Problems facing by Strategic Marketing Unit Two (SMU2) of Fine Food: Unfairly allocated costing system
Unreliable performance evaluation standard leads to undervaluation of SMU2 and negative motivational effect on employees. Key Findings:
Fine Foods allocates some period costs (including sales and marketing costs, media and sales promotion costs, and freight out cost) based on weight of product sold. SMU2 thus seems less profitable because the main product of SMU2 is Product MP and its special orders, which are relatively dense and bulky. This allocation method makes SMU2 seems less profitable. Fine Foods evaluate the performance of SMUs based on operating profit, which includes several uncontrollable cost elements in the calculation. Hence, operating profit cannot reflect the true performance of each SMU. Recommendations:
Allocate indirect costs based on number of unit sold instead of weight of product sold Use CM1 and CM2 as the primary evaluation for the SMUs instead of operating profit.
Fine Food Inc. is a branded, high-quality food provider. It has a big market and loyal customers, including supermarkets, convenience shops, restaurants, large food service groups, caterers, and etc. Fine Food Inc. is owned by Great Plains Capital. However, it has completely freedom and control over management, product selection, and performance evaluation. Therefore, external reporting is not mandatory, and internal reporting is not regulated by any financial accounting standards. Any external reporting will be done by Great Plains Capital on a group basis. Fine Food Inc. is organized in three units called Strategic Marketing Units (SMUs). Each unit serves a segment of market. SMU1 serves supermarkets and similar outlet. SMU2 serves institutional customers who order in large volume and bulk quantities. SMU3 serves Fine Food in other countries, and governmental organizations.
SMU2 and Special Orders
SMU2, which will be further discussed, mainly sells product MP and its special orders. A special order is one in which the contract specifies that it can be rejected within a year before delivery. All the special orders are for a food distributor in Mexico, which account for 2% of the total revenue. SMU2 accepts special orders when CM1 (Net Sales-variable manufacturing costs-fixed manufacturing costs-freight out) is positive. Product MP is a relatively heavy and bulky product. Although other two units sell Product MP as well, it represents a smaller portion of sales for them. Fine Food is now using product-costing method, which is to allocate all costs to its products mainly based on weight of product sold. The following report will be divided into four sections.
Section 1: Cost Allocation Analysis*
Section 2: Special orders
Section 3: Performance evaluation system
Section 4: Recommendations
*To further illustrate the costs composition, a list of terms will be attached as an appendix.
Cost Allocation Analysis
Currently, Fine Foods allocates all costs, including fixed costs, to products to get a true and accurate measure of each product’s profitability. These allocations are mainly based on weight of product sold. However, this allocation method is not as accurate as it sounds, and it is unfair to SMU2. SMU2 mainly produces Product MP and related special orders, which are relatively heavy, comparing to other products. Although SMU1 and SMU3 produce Product MP as well, their major sales come from other Fine Food products. Due to this situation, excessive costs are allocated to SMU2, including freight out costs, some fixed manufacturing cost, media and sales promotion costs, and sales and marketing costs. These costs significantly reduce the contribution margin1 (CM1), contribution margin2 (CM2) and contribution margin3 (CM3), which makes it uncontrollable for the SMU2 management. Special Orders
Special orders provide product MP for a food distributor...
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