Review My Answer of Case Study “Managerial Accounting”

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ISSN 1940-204X
Forest Hill Paper Company
Thomas L. Albright
University of Alabama
Introduction
minimal inventories. Production schedules are driven by
two factors: market demand and the theoretically optimal
production schedule. The optimal production schedule is
designed to reduce waste associated with grade changes by
producing successive batches with minor differences in
basis weight.
Forest Hill Paper Company (FHPC) is a small, closely-held
paperboard manufacturer that produces a broad line of
paperboard in large reels, termed parent rolls. These parent
rolls are sold to converters who further process them into
containers used for a diverse line of consumer products,
such as packaging for microwavable meals. The owners of
FHPC have long pursued the strategy of producing a full
range of products. As a small company competing against
large companies in a commodity market, management
believes Forest Hill must offer a full range of both products
and services. Thus, Forest Hill’s strategy is to create a niche
based on service and rapid response to customer needs.
While product diversity within a paperboard plant would not
be apparent to a casual observer, subtle differences exist.
For example, paperboard differs by basis weight (thickness
determined by caliper measurements) for a specified length
of product. Additionally, paperboard may be uncoated or
coated with an opaque, white clay-based material that masks
cosmetic flaws and smooths surface variability. Customers
are increasingly concerned with surface variability because
an extremely smooth finish is required to accommodate
complex printed designs on the completed paperboard
container or carton.
FHPC produces 20 different grades of paperboard. Some
grades are produced in large quantities requiring production
runs of several days, while others are produced in smaller
quantities requiring runs of only a few hours. Consistent
with lean manufacturing principles, the company maintains
IMA EDUCATIONA L CA S E JOURNAL
Competitive Environment
Paper and paperboard producers operate in a cyclical
economic environment, with upswings every three to four
years. In response to limited supply during an economic
boom, customers often double or triple the quantities
ordered. Then, they begin receiving their large orders as
the economy, once again, begins to slow. As a result, many
customers find their paper inventories exceed current needs
and temporarily stop placing orders. To further confound the
paperboard producers’ headaches, market share for domestic
paperboard has been declining. The most significant
contributors to the loss of market share are the trend toward
plastic and to more environmentally friendly grades of
recycled paperboard.
Throughout the industry, companies have made very
limited investments to expand capacity. When a surge in
demand for paper products occurs, demand will exceed
capacity. In boom times the industry experiences steep price
hikes resulting in record selling prices for most grades.
1
VOL. 1, N O. 2, ART. 4, JUN E 2008
The Manufacturing Process
Continuous processors, such as chemical and paper producers,
historically have used volume-related drivers to attach
overhead to products. Forest Hill traditionally applied
overhead to its products as a function of material costs.
Management believed using “material costs” as an allocation
base made sense because thicker products (containing more
material per lineal foot than thinner products) required more
machine time to process as they demanded slower machine
speeds. Additionally, drying time and energy consumption
increase with thicker basis weights. (See Exhibit 1 for material
costs associated with each product, or grade.) Thus, unit level
(or volume-related) drivers made sense for applying certain
types of overhead to products. However, other important costs
were incurred without respect to volume. For example, grade
changes induce instabilities into the manufacturing process
that result in scrap until the process resumes stability. On
average, production engineers estimate that approximately
one-half reel is lost to scrap each time a grade change is made.
Just as discrete-part manufacturers incur machine setup costs
between production runs of two different products, scrap
produced following grade changes is a predictable cost of
production. Some of the pulp can be recovered by recycling
the scrapped paper, termed “broke” paper. Thus, the grade
change cost figures presented in Exhibit 2 include only
depreciation, labor, energy, and lost chemicals associated with
grade changes.
Recently, some managers at the company began
questioning the long-standing strategic policy of producing
a full product line. Because selling prices and profit margins
significantly varied across the product mix, some managers
questioned whether the company’s assets were being
used to the greatest advantage. Currently Forest Hill was
experiencing demand in excess of its production capacity.
A sample representing significant categories of grades is
presented in Exhibit 1. The sample contains thin paperboard
grades (caliper .013) as well as heavier grades (caliper .020).
In addition, Exhibit 1 identifies whether a grade is coated or
uncoated, or slit. The sample is representative of the variation
in batch quantities. Some grades are produced and sold in
small quantities, while the market demands significantly more
production of other grades. Material cost per reel includes
pulp and chemical costs, while the selling price reflects recent
spot market prices.
