Case
#3 – Performance Drinks -A further study of:

Regression
Analysis

Contribution
Margin Reporting

Cost-Volume-Profit
Analysis

Differential
Analysis

Capital
Budgeting

Written
by:

Tim
Bergsma, CMA, CFE

Assistant
Professor – Accounting

Davenport
University

Donald
W. Maine – College of Business

Background:

Performance Drinks, LLC is owned by
Dave N. Port. Performance Drinks
produces a variety of sports centered drinks.
They began operations in 1993 shortly after Mr. Port graduated with his
M.B.A. from Davenport University. The
company saw early success as sports and fitness nutritional products gained new
popularity in the 1990’s. Financially
the company is sound and has been wise in controlling their growth over the
years. However, within the last 18
months Mr. Port has noticed a drop in overall company profitability. This is especially troubling considering that
the company has continued to experience top-line growth. Mr. Port and his management team have been
considering developing a new product line.
However, those plans have been put on hold until they can figure out why
their profits are shrinking.

Performance Drinks makes four
different kinds of sports drinks. Those
drinks are as follows:

·
Basic

·
Hydration

·
Intensity

·
Post-Workout

Each
of these drinks contains a slightly different nutritional profile and is
targeted for different users and uses.
The Basic drink has the least nutritional benefit and is targeted for
general consumption. The Hydration
product targets endurance athletes and specializes in hydration
replacement. The Intensity product was
designed with energy enhancement in mind. It serves the needs of extreme
athletes who need long durations of sustained energy. Lastly, the Post-Workout product is a
nutritional replacement product that is generally used following exertion.

Information Related to Case #2(this section is the same as you received when you were assigned
Case #2)
:

You
are the Controller for Performance Drinks.
You feel as though you have a good handle on the financial reporting and
the overall company performance.
However, admittedly, your accounting information system has been
designed to serve the needs of external users from an aggregate perspective. To that end you utilize absorption costing
exclusively within the organization. You
recall studying the concept of Activity Based Management (ABM) and Activity
Based Costing (ABC) while taking a managerial accounting course. You wonder if applying those ideas to your
business would help to uncover the mystery of the disappearing profits.

You recall from your Management
Accounting class that product costs are comprised of:

·
Direct Materials

·
Direct Labor

·
Manufacturing Overhead

You
don’t suspect that anything strange is going with your direct costs. You do wonder, however, if a more thorough
understanding of your indirect costs may be in order. Over a series of weeks you talk with a
variety of employees, representing a multitude of functional areas, from within
the company. During those conversations
you take careful note on what activities might be consuming resources and how
those activities might be measured. You
sharpen your pencil and begin to unpack what you’ve learned. You start with reviewing last month’s
Product-Level Profit Report. That report
is following:

Since your primary area of focus is
on the indirect costs you compile the following report which further details
your overhead charges:

Overhead
Activities:

Using
traditional costing methods, which support your absorption costing system, you
base overhead allocation on direct labor cost.
Furthermore, “fringe benefits” are a function of direct labor cost.

As
a result of your many meetings to discuss company overhead you determine that
the majority of your indirect costs are related to four primary
activities. Those activities are
equipment set-ups, production runs, production management and machine-hour
capacity. “Production Management” refers
to a number of items that are correlated to the number of products the company
produces. Ultimately you determine that
your key activities have the following usage patterns, as they pertain to the
monthly overhead costs:

Upon reviewing budget data from the
last budget cycle you discover that the monthly number of set-ups was estimated
to be 85. The number of production runs
was estimated to be 250. That monthly
machine-hour capacity is presently at 20,000 machine-hours. Lastly, Performance Drinks produces a total
of four products.

After talking with the Plant Manager
you create the following usage data relative to products and activities:

New
Information Pertaining to Case #3:

The financial
reporting to date has been done using absorption costing. That is to say that the manufacturing costs
included direct materials, direct labor, variable manufacturing overhead and
fixed manufacturing overhead. In this
sense the Income Statements have historically reported Gross Margin. Following is a Monthly Income Statement,
based on absorption costing, for Performance Drinks:

You
begin to wonder if there would be any value in repackaging the income statement
in a way that would report Contribution Margin as opposed to Gross Margin. You know that in order to report Contribution
Margin you will need to understand your costs as variable and fixed. Unfortunately the general ledger does not
specifically report costs as variable and fixed. You remember learning that regression
analysis can be used to generate data that can be used to create a total cost
equation. With the total cost equation we
can understand our total cost as the sum of fixed costs and variable
costs. After doing some research your
collect the following data related to overhead and possible causal factors:

Requirement
#1

Using the data above, which
has also been provided electronically in Excel, run the following regression
analyses:

  • Linear
    regression analyzing total overhead cost and units sold
  • Linear
    regression analyzing total overhead cost and machine hours used
  • Multiple
    regression analysis analyzing total overhead cost along with both units
    sold and machine hours used

Requirement
#2

Based on the results from the three
regression analyses determine which correlation provides the best estimate of
the total cost equation. Explain why you
selected the correlation that you did.

Requirement
#3

Write out the total cost equation
using the results from the multiple regression test.

Requirement
#4

Create a “Contribution” formatted
income statement using the results from the multiple regression test. Use the following additional information
regarding machine hours, used by each product, which has also been provided in
Excel electronically:

Reference the following sales volumes, by product, for
your cost allocation related to units sold:

Use the following template as a guide for the format
of your “Contribution” Income Statement:

Requirement
#5

Compute the following:

·
Break-even point in units

·
Break-even point in sales dollars

·
Targeted profit point in units (use
$50,000 as your targeted profit point)

·
Margin of Safety

Requirement
#6

A new customer has surfaced. That customer has asked you to consider
producing a special one-time order for them.
This special order would require a modification to the recipe that will
slightly increase the variable cost per unit.
Furthermore, there would be a small fixed cost addition. The details for the order as follows:

Conduct a
differential analysis regarding this special order. Would you accept this order under the
conditions provided? Explain and defend
your position.

Requirement
#7:

Your management team has asked you
to consider investing in a new piece of equipment. The details of that investment opportunity
are following:

The discount
rate for this project is 5%. Compute the
following:

·
Net Present Value

·
Internal Rate of Return

Would you recommend
investing in this new piece of equipment?
Explain and defend your position.

Clarification
on format and data:

Clear
communication and professionalism are important. Defending your answer with data is
important.

·
An electronic copy of this Case (this
document) is available within Blackboard.
Additionally, an Excel file, containing the necessary data for the case
will be available within Blackboard.

·
Create one professional report, in Word,
that contains all of answers. In that
report you should clearly label all of your answers. Make your answers easy to read and find. Imagine you were giving this report to your
boss. Further imagine you have to lead
your boss and the executive team through your findings. You will then have one Word document as your
final product. You will also have one Excel file.

·
Grading is based on both accuracy (see
rubric) and your ability to communicate your answers professionally and
clearly.

·
Use the following naming structure for
your files: last name_first initial_case3.docx.
Of course your Excel file will have an .xls suffix.

·
Double space your report.

·
Put good thought into how you organize
your Excel document. Part of your grade will be based upon the usability and
layout of your Excel file. Imagine that have to give the electronic copy of
your Excel file to your boss, or a peer, to work with. Imagine that you could not coach them at all
on how to use your file. Is your file
organized and labeled so clearly that anyone could use it, easily, without
instructions from you? You want to
strive for that kind of clarity in your work.

·
Your report should have a title page.
Use APA 6th edition for guidance on title pages.

·
You will also upload to Blackboard both
your Word document and your Excel file.

Grading
Rubric:

Total >>

150

Requirement

Points
Possible

Accuracy – Requirement #1 (Regression
Analysis)

15

Accuracy – Requirement #2 (Regression
Comments)

10

Accuracy – Requirement #3 (Total Cost
Equation)

5

Accuracy – Requirement #4 (Income
Statement)

25

Presentation – Requirement #4 (Profit
Report)

15

Accuracy – Requirement #5 (CVP)

15

Accuracy – Requirement #6 (Differential
Analysis)

15

Quality – Requirement #6 (Differential
Analysis)

10

Accuracy – Requirement #7 (Capital
Budgeting)

10

Quality – Requirement #7 (Capital
Budgeting)

10

Quality – Excel File (Organization /
Usability)

10

Overall Professionalism

10

Notes:

1.
“Quality” scoring is based up the comprehensiveness of your
work. Did you answer the questions asked?
Are those answers correct and / or reasonable? Did you defend your
answers where appropriate?

2.
“Presentation” scoring is based on how your report/work
reads. Is your work well organized?
Did you include all necessary supporting work? Is your work labeled well?