Buford Industries

Buford Industries

Buford Industries (BI) was started by Walter Buford in 1980. Prior to founding BI, Walter had been a machinist at a valve manufacturer. He had an idea which he thought would allow him to make better valves at a lower cost. Walter started his company in his garage and it grew until in 2001, Buford had gross sales of over $40 million. Buford’s sole manufacturing plant is located in Chicago, Ill. Unfortunately, Walter Buford died at the end of 2000 (at the age of 56). For three years, Walter had been training his only son, Peter, to take over the presidency of BI. Prior to his death, Walter expected it would take at least 7 more years to complete Peter’s training. However, shortly after Walter’s death, Peter (age 31) assumed full control of Buford Industries.

At the end of 2001 (a relatively good business year), Peter received an income statement that indicated that BI had suffered a loss of over $200,000 (see Exhibit 1). This was the first loss that BI had in over 15 years. Peter knew that he had made some poor decisions during 2001 and that employees lacked confidence in him. Peter was quite shocked by the income report and immediately decided to hire an experienced manager. Peter was fortunate in being able to attract Bob Wiseman (age 57) from a competitor. Mr. Wiseman had wide executive experience in manufacturing products similar to those of BI. Peter knew that Bob wanted to have financial security for his retirement, so Peter offered Bob stock options in addition to an attractive salary. At the end of January 2002, Peter appointed Bob Wiseman as general manager. Wiseman had full authority to run Buford as he saw fit and agreed to explain the logic for his decisions to Peter. Thus, Peter would be ready for successful leadership upon Wiseman’s retirement.

BI manufactured three water valves: A-1 (agricultural applications), I-1 (industrial), R-1 (residential). These were sold by BI’s sales force, on a salary basis, for use in the processes of other manufacturers. BI sold throughout the Midwest and was one of seven companies with similar valves. A few of its competitors were larger and manufactured a wider variety of products. The dominant company was Heartland Valves, which operated a plant only 35 miles from BI. Hartland usually announced prices annually and the other producers followed suit.

Price reductions were rare—the only reductions from quoted prices took the form of cash discounts. In the past, all attempts at price cutting resulted in all competitors meeting the price reduction and the industry as a whole selling about the same number of valves but at lower prices. This would continue until there was a general recognition of the failure of price cutting and Heartland would again stabilize the situation by raising prices. Because sales were to industrial buyers and products of different manufacturers were very similar, BI believed that it could not individually raise prices without also having volume decreases.

During 2001, BI’s share of the water valve market was 12% for Product A-1, 9% for Product I-1, and 10% for R-1. The industry-wide quoted selling prices were $9.80, $10.32, and $11.00, respectively.

Wiseman decided against immediate major changes; he chose instead to analyze 2001 operations and to wait for the results of the first half of 2002. He instructed the accounting department to produce detailed expense and earnings statements by product for 2001 (see Exhibit 2). He also requested an explanation of the nature of the costs, including their expected future behavior (see Exhibit 3).

Wiseman sent copies of these exhibits to Peter Buford and they discussed them. Peter stated that he thought that Product R-1 should be dropped immediately, as it would be possible to lower expenses on R-1 as much as $0.86 per unit. In addition, he stressed the need for economies on Product I-1.

Wiseman, however, continued to produce all three products. For control purposes, he had the accounting department prepare monthly statements using as standard costs the costs per unit from the profit and loss statement for 2001 (Exhibit 2). He used these monthly statements to make minor marketing and production changes during the spring of 2002. Mid-July 2002, Wiseman received, from the accounting department, the six month’s statement of cumulative standard costs including variances of actual costs from standard (see Exhibit 4). They showed that the first half of 2002 was a successful period.

During the second half of 2002, the sales of the entire industry weakened. Even though BI retained its share of the market, its profit for the second half was small. On January 7, 2003, Heartland announced a price reduction on Product A-1 from $9.80 to $9.00 per unit. This caused an immediate pricing problem for its competitors. Wiseman carefully analyzed the situation and forecast that if BI held the price at $9.80 per unit during the first six months of 2003, unit sales would be 750,000 units of A-1. His analysis further indicated that if the price were dropped to $9.00 per unit, the six-month’s volume would be 1 million units. Wiseman knew that management of other competitor firms anticipated a further decline in demand for 2003. He thought that a decline in prices was probable.

The accounting department reported that the standard costs currently in use would apply during 2003, with two exceptions: materials and supplies would be 5% lower than current standard; and light & heat would decline about 3%.

Peter and Bob discussed the pricing problem. Peter remarked that even with the forecast decline in materials and supplies and light & heat costs, a sales price of $9.00 would be below the cost of Product A-1. Peter wanted the $9.80 price to be continued. He stated that, “The company cannot be profitable while selling a key product below cost.”

