A case study on Fine Foods, Inc.

Fine ’n’

Fast2013

Case competition

Is it a symptom or a problem?

4.Perforance

Evaluation

Is it A

symptomOr

A problem?

1.CaseOvervie

w

2.Product

Costing

3.Special

Order 2

Great Plains Capital

Great Plains Capital

Fine Foods

Canada, Ltd.

Fine Foods

Canada, Ltd.

Fine Foods, Inc.

Fine Foods, Inc.

Smaller companie

s

Smaller companie

s

3

My 3 concerns

• Product costing for my unit is unfair, and special order for Product MP has allocated excessive costs.

Unfair Allocation

Uncertain special orders

Unreasonable performance evaluation

• Have an negative effect on the employees.

• Accept special orders are good for the company but have an negative impact on unit operation.

1. Background Introduction

SMU2SMU2

Special order for MP

Special order for MP

Dense, bulky,

heavy, but profitable

2.1 PRODUCT COSTING – Current Product Costing Approach

Resource Factory Product

Raw material

Direct production Salaries

（ Time required for one unit × The hourly labor cost ）

（ The cost required for one unit ）

Packaging material

5

Manufacturing Cost

Nonmanufacturing Cost

（ Estimation and a mark-up ）

Electricity

Warehouse costs

Steam

Water

Other

fixed costs

Sales and marketing costs

Cost centers

General management expense from

top management

（ The weight of product ）

Freight out

Media and sales

promotion costs

Steam boilers,

Building-

Maintenance,

Vehicles,

Sanitation

（ Net weight or gross weight ）

Quality, the remaining production management.

Product groups

（ Weight, labor time, or production time ）

2.1 PRODUCT COSTING – Current Product Costing Approach

6

2.2 PRODUCT COSTING – Problem Analysis

Problem 1 Problem 2 Problem 3

Unfair Allocation standard

Unfair Allocation standard

InappropriateAllocation Method

InappropriateAllocation Method

Unreasonable cost range

Unreasonable cost range

MP

Relative dense, bulky

Allocation based on weight

Bear excessive cost

Allocation only Based on number driver

Unreasonable result

Indirect cost is

not proportio

-nal to numbers

Weak combina-tion with activity

Product cost

Period cost

Nonmanufacturing Cost

?

√

2.2 PRODUCT COSTING – Advices for Improvement

7

Other fixed costs

Compensatedfrom

revenue

Costs for top management, business administration , information systems ,etc. → Administrative expense

Media and sales promotion costs for SMU1 and SMU2, freight out, Sales and marketing costs → Sale expense

Inappropriate Allocation Standard & Method

Direct cost →

Activity costs Can be traced →

Activity costs Can`t be traced → Product

costsResource

Allocates to product directly

Based on certain standards

Allocation based on ABC

Production process1

Production process2

Transition

Production process3

Production process4

Ending

The Production Process

TOTAL

Electricity Steam WaterWarehouse

Cost Total

Machine hour Steam volumeCost driver Water volume Area occupied

Resource

AB

C

Preliminary inspection

Sorting

Chopping, peeling , etc.

Preliminary cooking

Temporary storage

The final cooking

Packaging

Frozen

Store temporarily

D

E

F

√√√√

√

√

√

√

√

√

√

√

√

√

√

√

√

D` ZA` B` C`

Step 1: Activity consumes resource

G

H

I

2.3 PRODUCT COSTING – ABC for Variable Costs

The production process

TOTAL

TotalSpecific activity

ABC

Preliminary inspection

Sorting

Chopping, peeling , etc.

Preliminary cooking

Temporary storage

The final cooking

Packaging

Frozen

Store temporarily

Step 2: Product consumes activity

Activity driver

Inspection time

Labor time

Machine hours

Machine hours

Area occupied

Machine hours

Labor time

Machine hours

Area occupied

Product MP Other Products

D

E

F

G

H

I

Z

Activity driver number

Activity cost

Activity driver number

Activity cost

a bAa/i Ab/i

2.3 PRODUCT COSTING – ABC for Variable Costs

FOR EXAMPLEFOR EXAMPLE

The total cost of Preliminary Inspection

A

The total number of Preliminary Inspection

i

Distribution ratio of Activity driver A/i

The activity driver Number of product

MP

a

Costs should allocated

To product MP

Aa/i

10

Activity costs can’t be traced2.4 PRODUCT COSTING – Allocation for fixed costs

Production time

3. SPECIAL ORDER

Joint product & By-product

PRODUCTION LINE 1

PRODUCTION LINE 2

TEMPORARYWARE-HOUSING

PRODUCTION LINE 3

PRODUCTION LINE 4

OTHER PROCESS

OTHER PACKAGING

PRODUCT

MP

PRODUCT

MP

OTHER PRODUCTSPACKAGING MATERIAL

RAW FOOD AND

INGREDIENT

Joint product and by product refer to products produced by using the same raw materials and production line with other products.

