Wilson Lighting Systems In mid-December 2013, Jane Erickson and Devin Bunn were
ID: 2468183 • Letter: W
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Wilson Lighting Systems
In mid-December 2013, Jane Erickson and Devin Bunn were almost through with the 2014 operating budget for their company, Wilson Lighting Systems (Wilson). Wilson produced specialty lighting lamps in three primary models (Lamp N, Lamp V, and Lamp T). The industry was dominated by General Electric, Sylvania, Sunbeam, and Philips, which together made dozens of types of lamps, chandeliers, and outdoor lighting. Wilson was a small player in the industry, but business had been good, and it was expecting another profitable year. A draft of the company’s operating budget is shown in Exhibit 1. Standard costs for the three products are explained in Exhibit 2. The fixed manufacturing costs are allocated to each product line but are not unique to the product lines. For example, all the machines can make all the products. If one of the product lines were discontinued or the product mix were changed, the total fixed costs would remain the same. Selling, general, and administrative (SG&A), other costs, interest income, and interest expense were likely to remain the same no matter which product-line combinations the company produced unless a strategy required a change in advertising. For purposes of this case, we will be analyzing based on operating income. We will not consider interest income, interest income or taxes in our analyses.
Before calling it a day, the two owners asked their assistant, Meagan Thompson, to complete the budget based on the original costs and planned volumes. They said they may look at alternative prices and volumes, but their initial plans currently remain intact.
Thompson and the owners met the following morning to review her work. After considerable discussion, Erickson and Bunn asked Jane to evaluate the budget and consider the impact of a few alternatives. After finishing her analyses, she left for an early weekend getaway. She didn’t give the budget another thought.
Early in January 2015, Thompson prepared a rough draft of the actual 2014 financial results (Exhibit 3); happily, they were better than had been expected. Prices on each lamp were as planned, and volume was as shown in Table 1.
Thompson reviewed the results and began to wonder if the bottom line was as high as it should have been.
Please complete the following:
Complete a contribution margin product line budgeted income statement for the 2014 based on the information presented in Exhibit 2. Your statement totals should agree with the gross margin reported in Exhibit 1.
Based on your answer to # 1 calculate the breakeven sales and margin of safety for the company based on Operating Income in Exhibit 1. Assume all SG&A and Other Costs in Exhibit 1 are fixed. At the company breakeven, what are the breakeven quantities for each product line? Comment on the company’s position relative to breakeven.
Based on your answer to #1 and based on operating income calculate operating leverage for the company. Assume all SG&A and other costs in Exhibit 1 are fixed. At the current level, determine the impact that a 15% increase in sales will have on operating income and explain how it can be determined without preparing an income statement.
Based on the 2014 budget, assume the company wanted to generate operating income of $8 million. Given the current product mix and cost structure, what level of sales would the company have to generate? Assume SG&A and other costs are fixed.
Without preparing a separate income statement, calculate the impact on operating income of dropping Lamp N assuming no other actions are taken.
Without preparing a separate income statement, calculate the impact on operating income of a $5 decrease in Lamp T’s price and a change in advertising focus that will lead to a 10,000 unit decrease in Lamp N volume and a 30,000 increase in Lamp T volume. Assume the change in advertising focus will cost an additional $65,000 in advertising. Based on your results, explain why or why not the company should take this option.
Without preparing a separate income statement, calculate the impact on operating income assuming the company decided to lower the price of Lamp T to $75 and expects sales volume to increase to 220,000 units assuming no other actions are taken.
Based on the actual 2014 volumes and prices in Table 1, analyze overall performance against the original plan. Beginning with the budgeted gross margin, reconcile each component of actual activity to arrive at the actual gross margin. Assume that the standards in Exhibit 2 related to costing apply. Identify areas of strength and opportunities for improvement based on your analysis.
Extra Credit – up to 5 points added to your extra credit but not to the test– Without preparing another income statement and based on the 2014 budget, assume that direct labor is a constraint to the company (their current Direct Labor is the most they can have). If the management told you they wanted to drop the lowest profit product relative to the constraint and transfer the volume to the highest profit product relative to the constraint, what total increased margin could they achieve by undertaking this strategy? Assume that the 2014 budgeted pricing and costs apply and that the market will purchase any additional volumes of any products. You must prepare and explain a schedule showing the incremental increase (decrease) in gross margin of aspects of your decision.
Note: Assume all costs listed above are product costs.
Table 1.Actual 2014 Volumes. Volume Lamp (number of units) N 115,000 V 110,000 T 225,000Explanation / Answer
A contribution margin product line budgeted income statement for the 2014 based on the information presented in Exhibit 2 Lamp N Lamp V Lamp T Total Volume 80,000 120,000 200,000 Sales @ $150 : $110: $80 each $ 12,000,000 $ 13,200,000 $ 16,000,000 $ 41,200,000 Less: Variable expenses Material($17: $10: $7) $ (1,360,000) $ (1,200,000) $ (1,400,000) $ (3,960,000) Labor($21: $16: $4) $ (1,680,000) $ (1,920,000) $ (800,000) $ (4,400,000) Supplies($7:$2:$1) $ (560,000) $ (240,000) $ (200,000) $ (1,000,000) Variable indirect labor($5:$4:$2) $ (400,000) $ (480,000) $ (400,000) $ (1,280,000) Energy($ 6:$3:$2) $ (480,000) $ (360,000) $ (400,000) $ (1,240,000) Total variable expenses $ (4,480,000) $ (4,200,000) $ (3,200,000) $ (11,880,000) Contribution margin $ 7,520,000 $ 9,000,000 $ 12,800,000 $ 29,320,000 Less: Fixed costs Indirect labor($5:$4:$2) $ (400,000) $ (480,000) $ (400,000) $ (1,280,000) Supervision($8:$3:$1) $ (640,000) $ (360,000) $ (200,000) $ (1,200,000) Energy($ 6:$3:$2) $ (480,000) $ (360,000) $ (400,000) $ (1,240,000) Depreciation($22:$7:$5) $ (1,760,000) $ (840,000) $ (1,000,000) $ (3,600,000) Head office support($12:$6:$3) $ (960,000) $ (720,000) $ (600,000) $ (2,280,000) All other($11:$2:$1) $ (880,000) $ (240,000) $ (200,000) $ (1,320,000) Total Fixed cost $ (5,120,000) $ (3,000,000) $ (2,800,000) $ (10,920,000) Gross margin $ 2,400,000 $ 6,000,000 $ 10,000,000 $ 18,400,000 Contribution margin ratio =(Contirbution margin/sales)*100 =$7,520,000/$1,2000,000 =$9,000,000/$1,3200,000 $12,800,000/$16,000,000 62.67% 68.18% 80.00% Break even sales=Fixed cost/contribution margin ratio =$5,120,000/62.67% =$3,000,000/68.18% =$2,800,000/80% Break even sales $ 8,170,213 $ 4,400,000 $ 3,500,000 Selling price per unit $ 150 $ 110 $ 80 Break even quantities(BEP Sales/SP) 54,468.09 40,000.00 43,750.00 Margin of safety=Sales-Break even sales Sales $ 12,000,000 $ 13,200,000 $ 16,000,000 Break even sales $ (8,170,213) $ (4,400,000) $ (3,500,000) Margin of safety $ 3,829,787 $ 8,800,000 $ 12,500,000 Operating leverage ratio=Contribution margin/Gross income Contribution margin $ 7,520,000 $ 9,000,000 $ 12,800,000 Gross income $ 2,400,000 $ 6,000,000 $ 10,000,000 Operating leverage ratio 0.32 0.67 0.78
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