You have been retained as a consultant to make a report that addresses the following:

(1) If BI had dropped Product R-1 on 1/1/2002, what effect would that action have had on the $321,000 profit for the first six months of 2002?

(2) Should the company have reduced the price of A-1 from $9.80 to $9.00 during January 2003?

(3) What is BI’s most profitable product?

(4) What is the major cause for the return to profitable operations in the first half of 2002?

Exhibit 1

Income Statement—Year Ended December 31, 2001

Gross Sales$42,378,215

Cash Discounts 648,304

Net Sales41,729,911

Cost of Goods Sold26,042,819

Gross Margin15,687,092

Less:

Selling Expense$7,352,495

General Administration2,609,114

Depreciation5,432,85515,394,464

Operating Income292,628

Other Income 81,271

Income before Interest373,899

Less: Interest Expense 578,785

Income (Loss)$ (204,886)

Exhibit 2

Analysis of Profit and Loss by Product—Year Ended December 31, 2001

Product A-1 / Product I-1 / Product R-1 / Total
$000s / $/unit / $000s / $/unit / $000s / $/unit / $000s
Rent / 751 / 0.3524 / 628 / 0.6100 / 748 / 0.7576 / 2,127
Property taxes / 250 / 0.1172 / 200 / 0.1940 / 160 / 0.1620 / 610
Property insurance / 209 / 0.0980 / 159 / 0.1548 / 210 / 0.2132 / 579
Compensation insurance / 330 / 0.1548 / 174 / 0.1688 / 180 / 0.1820 / 683
Direct labor / 5,171 / 2.4252 / 2,439 / 2.3688 / 2,750 / 2.7860 / 10,360
Indirect labor / 1,764 / 0.8272 / 848 / 0.8232 / 920 / 0.9320 / 3,531
Power / 90 / 0.0420 / 100 / 0.0968 / 120 / 0.1220 / 310
Light and heat / 60 / 0.0280 / 51 / 0.0492 / 40 / 0.0408 / 151
Building service / 40 / 0.0188 / 31 / 0.0300 / 30 / 0.0300 / 101
Materials / 3,058 / 1.4340 / 1,885 / 1.8304 / 1,939 / 1.9648 / 6,881
Supplies / 209 / 0.0980 / 190 / 0.1848 / 140 / 0.1420 / 539
Repairs / 71 / 0.0332 / 60 / 0.0580 / 41 / 0.0412 / 171
Total / 12,002 / 5.6288 / 6,764 / 6.5688 / 7,278 / 7.3736 / 26,043
Selling expense / 3,642 / 1.7080 / 1,831 / 1.7780 / 1,880 / 1.9048 / 7,352
General administration / 1,379 / 0.6468 / 520 / 0.5052 / 710 / 0.7192 / 2,609
Depreciation / 2,259 / 1.0596 / 1,711 / 1.6620 / 1,462 / 1.4816 / 5,433
Interest / 209 / 0.0980 / 160 / 0.1552 / 210 / 0.2128 / 579
Total cost / 19,491 / 9.1412 / 10,986 / 10.6692 / 11,540 / 11.6920 / 42,016
Less other income / 41 / 0.0192 / 21 / 0.0200 / 20 / 0.0200 / 81
19,450 / 9.1220 / 10,965 / 10.6492 / 11,520 / 11.6720 / 41,935
Sales (net) / 20,670 / 9.6942 / 10,390 / 10.0909 / 10,670 / 10.8108 / 41,730
Profit (loss) / 1,220 / 0.5722 / (575) / (0.5583) / (850) / (0.8612) / (205)
Unit sales / 2,132,191 / 1,029,654 / 986,974
Quoted selling price / $9.80 / $10.32 / $11.00
Cash discounts taken
(% of selling price) / 1.08% / 2.22% / 1.72%

Note: Numbers may not add exactly because of rounding.
Exhibit 3

Accounting Department’s Analysis of Costs

Direct Labor: Variable. Union shop at going rates of $6.40/hr. (including social security taxes). Due to high unemployment, no abnormal demands foreseen. It may be assumed that direct labor dollars is an adequate measure of capacity utilization.

Compensation Insurance: Variable. 5% of direct and indirect labor is an accurate estimate.

Materials: Variable. Exhibit 2 figures are accurate. Includes waste allowances. Purchases are at market prices.

Power: Variable. Rates are fixed. Use varies with activity. Averages in Exhibit 2 are accurate.

Supplies: Variable. Exhibit 2 figures are accurate. Purchases are at market prices.

