Model Solution to Peterson Pottery

Model Solution to Petersen Pottery BEGINNING OF ASSIGNMENT A REQUIREMENTS Petersen Pottery is a manufacturer of ceramic toilets located in the United States which has been in operation since 1960. The demand for its products is increasing and the bank has required evidence of cost control before advancing the money needed for further expansion. Mr Petersen has attempted to employ standards and budgets unsuccessfully. Production Methodology: For the production process, please see Appendix A.

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As you can see from Appendix A, the major raw materials are clay and glaze. Potters are used for the majority of direct labour and the products are fired in kilns or ovens. Industry background: Macroeconomic analysis: The construction of housing have increased dramatically during the period from 1972 to the present as you can see in Appendix B . Since each housing unit has to contain at least one bathroom, the growth in housing units means a growing demand for toilet fixtures.

As you can see in Appendix C – there has been continuing growth in both the GDP and in personal expenditures showing that the economy is strengthening and more people will be able to buy housing units. This also supports the growth in demand for toilet fixtures. Although there was a small recession during the late 1980’s and early 1990’s, since then demand for housing has increased at a average of 3. 3% every year ( SHOULD REFERENCE TO SOURCE). There have been few technology innovations in this business. Microeconomic analysis:

Petersen Pottery currently has 70 competitors however this segment has grown to approximately 1,700 manufacturers in the United States and 1300 in China. There is much competition in this industry ( Quote reference and name some suppliers) and therefore downward pressure on price. Clay is a cheap commodity with many suppliers ( reference and name). BEGINNING OF ASSIGNMENT B REQUIREMENTS Problem: Mr. Petersen must show he can effectively control and monitor his operating costs so that the bank will give him the money he needs for expansion.

Strategy: Petersen Pottery makes toilets in an industry where there are about 70 competitors. Petersen Pottery mass produces toilets and, although they produce high quality toilets, this company is primarily a cost leader making cost control very important. BEGINNING OF ASSIGNMENT C REQUIREMENTS Alternatives and analysis: Petersen Pottery has three alternatives: Alternative 1: Status quo Alternative 2: Revert to original management costing procedures Alternative 3: Change existing costing system Each of these will be analyzed in turn.

Alternative 1: Status quo Under this alternative, no changes will be made to the current costing system. The senior master potter supervising production will be held accountable for all variances. Advantages: This system requires no risk or changes in existing methodology so incrementally it is cheap. It satisfies the bank manager’s requirement that Petersen show that it has systems in place for controlling its costs which may mean that the bank will continue advancing Petersen the money it needs for expansion purposes.

Since Petersen is experiencing high demand for its product and this demand will continue through to 2003 except for a small recession in the late 1980’s ( see Appendix B) , the need to expand is very real. The current costing system is also consistent with Petersen’s strategy as a cost leader as it will help them lower their costs to meet the competition which will come in the future from the Pacific Rim countries – particularly China ( refer to appendices listing growth of competition which is not included in this write up but should be). Disadvantages: Petersen currently relies on highly skilled labour (potters) to produce its toilets.

Although management is considering replacing the potters with machinery, they have not taken that step yet and therefore cannot risk losing their workforce. The master potter supervising production is not pleased that he is being held responsible for all the variances. He also seems to be confused about whether the company strategically is a cost leader or a product differentiator and is suggesting that the standards established for costs – particularly those for the major raw material clay ( see Appendix A for production sequence which illustrates the importance of clay) are meaningless.

This implies that far from installing effective controls over costs, Petersen’s cost accountant has managed to install and expensive system that is ineffective as the variances in Appendix D suggest as there is a total of $1,446. 25U for the month. The master potter is being held responsible for variances that could all have been caused by the poor quality clay purchased by the Petersen himself. More spoilage due to poor clay would mean wasted materials, and labour – more so if the units broke after being glazed which seems to have been the case.

If the master potter leaves, Petersen may not be able to maintain production at all in the short run as he would be very hard to replace. Alternative 2: : Revert to original management costing procedures Under this alternative, management could return to the old system of not monitoring costs at all. Advantages: This system would not place blame on individuals not responsible for actions causing problems. The master potter could remain focused on building good toilets. The company could get rid of the cost accountant and save his/her salary. Disadvantages: Return to the old system is not consistent with the company’s cost leadership strategy.