Pulp and paperboard is a capital-intensive industry
requiring expensive processing equipment. Forest Hill’s
accountants estimated that manufacturing overhead,
including labor, energy, and depreciation on capital
equipment, approximates 105% of material costs.
Pulp manufacturing begins with hardwood or softwood
timber in the form of logs or wood chips. If raw materials are
received in the form of logs, the first step in the process is
debarking. A rotating debarking drum that measures 16 feet
in diameter by 100 feet in length tumbles the logs to remove
the bark. After debarking, chippers reduce the logs into oneinch cubes.
The second step in the process is termed “digesting.”
Wood chips are cooked at 325 degrees Fahrenheit to break
down the glue-like material bonding the wood fibers.
Chemicals used in the digestor are reclaimed and reused in
future pulp production. Following the digesting process,
the naturally brown fibers are washed and screened. A
bleaching process converts brown pulp into white pulp.
The paperboard manufacturing process begins by
mixing pulp with water and chemicals in the first stage,
or headbox, of a paper machine. The mixture is applied
to a porous wire mesh; formation of paper actually occurs
within this step. The wire mesh travels through a press
that forces the pulp mixture against the wire to eliminate
water within the mixture and to form the desired paper
thickness. The material then proceeds to a drying section
where it travels across numerous cylindrical dryers that are
heated with steam. In the final section of the paper machine,
long sections of paperboard (approximately five miles long
and weighing ten tons) are rolled up into parent rolls and
are removed from the machine. The parent roll is further
processed by FHPC’s customers to make various types of
paperboard containers.
Sometimes customers require additional processing on
parent rolls. For example, food processors often require
widths of 18 inches, rather than the standard width of a
reel (approximately 12 feet). Thus, reels are loaded onto
a rewinder slitter to produce eight reels 18 inches wide
from one 12-foot-wide reel. For convenience, Forest
Hill had always combined labor and machine costs of
the rewinder slitter with those of the paper machine for
allocation purposes. Thus, all grades of paperboard shared
in the costs of slitting even though most grades were not
slit. Engineering studies suggest slitting may be more
expensive than previously thought. In addition to the costs
of specialized equipment and extra labor, knives used in
the slitting process often damage the paperboard’s edges.
Thus, more quality inspection and testing are required when
producing slit reels.
IMA EDUCATIONA L CA S E JOURNAL
2
VOL. 1, N O. 2, ART. 4, JUN E 2008
Exhibit 1
Selected product grades with production and financial data
Product
Average Material Cost
(Grade) Caliper Coated/Uncoated
Slit Reels per Batch
per Reel
A
.013
Coated
yes
B
.014
Uncoated
C
.015
Coated
D
.020
Coated
no
Selling Price
per Reel
50
$4,800
$12,600
no
2
$5,200
$13,500
yes
35
$5,600
$14,200
175
$7,400
$19,500
Exhibit 2
Overhead Structure
Total Grade Change
Depreciation
Slitting Net
$800,000
$8,000
$70,000
$722,000
Labor
300,000
3,000
25,000
272,000
Energy
500,000
5,000
80,000
415,000
Other
198,470
1,000
20,000
177,470
30,000
30,000
-0-
-0-
$1,828,470
$47,000
$195,000
$1,586,470
Unrecoverable Clay and Chemicals
from Grade Changeovers
Total
3. Identify and discuss the strategy used by Forest Hill to
Historically, product costs at Forest Hill were calculated
by multiplying the overhead rate by material costs. However,
brand managers had begun to suspect that some grades were
subsidizing others with respect to costs. Two significant
activities, grade changes and slitting, were identified to
help reduce cross-subsidy and provide more accurate cost
estimates. Exhibit 2 identifies total overhead costs with
respect to the four grades shown in Exhibit 1, estimated
grade change costs, and slitting costs. These costs are based
on one run of each grade.
The capital intensive structure of a paper company
coupled with the cyclical nature of the industry makes
accurate cost information an important strategic tool. Though
current demand exceeds existing capacity, managers at
Forest Hill know that a downturn is inevitable. Gaining an
understanding of the costs associated with grade changes
and slitting is a first step that will enable managers to more
effectively manage their business in good times and in bad.
compete in a commodity market.
4. What are some examples of complexity that drive
overhead costs for Forest Hill?
5. How does the current system capture manufacturing
costs and assign them to products? (Prove the overhead
rate is 105% of material cost.)
6. Calculate the volume-based (traditional) cost per reel for
grades A-D identified in Exhibit 1.
