Advanced Management Accounting ACCTG 835

Case 20-3 Cotter Company, Inc.

Group 3 Calvin Consultants Alexa Sakaguchi Cong Ye Neil Bergman

March 4, 2013

Case Overview Cotter Company, Inc. manufactures and sells a single product to their customers. Their product has an expected profit of $240,000 before taxes for the year; however, sales of the product are subject to seasonal variations each month. Sam Cotter, president of the company, expects a profit of $20,000 per month. When the company showed a loss for $7,000 in January, Sam did not understand and asked our group to explain why the profit was lower than expected for the month. Question 1 The first question that Sam asked our group is why the January profit was $27,000 less than expected. Cotters product suffered from a slow month of sales, and it is assumed that January is one of the months in which there is little demand. The product had large unfavorable variances related to prime costs and volume that could not be offset by a minor favorable spending variance. The largest prime cost variances were due to a larger amount of material used along with an increase in the labor rate. These variances along with an unfavorable volume variance compose a large part of the change in expected profit, while the rest was made up of smaller than expected sales. Since the product did not sell as expected, the overall profit lessens along with the associated costs. Question 2 Next our group was asked to find the level of monthly volume required to break even for Cotter Company. We were told that to find this we needed to assume that the selling price for Cotters sole product was exactly $1. Further, for this question we assumed that everything Cotter produces, they also sell. For our equation we used the provided annual budget table to set the variable prime costs rate as 40 percent of production, the variable production overhead rate as 10 percent, and the variable selling and general expenses rate as 5 percent. Included as well, is $50,000 for fixed production overhead, and $20,000 for fixed selling and general expenses. With these assumptions and equation, we found that Cotter needs to sell 155,556 units of their product to break even; the calculations for this can be found in Exhibit 1. Question 3 Using the relationship between overhead variances we found the January production volume for Cotter. We knew that the difference between absorbed and budgeted overhead is the volume variance. We were given the volume variance in their Operating Statement. We then set up a formula to solve for the actual volume. Exhibit 2 shows that the company produced 150,000 units of their product in the month of January. Question 4 Cotter Company, Inc. had an increase in their inventory of 10,000 units. This was due to Cotter producing 150,000 units in January, but only selling 140,000 units.

Question 5 We were asked to find the actual production overhead costs in January for Cotter. Exhibit 3 shows that we used the spending variance and budgeted overhead to find the actual overhead for the month. Our conclusion was that the actual overhead for January was $64,000. Question 6 Our final question to answer for Cotter Company, Inc. was to find the four detailed prime cost variances. Exhibit 4 shows our calculations for the four variances and the summarization of our findings can be found below in Table 1. Table 1 Material Usage Variance $1,500 unfavorable Material Price Variance $3,900 favorable Labor Efficiency Variance $0 Labor Rate Variance $5,900 unfavorable

These four variances combine to provide an overall $3,500 unfavorable prime cost variance.