Whether a specific product can be treated rely on the goal of the enterprise.

It can be treated as joint product.

DefinitionDefinition It can be rejected within one year before delivery.

ObjectObjectAll of the special orders are for product MP and a food distributor in Mexico.

OthersOthers Product MP sold in Mexico are packaged without label.

Consideration with respect to special order

3. SPECIAL ORDER

Basic information

Strategyperspective

Is it helpful to improve the market share if we take special orders?

Does it have media publicity benefit from special orders?

Accounting perspective

Idle capacity

Incremental revenue and cost

Inventory management

Opportunity cost

13

Special orders accepted

Special orders accepted

• Accepting special order passively

• Failing to ration-alize capacity

and inventory

• Accepting special order passively

• Failing to ration-alize capacity

and inventory

3. SPECIAL ORDER

Have plenty of idle capacity

Have plenty of idle capacity

CM1 ＞ 0CM1 ＞ 0

The current way of decision makingBenefits

recognition

• Make full use of idle capacity

• Increase resource utilization rate

• Maintain market shares

• Lay foundation for expanding

• Meet various demands of customers

• Leading to an increasein profit

Net Sales-Variable manufacturing cost-Fixed manufacturing cost-Freight out=CM1

Irrelevant costs

14

3. SPECIAL ORDER

Advices in Special orders Have plenty of idle

capacity

CM’ ＞ The loss CM’ ＜ The loss

No idle capacity

CM’ ＞ 0

CM’=Net sales-Variable manufacturing cost-Freight outThe loss is caused by giving up producing normal production.

Special orders acceptedSpecial orders accepted Special orders refused

Special orders refused

15

3. SPECIAL ORDER

Advices in other perspectives

Inventory•Apply ERP and SSPM to conducting reasonable inventory management.•Forecast demand of special orders. •Rationalize production Capacity.

Package•Print the brand on the package of products for special orders.

Freight out•Form a strategic alliance with a third-party logistics company to reduce transportation costs.

Marketing•Establish a specialized marketing team to approach the customer to indicate that idle capacity is planned.

Revenue centerResponsible for

revenue

Expense centerResponsible for

expense occurred

Profit centerResponsible for

Cost and revenue

Investment center Has control

over the whole investment

TOP MANAGEMENT

TOP MANAGEMENT

R&DR&DHUMAN

RESOURCE

HUMAN RESOURC

E

SMU1SMU1 SMU2SMU2

MARKETING/

SALES

MARKETING/

SALES

MARKETING/SALES

MARKETING/SALES

SUPPLY CHAIN

MANGEMENT

SUPPLY CHAIN

MANGEMENTITITFINANCEFINANCE

SMU3SMU3

Production Factory

Production Factory

4.1 PERFORMANCE EVALUATION – Responsibility Center

Cost centerHas control over

resource consumption

17

4.2 PERFORMANCE EVALUATION – Problem Analysis

Contribution Margins and Operating Profit

Contribution Margins and Operating Profit

Sales revenueSales revenue

-- Variable costVariable cost

CONTRIBUTION MARGIN 1CONTRIBUTION MARGIN 1

-- Media and Sales promotion

Media and Sales promotion

-- Controllable fixed costsControllable fixed costs

-- Uncontrollable fixed costs

Uncontrollable fixed costs

CONTRIBUTION MARGIN 4CONTRIBUTION MARGIN 4

CONTRIBUTION MARGIN 2CONTRIBUTION MARGIN 2

CONTRIBUTION MARGIN 3CONTRIBUTION MARGIN 3

-- Structural costs and total depreciation

Structural costs and total depreciation

Operating Profit

Operating Profit

Identification

Analysis

• Uncontrollable elements were included in the calculation.

• It fluctuates strongly due to the fixed costs of inventories.

• Uncontrollable elements were included in the calculation.

• It fluctuates strongly due to the fixed costs of inventories.

Perspective of the indicator itselfPerspective of the indicator itself

Perspective of the company`s developmentPerspective of the company`s development

• Have negative effect on company’s development

in the long run .

• Have negative effect on company’s development

in the long run .

UNREASONABLE!!!

OperatingProfit

e.g. Top managem

ent Human

resources

18

How about the Contribution Margin ?

How about the Contribution Margin ?

Sacrificing of product quality

Raising prices

Cutting freight out

Decreasing product costs

How about the relative indicators? How about the relative indicators?

Also Unreasonable

“The absolute indicators

are UNREASONABLE!!”

In addition , we can’t use absolute indicators (such as EVA) to compare different scale units

Take Sales profit ratio for an example:

We refuse the special order to increase Sales profit ratio to improve units’ performance regardless of the company’s profit.

4.2 PERFORMANCE EVALUATION – Problem Analysis

4.3 PERFORMANCE EVALUATION – Agency Cost

ABOSOLUTE

INDICATERS

RELATIVE

INDICATERS

If only

one indicator

is adopted

to evaluate

performance.