7. What is the cost for Forest Hill to conduct a grade change?
8. What is the cost for Forest Hill to slit a reel of
paperboard? As shown in Exhibit 1, only products A and
C are routinely slit. For purposes of your analysis, assume
the slitting equipment must be set up and adjusted
between each reel slit.
9. Calculate the new volume-based overhead rate after
removing grade change and slitting costs.
10. Determine the activity-based costs for grades A-D
11. Prepare a table that illustrates the percentage change in
costs between the volume-based system and the strategic
activity-based system.
12. What conclusions can you draw from your analysis?
As a consultant to Forest Hill, what actions would you
recommend?
requirements
1. How would you classify Forest Hill Paper Company in
terms of size and ownership?
2. What is the nature of the industry in which Forest Hill
competes?
IMA EDUCATIONA L CA S E JOURNAL
3
VOL. 1, N O. 2, ART. 4, JUN E 2008
About IMA
With a worldwide network of nearly 60,000 professionals,
IMA is the world’s leading organization dedicated to
empowering accounting and finance professionals to drive
business performance. IMA provides a dynamic forum for
professionals to advance their careers through Certified
Management Accountant (CMA®) certification, research,
professional education, networking and advocacy of the
highest ethical and professional standards. For more
information about IMA, please visit www.imanet.org.
IMA EDUCATIONA L CA S E JOURNAL
4
VOL. 1, N O. 2, ART. 4 TN , JUNE 2008
Forest Hill Case Study
Abbad Alharbi
Shippensburg University
FOREST HILL CASE STUDY
Executive Summary
This report analyses the two primary type of costs which are volume-based costing and
activity-based costing. To do this, a case study of Forest Hill Company will be utilized. The will,
therefore, answer questions based on the case study presented. The questions answered are
twelve in total, and they include Forest Hill size and ownership, industry nature, competitive
strategies and the complexities that drive the company’s overhead costs. Also, the report answers
some calculation problems. These include overhead rates and total cost using both volume-based
costing and activity-based costing.
So, the paper compares the two methods and identifies the percentage change between
the volume-based costing and activity-based costing. Based on the analysis of the two methods, a
recommendation is given to the Forest Hill management on which costing method is the best for
their company.
Q1: Size and Ownership
According to the case study, Forest Hill is a small manufacturing company that deals in
paperboard manufacturing. The text also states that the company is closely-held meaning it is
managed by just a few individuals who are also owners. From this statement, we can, therefore,
conclude that Forest Hill is privately owned and does not trade its shares to the public.
Q2: Industry Nature
Despite the size, Forest Hill operates in a very competitive and seasonal industry. The paper
manufacturing industry is extremely seasonal with companies experiencing high sales during the
economic boom and extremely low sales during economic downturns. This because during
FOREST HILL CASE STUDY
economic booms customers purchase a lot of paperboard leading to high stock levels. And due to
this stock levels, the customers purchase very few paperboards when the economy is experiencing
turbulence. The paper manufacturing industry also experiences competition from electronic form
of communication causing the industry to remain stagnant. The industry also has entry barriers
caused by the initial cost of establishing a paper manufacturing company and the strict government
regulations.
Q3: Competitive Strategies
Considering that Forest Hill is a small company operating in an industry with big
companies, the company has identified offering a range of products and services as a strategy that
will give it a competitive advantage. It is particularly interested in creating a niche in the market
based on excellent and rapid customer services.
Q4: Complexity that Drives Overhead Costs
As a paper manufacturing company, Forest Hill undergoes a number of complexities in its
day to day operations that drive the overhead costs. One of these complexities is the production
process which is extremely long and time-consuming (Lanen, Anderson & Maher, 2010).
Secondly, the material cost especially those of thicker products is very high and forms a big
percentage of the overhead cost. Last but not least, product grade changes also lead to increase in
overhead costs.
Q5: Current Capturing of Manufacturing Costs
As opposed to the company historical way of capturing costs where cost was determined
by multiplying the material costs with the overhead rate, Forest capture manufacturing cost by
FOREST HILL CASE STUDY
subtracting the grade change and the slitting cost from the gross overhead cost. This system
eliminates the problem of one product cost subsidizing another product costs.
