managerial accounting problem

managerial accounting problem.

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Husky Bicycle Company

In May 2018, Suzanne Sommers, marketing vice president of Husky Bicycle Company, was mulling over the discussion she had had the previous day with Tom Brady, a buyer from Robie Discount Sports (RDS). RDS operated a chain of discount department stores in the Northeast. RDS’s sales volume had grown to the extent that it was beginning to add “house-brand” (also called private-label) merchandise to the product lines of several departments. Brady, RDS’s sporting-goods buyer, had approached Sommers about the possibility of Husky producing bicycles for RDS. The bicycles would bear the name ‘Speedster’ which RDS planned to use for all of its house-brand sporting goods.

Husky had been making bicycles for almost forty years. In 2018, the company’s line included ten models, ranging from a small beginner’s model with training wheels to a deluxe twelve-speed adult’s model. Sales were at an annual rate of about $10 million. The company’s 2017 financial statements appear in Exhibit 1. Most sales were made through small independently owned retailers and bicycle shops. Husky had never before distributed its products through department store chains of any type. Sommers felt that Husky bicycles had the image of being above average in quality and price, but not of being a “top of the line” product.

RDS’s proposal had features that made it quite different from Husky’s usual way of doing business. First, RDS needed access to a large inventory because it had had great difficulty in predicting bicycle sales, both by store and by month. RDS wanted to carry this inventory in its regional warehouses but did not want title on a bicycle to pass from Husky to RDS until it was shipped from a regional warehouse to a RDS store. At that point, RDS would consider the bicycle purchased from Husky, and would pay for it within thirty days. However, RDS would agree to purchase any bicycle that had been in one of its warehouses for four months, again paying for it within thirty days. Brady estimated that, on average, a bike would remain in a RDS regional warehouse for two months.

Second, RDS wanted to sell Speedster bicycles at lower prices than the name-brand

bicycles it carried, yet still earn approximately the same dollar gross margin on each bicycle sold, the rationale being that Speedster bike sales would take away from name- brand bike sales. Thus RDS wanted to purchase bikes from Husky for less than the wholesale price of comparable bikes sold through Husky’s usual channels.

Finally, RDS wanted the Speedster bike to look different from Husky’s other bikes. While the frame and mechanical components could be the same, the fenders, seats, and handlebars would need to be somewhat different and the tires would have the name “Speedster” molded into their side- walls. The bicycles would also have to be packed in boxes printed with the RDS and Speedster names. Sommers expected these requirements to increase Husky’s purchasing, inventorying, and production costs over the added costs that would be incurred for a comparable increase in volume for Husky’s regular products.

On the positive side, Sommers was acutely aware that the “bicycle boom” had flattened out; this plus a poor economy had caused Husky’s sales volume to fall in the past two years.1 As a result, Husky was currently operating its plant at about 75 percent of one- shift capacity. The added volume from RDS’s purchases could be very attractive. If an agreement could be reached on prices, RDS would sign a contract guaranteeing to buy its house-brand bicycles only from Husky for a three-year period. The contract would be extended automatically on a year-to-year basis unless either party gave at least three months’ notice that it did not wish to extend the contract.

Suzanne Sommers realized she needed to do some preliminary financial analysis before having any further discussions with Tom Brady. She had written down the information she had gathered to use in her initial analysis; this information is shown in Exhibit 2.

1 The American bicycle industry had become very volatile in recent years. In the region that is served by Husky from 1997 through 2000 sales averaged about 7 million units a year. By 2007 the total was up to a record 15 million units. By 2009 volume was back down to 7.5 million units. By 2017 volume was back up to 10 million units, but still well below the peak years.

