Due: November 15, 2013
Playtime Equipment: Accounting for this company is not child’s play
It was Tuesday morning and Valerie Fan, Controller, had just returned from a meeting with Kirk McFadyen, Chief Executive Officer of Playtime Equipment (Playtime). Playtime is a privately-owned manufacturer of children’s swing sets. It has three main product lines: small swing sets with two swings, a medium set which includes three swings and a slide and a large swing set which includes three swings, a slide and a jungle gym. The company is located in Sherbrooke, Quebec and sells its products to cities and towns throughout Canada for use in public playgrounds. Valerie has a CPA designation and just joined the company after spending 10 years in senior financial positions in a rental property management company. During the meeting, Kirk expressed his concern about the company’s declining profitability.
Upon returning to her office, Valerie reviewed Playtime’s financial records to examine the revenues and costs for each product. Her review revealed that Playtime uses a job-order product-costing system. The cost of each product is calculated using the actual direct-material cost, actual direct-labour cost, and applied manufacturing overhead. Overhead of $2,825,000 was applied using a predetermined overhead rate based on direct-labour hours. This accounting approach is similar to that of other manufacturing companies. Appendix 1 provides the data used in Playtime’s costing system.
Playtime’s Financial Situation
Playtime’s profitability has been declining in the last five years. According to Playtime’s pricing policy, the company sets its target price for each swing set equal to 120 percent of the full product cost. However, the actual prices that Playtime charges for its products does not adhere to the policy as the company charged $700 for the small swing set, $900 for the medium and $1,600 for the large set. The company had reduced is selling prices in response to increased competition from manufacturers in Mexico who had recently obtained a significant order from one of Canada’s largest cities. In fact, the Mexican manufacturer’s prices were $200 lower than Playtime’s for the small and medium swing set, but $1,800 for the large set. Despite reducing its selling prices, the company continued to experience difficulty in obtaining orders for its planned production of small and medium swing sets. However, Playtime was quite pleased with the sales of its large swing set. Since the large swing set was selling so well, Ahmad Kahn, Vice-President of Sales decided to increase the selling price by $100 from $1,500 to $1,600. Even after this price increase, Playtime continued to experience strong demand for its large swing set and the company could barely keep up with demand. Ahmad was very surprised that competitors did not introduce a comparable product in this price range. He wished the company’s other swing sets were in such high demand. He wondered if he should recommend a decrease in production of the small and medium sized sets in order to facilitate an increase in production of the large sets. When he casually mentioned this idea in a recent staff meeting, the CEO was concerned about this idea because the small and medium sets took up most of the production time and despite lower sales levels, the company still sold a significant number of these sets.
Valerie called a meeting with Mark Baxter, Financial Analyst, who had just graduated from Saint Mary’s University. She explained the situation to Mark and asked him to analyze Playtime’s costing and pricing methodology. Mark commented that he had recalled learning in his Accounting 3333 course about activity based costing (ABC) and activity based management (ABM). He suggested considering if ABC would provide more insight into each product’s costs. Valerie agreed this would be a good approach. Mark…