly. The Typical Pulp Manufacturing Process The manufacturing process begins with timber in the form of logs or wood chips. if raw materials are received in the form of logs, the first step in the process is debarking. A rotating drum that measures to feet in diameter by 100 feet in length tumbles the logs to remove the bark. After debarking. chippers reduce the logs into one-inch cubes. Theo wood chips are cooked to break down the glue—like material bonding the wood fibers. Chemicals used in the process are reclaimed and reused in future production. Next. the naturally brown fibers are washed and screened. A bleaching process converts brown pulp into white pulp. The paperboard manufacturing process begins by mixing pulp with water and chemicals. The mixture is applied to a porous wire mesh; formation of paper actually occurs within this step. The wire mesh travels through a press that forces the pulp mixture against the wire to eliminate water within the mixture and to form the desired paper thickness. The material then proceeds to a drying section where it travels across numerous cylindrical dryers that are heated with steam. In the final section ol‘the paper machine. long sections of paperboard (approximately five miles long and weighing ten tons) are rolled up into parent rolls and are removed from the machine. The parent roll is further processed by the Company’s customers (including other Eastvaco segments} to make various types of paperboard containers. Sometimes customers require additional processing on parent rolls. For example. food processors often require widths of 18 inches. rather than the standard width of a roll (approximater 12 feet). Thus. rolls are loaded onto a rcwinder slitter to produce eight rolls 18 inches wide from one lZ-foot-wide roll. The Company had always combined labor and machine costs ol‘thc slittcr with those of the paper machine for allocation purposes. Thus. all paperboard products shared in the costs of slitting even though most products were not slit. it is now thought that slitting may be more expensive than previously thought. In addition to the costs of specialized equipment and extra labor. knives used in the slitting process often damage the paperboard’s edges. Thus. more quality inspection and testing are required when producing slit rolls. Timberland’s Cost Allocation Process The Company had always combined labor and machine costs of the siitter with those of the paper machine for allocation purposes. Thus. all paperboard products shared in the. costs of slitting even though most products were not slit. It is novr thought that slitting may be more expensive than previously thought. in addition to the costs of specialized equipment and extra labor. knives used in the slitting process often damage the paperboard‘s edges. Thus. more quality inspection and testing are required when producing slit rolls. Continuous processors. such as chemical and paper producers. historically have used volume-related drivers to attach overhead to products. The Company traditionally applied overhead to its products as a function of material costs. Management believed using "material costs" as an allocation base made sense because thicker products required more machine time to process as they demanded slower machine speeds, Additionally. drying time and energy consumption increase with thicker basis weights. (See Table l for material costs associated with each product,} Thus. unit level (or volume-related] drivers made sense for applying certain types of overhead to products. However. other important costs were incurred without respect to volume. For example. product changes induce instabilities into the manufacturing process that result in scrap until the process resumes stability. On average. production engineers estimate that approximater one-hall roll is lost to scrap each time a product change is made. Just as discrete-part manufacturers incur machine setup costs between production runs of two different products, scrap produced following product changes is a predictable cost of production. Seine ol‘the pulp can be recovered by recycling the scrapped paper. termed “broke” paper. Thus. the product change cost figures presented in Table 3 include 01in depreciation. labor. energ). and waste materials associated with product changes. Recently, some managers at the cornpany began questioning the long-standing strategic policy ot‘producing a full product line. Because selling prices and profit margins significantly varied across the product mix, some managers questioned whether the company’s assets were being used to the greatest advantage. Currently the Company was experiencing demand in excess of its production capacity. A sample representing significant categories of products is presented in Table 1. The sample contains thin paperboard products(caliper .0l3) as well as heavier products (caliper .020). in addition. Table 1 identifies whether a given product is coated or uncoated. or slit. The sample is representative ofthe variation in batch quantities. Some are produced and sold in small quantities. while the market demands significantly more production ofothcr products. Material cost per roll includes pulp and chemical costs. while the selling price reflects recent market prices. Pulp and paperboard is a capital-intensive industry requiring expensive processing equipment. The company cost accountants estimated that manufacturing overhead. including labor. energy. and depreciation on capital equipment, approximates 105% ofrnaterial costs. Table 1 Selected production and financial data Product Thickness Coatch'Uncoatcd Slit Average Rolls per Batch Materials Cost per Roll Selling Price per Roll A .013 Coated Yes 50 84,800 $12,600 B .014 Uncoated No 2 35.200 $13,500 C .015 Coated Yes 35 85.600 $14100 D .020 Coated No 1 57400 $19,500 Table 2 Overhead Totachpreciation is $800,000 : Product Change “$8.000 + Slitting $70,000 + Net *S?22.000 Total Labor is $300,000 = Product Change ** $3.000 + Slitting $25,000 + Net *$272.000 TotalEncrgy is $500000 = Product Change “$5,000 + Slitting $80,000 + Net * 5415.000 Total Othcris $198470 = Product Change “$1.000 + Slitting $20,000 + Net * $177,470 Total Waste is S 30.000 = Product Change “3530.000 + Slitting -0- + Net -0- “' Net is equal to total amount minus product change cost and minus slitting cost. This amount represents the general overhead, ie. Overhead that is not specific to a particular product. “Product change is required of all four products and the cost is to be divided equally among the four products. Total product cost is equal to materials, overhead. product cost and where incurred slitting costs. Requirements 1. Prepare a schedule proving that overhead is currently 105% of material costs. 2. Prepare a schedulc showing Cost per roll of each of the four products using the 105% overhead rate. 3. As Eastvaco’s cost accountant you believe the general overhead should be allocated separately. Prepare a schedule showing what you believe the new overhead rate should be. 4. Using the new overhead rate from requirement 3, prepare a schedule calculating the revised cost per rqll of each product. 5. Assuming that the selling price for each product is relatively inelastic. write a short memo to Eastvacois CEO with your conclusions and suggestions. Nae/git % Correction on EV Case Assignment - Overhead Allocation Posted on: Friday. October 14., 201] Hello Everyone, There is a typo in the Overhead allocation assignment. The materials cost should be: Product A 50 x $4,800 = $240,000 Product B 2 x $5,200 = 10,400 Product C 35 x $5,600 = 196,000 Product .D 175 x $7,400 = 1,295,000 Total $1,741,400 Product D in the case was mistyped as 1 roll and it should be 175 rolls per batch. ...
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This note was uploaded on 12/01/2011 for the course ACT 5060 taught by Professor Debroahpendarvis during the Fall '08 term at Nova Southeastern University.

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ACT 5060 (W4) - W (Weird MTSOLO 0 Timberland’s Overhead...

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