Conflicts betweencompanyand units

Conflicts between

unitsand individuals

The cost

to prevent

these selections

is called

AGENCY COST

Adverse selection

How to decrease?Build a new performance

evaluation and reward system

Build a new performance

evaluation and reward system

On the basis of BSC (Balanced Scored Card)

Combine absolute indicators with relative indicators

Evaluate units and individuals’ financial and nonfinancial performance

4.4 PERFORMANCE EVALUATION – Execution Steps

1.

4.4 PERFORMANCE EVALUATION – Execution Step 1

Threats

• Competitive industry• The different diet culture• Instability of the special order requirements

Strength

• The diversity of the products • high Quality• Sales channel is wide• Professional Marketing Department

Weakness

• Insufficient production capacity• Supply chain management is not perfect• The products are lack of brand effect in the international market

Opportunity

• Stable customer demands• A large market• Loyal customers

2.

4.4 PERFORMANCE EVALUATION – Execution Step 2

Customer

Learning &Develop-ment

Operation

Finance

BSC

Establish a system based on the BSC

EVA is regarded as one of thekey financial indicator

Department key performance examination table

Evaluate content Indicator W eight Actual val

ueStandard value

Comprehensive

score

Financial（ 30% ）

EVA 16% ROI 9%

Contribution margin 5%

Customer（ 24% ）

Market share 8%Customer satisfaction 8%

Customer acquisition rate 8%

Internal processes

（ 25% ）

Order processing cycle 7%Production capacity utilization 9%

Raw material loss rate 9%Learning a

nd develop-m

ent （ 21% ）

Staff training rate 7%Employee satisfaction 7%

Human capital investment 7%

Note:date in the table are simulated data

4.4 PERFORMANCE EVALUATION – Execution Step 3

3.

EVA ： Similar to residual income Residual income = Net operating income – (Average operating assets * Minimum required rate of return)

ROI = Net operating income / Average operating assets

4.4 PERFORMANCE EVALUATION – Execution Step 3

Individual key performance examination tableEvaluate co

ntent Indicator W eight Actual value

Standard value

Comprehensive score

Financial（ 30% ）

Average sales revenue 16%Variable cost per unit 9%

Average profit 5%

Customer（ 24% ）

Average market share 8%Customer satisfaction 8%

Average customer acquisition 8%

Internal processes

（ 25% ）

Order processing time 7%Employee productivity 9%

Average amount of material loss 9%Learning a

nd develop-

ment （ 21% ）

Average training time 7%Employee satisfaction 7%

W age growth rate 7%

Note:date in the table are simulated data

3.

4.

4.4 PERFORMANCE EVALUATION – Execution Step 4

Results control , also called quantitative performance control, work as a guide in a kind of control method.

Actual value <Standard value

Take punitive measures

e.g. ROI

Actual value > Standard value

Take incentive measures

e.g. Completion rate of sales revenue.

Opposite :

The order processing cycleOpposite :

Variable cost per unit

4.

4.4 PERFORMANCE EVALUATION – Execution Step 4

Improve working environment ， promotion

In the next page

Performance salary*RONA(RONA≧15

%)

Share dividend

For all theEmployees

Only formanager

4.

4.4 PERFORMANCE EVALUATION – Execution Step 4

Indicator The percentage of completionIndividual indicat

or -2% -1% 1% 2%

EVA

-5% of the performance salary

-3% of the performance salary

+3% of the performance salary

+5% of the performance salary

Market share

Customer acquisition rate

Raw material loss rate

+5% of the performance salary

+3% of the performance salary

-3% of the performance salary

-5% of the performance salary

......

Performance salary

28

Unfair Allocation

UncertainSpecial orders

Unreasonable Performance

Evaluation

Activity-Based Costing Allocation

Contribution Margins Approach

Balanced Scored Card

• Reasonable allocation approach.

• Improve the initiative and satisfaction of employees.

• Make production plan more flexible.

• Reduce the conflict between company and units.

• Promote the company`s development in the long run.

Costs that can(not) be easily and conveniently traced to a cost object. e.g. Packaging materials/Production management

Costs that managers should (not) take into consideration when makingdecisions.e.g. Incremental costs costs/Common costs

Costs that stay the same as output changes ./Costs that varies in direct proportion to changes in output. e.g. Environment/Material , Labor

Expense consumed for production. /Related to specific period and was deducted from current revenue. e.g. Raw material/Selling cost

Driver Factors that cause changes in resource usage, activity usage, costs, and revenues e.g. Labor hour is the cost driver of labor cost.

Anything for which cost data are desired. e.g. Product MP and the other products

Costs that managers have/don’t have the power to influence.e.g. Sales promotion for SMUs/Management fees allocate to SMUs

An increase in cost between two alternatives./A cost that is incurred to support a number cost objects but that cannot be traced to them individually.e.g. A cost incurred when making decision on special order /Costs of Production management

A costing method based on activities that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore fixed as well as variable costs.

30

THANKS FORYOUR TIME ! 2013

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