In addition, the bank would not provide the needed funds for expansion and may require repayment of the existing line of credit. Unanticipated losses will continue to mount and will end up increasing the cost per toilet by at least (1446/1145) $1. 26 a unit or (1. 26/55) or 2. 3 % over anticipated cost. Since Petersen is a cost leader, it is unlikely that this cost increase can be passed on to its customers. Alternative 3: Change existing costing system Petersen could alter the costing system to be more effective by continuing to involve the master potter in formulating standards and by recognizing that roduction decisions such as deciding to change a major raw material should be treated with caution as the effects of such a decision are far reaching. Advantages: Under this alternative, Petersen could keep its new standard costing system which will show the bank that the management is trying to be fiscally responsible and may result in new funds being advanced for expansion. Establishing expectations for cost performance also indicates to the production workers that management is concerned with lowering the cost of their products.

If the system is not used to allocate blame, it can be used to keep track of experiments which will allow the company to lower its raw material costs. These are the important costs to focus on as the labour may shortly be replaced by machinery. Cost savings by lowering the cost of the product without lowering its quality will go right into increased cash flow and allow the company to reduce rather than constantly increase its line of credit with the bank. Since the change is a small one, it is likely to be immediately functional once the decision is made. Disadvantages:

The master potter will still be accountable for decisions he has made and may not pay attention to the variances as he should. Criteria for analysis: These are listed in order of their importance as explained below: Urgency:The solution recommended must have a short time to implementation as new funds are necessary for expansion and cost control is being monitored by the bank as a condition of the current loan remaining outstanding. This criteria will be measured in time to implementation with less time being preferred. Acceptability: The bank must approve of the alternative

Cost savings: The solution recommended should have cost savings – the greater the better. This criteria will be measured in dollars saved where possible. Consistency with strategy:The solution recommended should be consistent with the company’s strategy. Comparison of alternatives: Alternative| Urgency| Acceptability| Savings| Strategic consistency| 1| Immediate| Partial| Loss of $1,446 per month| No| 2| Within one month| Not acceptable| Loss of $1,446 per month| No| 3| Within one week| Acceptable| $0 loss per month| Yes| Conclusion: I recommend Alternative 3 as it fulfills all of the major criteria better than the other alternatives.

Steps for implementation: 1. Immediately arrange to purchase clay at a higher price from your original supplier and do not use any more of the defective material in the production process. 2. Meet with the Master Potter and encourage him to investigate new and cheaper raw materials and set up a testing program to see if they are acceptable prior to introducing them into the regular production process. 3. Review the production performance monthly with the Master Potter with the goal of the meeting being to discover ways to improve performance not to allocate blame for variances. 4.

Consider giving the potters small bonuses based on adherence to standards to signal the importance of cost reduction and budgeting. ( Include in “A”)Appendix A – Manufacturing Process for Toilets (Include in “A”)Appendix B – Graph showing the growth of new housing units (Include in “A”)Appendix C – Growth in GDP and Personal Expenditures (Include in “C”)Appendix D – Production variances for the month of June Purchase Price Variance: Actual Quantity Purchased * (Standard – Actual Price per lb) Clay: 30000lbs * ( . 95-. 92)= 900F Glaze: 6000 lbs * ( . 75 – . 78) = 180U Price variance:

Actual quantity used * (Standard – Actual Price per lb) Clay: 28900 * . 03 = 867F Glaze: 5900 * (-. 03) = 177U Direct labour: Molding: 1200hr * ( 15 – 15. 25) = 300U Glazing : 600 hr* ( 15-15) = 0 Overhead : Assuming no price differential in variable overhead. Standard : (1145 units * 1. 94) + 3672 = 5893 Applied 6100 ______ Unfavourable spending 207U ______ Efficiency variances: Clay : [28900 lbs – (1145 units * 25lbs)]*. 95 = 261. 25 U Glaze: [5900 lbs – (1145*5)]*. 75 = 131F Molding labour:[(1200- 1145*1)*15 = 825U Glazing labour: [(600 – 1145*. 5)*15 = 412U Total variances: $1,446. 25U for the month



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