Question

Emily Carrigan was recently transferred to the Appliances Division of Delancy Corporation. Shortly after taking over her new position as divisional controller, Carrigan was asked to develop the division’s predetermined overhead rate for the upcoming year. The accuracy of the rate is important. Delancy Corporation uses direct labour-hours in all of its divisions as the allocation base for manufacturing overhead. To compute the predetermined overhead rate, Carrigan divided her estimate of the total manufacturing overhead for the coming year by the production manager’s estimate of the total direct labour-hours for the coming year. She took her computations to the division’s general manager for approval but was quite surprised when he suggested a modification in the base. Her conversation with the general manager of the Appliances Division, Harry Dafoe went like this? Carrigan: Here are my calculations for next year’s predetermined overhead rate. If you approve, we can enter the rate into the computer on January 1 and be up and running in the job-order costing system right away for this year. Dafoe: Thanks for coming up with the calculations so quickly. They look just fine. There is however, one slight modification I’d like to see. Your estimate of the total direct labour-hours for the year is 110,000 hours. How about cutting that to about 105,000? Carrigan: I don’t know if I can do that. The production manager says she will need about 1110,000 direct labour-hours to meet the sales projections for next year. Besides, there will be over 108,000 direct labour-hours during the current year, and sales are projected to be higher next year. Dafoe: Emily, I know all of that. I would still like to reduce the direct labour-hours in the base to something like 105,000 hours. You probably don’t know that I had an agreement with your predecessor as divisional controller to shave 5% or so off the estimated direct labour-hours every year. That way, we kept a reserve that usually resulted in a big boost to operating income at the end of the fiscal year in December. We called it our Christmas bonus. Corporate headquarters always seemed as pleased as punch that we could pull off such a miracle at the end of the year. This system has worked well for many years, and I don’t want to change it now. Required: As an independent consultant apprised of the situation -  Prepare a brief report in the form of a memo, to Delancy owner Angela Su, providing the following: ➢ Explain to owner what is the main problem? ** ➢ What impact would shaving 5% off the estimated direct labour-hours in the base of the predetermined overhead rate have on financial statements? (consider MOH, WIP, FG, COGS, etc) a. During the year? b. At the end of the year? ➢ Include in your report a discussion about the following: Assuming the company stakeholders are investors, creditors, tax authority, employees, insurers - how are they impacted by PDOR manipulation? ➢ What is your recommendation to reduce yearend impact of cogs adjustment?  Be ready to present an ‘Elevator pitch’ or a quick summary of your analysis. ➢ The report should include the following:  Cover page with student name, student number, date  Memo – to/from/date/detailed subject line. This acts like an executive summary. If the owner was only to read one page, this would summarize your report. Complete this last.  Introduction – what the reader can expect from the report? Provide the scope.  Background/Situational Analysis and Assessment. ➢ Company context, business overview ➢ What is/are the major issue(s) ➢ Who are you writing – be mindful of your audience. ➢ What are the alternatives available to the company?  Analysis of alternatives (if applicable) ➢ Quantitative analysis (only using numbers provided – don’t make up numbers!) ➢ Qualitative analysis (non financial considerations) ➢ Other considerations ➢ Decision matrix – not utilized for these small cases  Recommendation/ ADVISE – based on your analysis, what should the company do? Do you address the main issues (and any secondary issues) identified ➢ Action plan. What are the next steps.

Answer 1

To: Angela Su,

From: Emily Carrigan

Date :4/2/2020

Subject:Under applied Overhead and malpractices followed by general manager of appliance division.

Miss/Mrs. Su,

Through this memo i quickly want to bring to your notice  malpractices followed by general manager of appliance division.. To compute the predetermined overhead rate, estimate of the total manufacturing overhead for the coming year is divided by the production manager’s estimate of the total direct labour-hours for the coming year. However, currently the estimated direct labour hours is shaved 5% or so off the estimated direct labour-hours every year , which results in wrong decision making.(Decision basis. If sales and production decisions are being made based in part on the predetermined overhead rate, and the rate is inaccurate, then so too will be the decisions.)

Projected financial statements incorporate current trends and expectations to arrive at a financial picture that management believes it can attain as of a future date. At a minimum, projected financial statements will show a summary-level income statement and balance sheet.

A better set of projected financial statements will incorporate the following features:

• A statement of cash flows
• Expense projections that include step costs for major points at which revenues increase or decline
• Consideration of the pace at which the business can reasonably grow, based on its prior history
• Consideration of the corporate bottleneck operation on the ability to grow
• The ability of the business to attract the funding needed in order to accomplish the financial results stated in the plan.

All of this cannot be achieved with wrong forecasting i.e. the decision taken will be incorrect.

A low estimated rate will lead to low projection of finished goods i.e. low efficiency of company as compared to the competitors. The current practice which is been followed results in inflation of estimated overhead rate which results in higher cost of goods sold and less profit margin, which is quite demotivating from the growth point of view.

At the end of the year If applied overhead is less than actual overhead, overhead is under-applied and vice-versa the difference is transferred to variance account.

As we know that projected estimates are really important for growth of the company, it should be estimated properly keeping in mind the projected sales of the company . This will help in correct decision making and will help the management to look into the matter which requires more attention.

Further, i will suggest you to kindly review the activities of general manager of appliance division .

Please let me know if you require any further details regarding the current matter.

Best,

Emily Carrigan

Divisional Controller

Delancy Corporation