Exhibit 1

Assets

Cash
Accounts receivable
Inventories 2,756 Plant and equipment (net) 3,635

$ 8,092

Income Statement
For the year ended December 31, 2017

Financial Statements (thousands of dollars) Balance Sheet as of December 31, 2017

$ 342 1,359

Liabilities and Equity

Accounts Payable Accrued expenses Short term bank loans Long term note payable

Total liabilities Owners’ equity

$ 512 340 2,626 1,512 4,990 3,102 $ 8,092

Sales revenue
Cost of sales
Gross margin
Selling & Admin. expenses Income before taxes Income taxes

Net income

$ 10,872 8,045 2,827 2,354 473 218 $ 255

Exhibit2 DataPertinenttoRDSProposal (Notes Taken by Suzanne Sommers)

1. Estimatedfirst-yearcostsofproducingSpeedsterbicycles(Averageunitcosts.assuminga

constant mix of models) Materials

Labour
Overhead (@ 125 % of labor)

Notes:
(1) Includes items specific to models for RDS not used in our standard models.
(2) Accountant says about 40 percent of total production overhead cost is variable; 125

percent of direct labour dollar rate is based on volume of 100,000 bicycles per year. (3) Fixed manufacturing overhead totals about $1.5 million per year.

2. Unit price and annual volume: RDS estimates it will need 25,000 bikes a year and proposes to pay us (based on the assumed mix of models) an average of $92. 29 per bike for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflat1on-caused increases in costs shown in item 1 above; thus the $92.29 and $83.90 figures are in effect “constant-dollar” amounts. Brady intimated that there was very little if any negotiating leeway in the $92. 29 proposed initial price.

3.Asset-related costs (annual variable costs as percent of dollar value of assets) Pre-tax cost of funds (to finance receivables or inventories)

Record-keeping costs (for receivables or inventories) Inventory insurance
State property tax on inventory
Inventory-handling labor and equipment

Pilferage, obsolescence, breakage etc.

4.Assumptions for Speedster-related added inventories (average over the year): Materials: two months’ supply.

18.0 % 1.0

0.3 0.7 3.0 0.5

Work in process: 1,000 bikes, half completed (but all materials for them issued) Finished goods: 500 bikes (awaiting next carload lot shipment to a RDS warehouse)

5.Impact on our regular sales: Some customers comparison shop for bikes and many of them are likely to recognize a Speedster bike as a good value when compared with a similar bike (either ours or a competitor’s) at a higher price in a non-chain toy or bicycle store. In 2017 we sold 98,791 bikes. My best guess is that our sales over the next three years will be about 100,000 bikes a year if we forgo the RDS deal. If we accept it, I think we’ll lose about 3,000 units of our regular sales volume a year, since our retail distribution is quite strong in RDS’s market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we’re making bikes for RDS. Also, I’m not entirely confident about only losing 3,000 units due to in effect competing against ourselves.

6.I think I need to work out the profitability of the bikes not just to us but also to our regular independent store customers. How will they be affected by RDS Speedster bikes?

$ 39.80

19.60

24.50 $ 83.90

Required: Play the role of a project analyst assigned to Suzanne Sommers, Vice President of the Husky Bicycle Company. You should prepare a confidential and professionally written report that she will use both in her discussions with Tom Brady of RDS and in her meetings next week with the top executives of Husky where the five year strategic plan for the company will be discussed.

Below is a list of questions that may be important to include in your report. These issues should be addressed in your report but they should NOT be considered the sole “requirements” of this assignment. Use them as a jumping off point to an analysis of whatever you consider important to the company at this stage in its development, the current market situation, strengths and weaknesses of the organization, and the overall economic climate the firm finds itself in, the current stage in the product life cycle, etc.

Your report should be approximately five to seven pages plus any exhibits or schedules that you deem appropriate to support your analysis. Your recommendations should be logically supported and address not only the short term implications of the decision on the RDS order but also the longer term strategic implications as well.

Questions to consider:

  1. (1) What is the expected annual profit (loss) associated with taking on the RDS order? Analysis the incremental revenue and incremental costs.
  2. (2) Will the RDS deal likely be something we would like to replicate with other major retailers?
  3. (3) What are the alternatives that Husky has to choose from? Be sure to indicate the advantages and disadvantages of each.

managerial accounting problem

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