Scarpe Italiane, S.?.? Is this diversification move good or not? First you tell

Question

Scarpe Italiane, S.?.? Is this diversification move good or not? First you tell me that machine-made shoes are money makers, then you tell me we're losing a bundle on each pair. Which is it? The speaker was Francesca Nadalini, CEO of Scarpe Italiane, S.p.A. (SISPA). SISPA had been manufacturing shoes in Italy for several generations. Three years ago, Ms. Nadalini had completed her B.S. in Business Administration, and had been asked by her father, the company's president, to initiate SISPA's North American operations. She commented: We've grown a lot and done well in the past three years. Most of our shoes are hand made, using very little in the way of machines, and we charge a premium price for them. Recently, however, we decided to diver- e could compete with the more automated manufacturers. We purchased some specialized equip- ment that we installed in our plant and that we use only for the machine-made shoes. We use very little la- bor to make these kinds of shoes. The problem now is that we don't seem to know how much it costs us to make either kind of shoe. It was easy when we produced only handmade shoes, but matters are now much more complicated. The problem seems to be with overhead allocation. SISPA's overhead costs and some related information, are shown in Exhibit 1. Giovanni Hoff man, SISPA's chief accountant, commented on the nature of the problem: When we produced only handmade shoes, we allocated all our manufacturing overhead [MOH] to them and there was no problem. Our MOH is relatively high, since receiving and handling the materials from each leather shipment takes a lot of time. Also, as part of receiving and handling, we cut and prepare much of the leather before it enters manufacturing, all of which we consider to be manufacturing overhead The shift to machine-made shoes has meant more than just some increased depreciation, which consider to be a direct cost, since we use completely different machines for machine-made shoes than for handmade ones. In addition, however, all the machines need to be repaired and maintained, which seems to be a function of the number of hours that each machine is used. Our repair and maintenan all of the machines, so we consider them to be part of manufacturing overhead cre ks o Then there's setup time for the machines, which is related to the number of batches we run. The hand- made shoes are stitched and fomed individually, but then finished up on a machine in batches. And, of course, all of the machine-made shoes are run in batches. A batch is a group of shoes of the same size, and we have to set up the machines to accommodate the particular size. Our setup crew works on all of the ma- chines, so we consider them to be part of manufacturing overhead also. Ms. Nadalini's concern about costs arose because Mr. Hoffiman had presented her with some conflicting information. Initially, Mr. Hoffman had allocated overhead to shoes on the basis of di rect labor dollars, as shown in Exhibit 2. Then, deciding that machine hours drove the use of much of the overhead, he had used machine hours to allocate the overhead, as shown in Exhibit 3. Ms Nadalini commented: With the first approach. I was pleased. The machine-made shoes were showing a bigger margin percent than the handmade ones, which didn't completely make sense to me, since the market for machine-made shoes is much more competitive than the market for handmade shoes, but I thought that perhaps we were doing something better than our competitors. Then along comes the report using machine hours as the ba- sis for allocating overhead. Wow! The margin percent on our handmade shoes is terrific, but we're losing a bundle on the machine-made ones.

Explanation / Answer

1. The main reason of difference in operting icome of variable costing and absorption costing is the treatment of manufacturing overhead is different in both the situations. Under absorption costing Fixed manufacturing becomes a part of mnufacturing expense. Closing inventory is deducted while calculting cost og goods sold.

If closing inventory is high it will absorb a portion of the manufacturing overhead of current period and hence profit will be higher. In the given question Cost of Goods Sold of $ 450000 arrives after the deduction of closing inventory. and hence the profit is high under such method.

2. Margin percentage is different for the two product lines under different method because the basis for the allocation of the overhead is different under different method. In exhibit 2 manufacturing expenses is divided on the basis of the direct labours which is higher in case of hand made. (1 :7is the ratio), So profit will be higher in machine made beacuse less overhead is apportioned there.

In exhibit 3 manufacturing expense is apportioned on the basis of the machine hours (ratio being 4:1) So, more expenses will be apportioned to machine made in comparison to hand made and hence lowering its profit.

The reason for such being difference is the basis for change in apportion which will directly affect the cost of the division.

4. Mrs. Nandalini shouldnot produce machine made shoes because its affecting the overall profitability of the company As a matter of fact , hand made is aslo running in loss due to this.

If following teo informations are available than we could be given better decisions:

1. Fixed cost of the comapny and impact on it.

2. If there is any limiting factor affecting the production capacity of the company.

3. Calculation of activity rate Activity Activity Cost (A) Cost driver No of cost driver(B) Rate (A/B) Machine Maint 50000 Number of machine hours 1000 50 Machine set up labour 115000 Number of batches 40            2,875 Material Handling 235000 raw material Shipment received 20          11,750 Apportionment of Overhead Machine made Hand made No of machine hours (A) 800 200 Rate (B) 50 50 Amount (A*B) 40000 10000 Number of batches 5 35 Rate (B) 2875 2875 Amount (A*B) 14375 100625 raw material Shipment received 2 18 Rate (B) 11750 11750 Amount (A*B) 23500 211500 Total 77875 322125 Machine made Hand made Direct Labour 5000 35000 Direct Material 7000 18000 Machine Depreciation 25000 5000 Manufacturing Overhead 77875 322125 Cost of goods manufactured 114875 380125 No of pair produced 400 1000 Cost per pair (A) 287.19 950.31 Price per share(B) 300.00 500.00 Difference(B-A) 12.81 -450.31 Margin percentage per pair 0.04 -0.90

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.