Q5: Prove that the overhead rate is 105% of material cost
Product
Material cost per
Grade
Average reel per batch
reel
Total cost
A
50
4,800
240,000
B
2
5,200
10,400
C
35
5,600
196,000
D
175
7,400
1,295,000
Total material cost
1,741,400
Overhead rate = overhead costs/material cost (Blocher, Stout, Juras & Cokins, 2013)
Given total overhead cost:
1828470
Rate
1.05
105.00%
Q6: Volume Based Cost for Product A – D
Given:
Overhead rate
105.00%
Material cost per Overhead
cost
Product
reel
per reel
Total cost per reel
A
$ 4,800.00
$ 5,040.00
$ 9,840.00
B
$ 5,200.00
$ 5,460.00
$ 10,660.00
C
$ 5,600.00
$ 5,880.00
$ 11,480.00
D
$ 7,400.00
$ 7,770.00
$ 15,170.00
FOREST HILL CASE STUDY
Q7: Determination of Grade Change Cost
Given number of grades
4
Overhead
Grade change
Depreciation
8000
Labor
3000
Energy
5000
Other
1000
Unrecoverable clay and chemicals from grade changeover
30000
Total
47000
Grade change cost
11750
Q8: Determination of Cost of Slitting a reel of Paperboard
Given
Total slitting cost
$195,000
Number of reels slatted
A
50
B
35
Total
85
Slitting cost
$2,294.12
Q9: Calculation of new volume-based Overhead
Total overhead cost
$1,828,470
Total slitting cost
47000
Total grade change cost
195000
Adjusted overhead cost
$1,586,470
Total material cost
$1,741,400
New overhead rate
91.10%
Activity-Based Cost
FOREST HILL CASE STUDY
Q10: Determination of activity-based cost for grades A-D
Overhead rate
91.10%
Grade change cost
11750
Grade
Material cost
A
$
Slitting cost
No. of
Grade
per reel
Reels
change
Total cost
50
$
235
$ 11,702
2
$ 5,875
$ 15,812
35
$
336
$ 13,332
175
$
67
$ 14,209
Overhead cost
4,800
$
4,373
B
5200
$
4,737
C
5600
$
5,102
D
7400
$
6,742
$
$
2,294
2,294
Q11: Percentage Change in cost between volume-based and activity-based
system
Traditional
Grade
Cost per Reel
Strategic
Grade
Cost per reel
Variance
% Change
A
$
9,840.00
A
$ 11,702.07
$(1,862.07)
-18.92%
B
$ 10,660.00
B
$ 15,812.36
$(5,152.36)
-48.33%
C
$ 11,480.00
C
$ 13,331.61
$(1,851.61)
-16.13%
D
$ 15,170.00
D
$ 14,208.77
$
961.23
6.34%
Q12: Conclusion
Both traditional costing system and activity based system are used by companies in
determining their product cost. The choice on which method depends on an individual company.
Therefore managers ought to evaluate the advantages and disadvantages of both methods to
determine which one best suit their company.
From the analysis above, it is obvious that the costs determined using the activity based
method are higher than those of the traditional method (Blocher, Stout, Juras & Cokins, 2013;
Hicks, 2002). This indicates that the traditional method is not as accurate as the strategic method
FOREST HILL CASE STUDY
because it excludes another cost which is not manufacturing costs. And as a result, cannot be used
by managers in decision making. Use of volume based costing will therefore overstate the
company’s projected profits making it unachievable projection. Therefore, I would recommend
that the company uses the activity-based costing because it gives more accurate results (Hicks,
2002). Moreover, it eliminates the error of allocating any irrelevant cost to product thereby
minimizing any subsidizing of one product cost by another product cost.
Prove that the overhead rate is 105% of material cost
Product Average reel per Material cost
Grade
batch
per reel
Total cost
A
50
4.800
240.000
B
2
5.200
10.400
C
35
5.600
196.000
D
175
7.400
1.295.000
Total material cost
1.741.400
Overhead rate = overhead costs/material cost
Given total overhead cost:
1828470
Rate
1,05
105,00%
Volume Based Cost for Product A – D
Given:
Overhead rate
Product
A
B
C
D
105,00%
Material
cost per reel
$ 4.800,00
$ 5.200,00
$ 5.600,00
$ 7.400,00
Overhead
cost per reel
$ 5.040,00
$ 5.460,00
$ 5.880,00
$ 7.770,00
Total cost per
reel
$ 9.840,00
$ 10.660,00
$ 11.480,00
$ 15.170,00
Determination of Grade Change Cost
Given number of grade
4
Overhead
Grade change
Depreciation
8000
Labor
3000
Energy
5000
Other
1000
Unrecoverable clay and
chemicals from grade
changeover
30000
Total
47000
Grade change cost
11750
Determination of Cost of Slitting a reel of Paperboard
Given
Total slitting cost
$195.000
Number of reels slatted A
50
B
35
Total
85
Slitting cost
$2.294,12
Calculation …
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