Repairs: Variable. Varies as volume changes within normal operating range. Lower and upper limits are fixed.

Cash Discounts: The percentage is almost nonvariable. Average cash discounts taken as a percentage of sales are consistent from year to year. Percentages in Exhibit 2 are accurate.

General Administration, Selling Expense, Indirect labor, Interest, and Other Income: All these items are almost nonvariable. Of course, they can be changed by management decision.

Light & Heat: Almost nonvariable. Heat varies slightly with fuel cost changes. Light is a fixed item regardless of level of production (fixed cost contract).

Rent: Nonvariable. Lease has 12 years to go.

Property Taxes: Almost nonvariable. Under the terms of the lease, BI pays the taxes; assessed valuation has been constant; the rate has risen slowly. Any change in the future will be small and independent of production.

Property Insurance: Nonvariable. Three-year policy with fixed premium.

Building Service: Nonvariable. At normal business level, variances are small.

Depreciation: Nonvariable. Fixed dollar total.

Accounting 311 Summer 2009 Case Assignment page 1

Exhibit 4

Profit/loss by Product, at Standard, Showing Variances from January 1 to June 30, 2002

Product A-1 / Product I-1 / Product R-1 / Total / Total
Total / Standard / Total / Standard / Total / Standard / Standard / Actual / Variances
Item / Standard / Per unit / Standard / Per unit / Standard / Per unit / ($000s) / ($000s) / ($000s)
Rent / 351 / 0.3524 / 434 / 0.6100 / 380 / 0.7576 / 1,165 / 1,044 / 121
Property taxes / 117 / 0.1172 / 138 / 0.1940 / 81 / 0.1620 / 336 / 308 / 28
Property insurance / 98 / 0.0980 / 110 / 0.1548 / 107 / 0.2132 / 315 / 292 / 23
Compensation insurance / 154 / 0.1548 / 120 / 0.1688 / 91 / 0.1820 / 366 / 368 / (2)
Direct labor / 2,418 / 2.4252 / 1,687 / 2.3688 / 1,397 / 2.7860 / 5,501 / 5,528 / (27)
Indirect labor / 825 / 0.8272 / 586 / 0.8232 / 467 / 0.9320 / 1,878 / 1,792 / 86
Power / 42 / 0.0420 / 69 / 0.0968 / 61 / 0.1220 / 172 / 168 / 4
Light and heat / 28 / 0.0280 / 35 / 0.0492 / 20 / 0.0408 / 83 / 80 / 3
Building service / 19 / 0.0188 / 21 / 0.0300 / 15 / 0.0300 / 55 / 40 / 15
Materials / 1,429 / 1.4340 / 1,303 / 1.8304 / 985 / 1.9648 / 3,718 / 3,712 / 6
Supplies / 98 / 0.0980 / 132 / 0.1848 / 71 / 0.1420 / 300 / 300 / 0
Repairs / 33 / 0.0332 / 41 / 0.0580 / 21 / 0.0412 / 95 / 100 / (5)
Total / 5,611 / 5.6288 / 4,678 / 6.5688 / 3,696 / 7.3736 / 13,985 / 13,732 / 253
Selling expense / 1,703 / 1.7080 / 1,266 / 1.7780 / 955 / 1.9048 / 3,924 / 3,932 / (8)
General administration / 645 / 0.6468 / 360 / 0.5052 / 361 / 0.7192 / 1,365 / 1,312 / 53
Depreciation / 1,056 / 1.0596 / 1,184 / 1.6620 / 743 / 1.4816 / 2,982 / 2,724 / 258
Interest / 98 / 0.0980 / 111 / 0.1552 / 107 / 0.2128 / 315 / 292 / 23
Total cost / 9,112 / 9.1412 / 7,598 / 10.6692 / 5,861 / 11.6920 / 22,571 / 21,992 / 579
Less other income / 19 / 0.0192 / 14 / 0.0200 / 10 / 0.0200 / 43 / 44 / 1
9,093 / 9.1220 / 7,583 / 10.6492 / 5,851 / 11.6720 / 22,528 / 21,948 / 580
Actual sales (net) / 9,664 / 9.6942 / 7,186 / 10.0909 / 5,419 / 10.8108 / 22,269 / 22,269 / 0
Profit or loss / 570 / 0.5722 / (398) / (0.5583) / (432) / (0.8612) / (259) / 321 / 580
Unit sales / 996,859 / 712,102 / 501,276

Note: Some numbers in this table may appear to be in error by +- 1%; this is due to rounding. Variances are F (U) if positive (negative).

Accounting 311 Summer 2009 Case Assignment page 1