Practice Case- Maytag Kitchens- managerial accounting PDF

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CPA MOCK Evaluation

Core 2 Module

MAYTAG KITCHENS CO.

Page 1 Suggested Time (60 minutes)

It is now early January 2021 and you, CPA, work for Bosch and Partners, Chartered Professional Accountants LLP. You have recently been introduced to Richard Maytag, the sole owner and operator of Maytag Kitchens Co. (MKC), a kitchen cabinet manufacturing company that specializes in high-quality cabinets. In 2020, MKC manufactured and sold 500 sets of kitchen cabinets, its best year ever. As a result, Richard began to share with you his ideas about the future of his company. “I have more space than I can use in our manufacturing facility right now. Therefore, I could immediately invest in equipment and hire additional employees to increase our production capacity by 75 sets of kitchen cabinets per year. I am not sure whether I should make this investment or not. Please analyze the investment quantitatively and qualitatively and conclude on whether to invest in the equipment. “I have also been approached by a start-up company, New Cabinets, who will manufacture the same quantity of sets of kitchen cabinets as investing in the equipment would produce each of the first 3 years. If I were to accept this contract, then I could rent out the manufacturing facility space at a monthly rate of $450. I am not sure whether I should enter into the contract with New Cabinets. Please analyze the contract quantitatively and qualitatively and conclude on whether I should sign the contract. Details are provided in Appendix II. “I spoke with my bank recently and they are willing to finance the entire equipment purchase at a fixed 5% annual interest rate, which is only 2% higher than the current prime lending rate. The loan would be secured by the equipment and repaid over a period of five years, consisting of blended annual principal and interest payments due at the end of each year. “Alternatively, the bank said that they could provide me with a line of credit secured by the company’s accounts receivable and inventory. The limit would be based on 75% of accounts receivable plus 50% of inventory, to be reviewed periodically. The interest rate would be prime plus 1% and it requires a minimum of annual interest-only payments. I am wondering whether I should consider the line of credit or the term loan to finance the investment in the equipment. I would prefer not to have both funding sources in place at the same time since I am rather debt averse. “To date, I think my main reason for success has been a focus on keeping tight control over the materials, labour, and overhead costs by reviewing them at the end of each quarter based solely on the results reported on the income statement. This helps me generate as high a profit as possible.”

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CPA MOCK Evaluation

Core 2 Module

Page 2

Richard also mentioned that he has been approached by Kerr Homes Inc. (Kerr), a national manufacturer of modular housing, to supply approximately 300 kitchen cabinets per year for its line of “Historic” homes. To become a supplier, MKC would have to supply its standard costing for a set of kitchen cabinets and Kerr would then pay a modest fixed premium over the amount given the high volume of the contract. Richard has never used a standard costing system in the past and he wants to know what such a system would entail in his situation. Although he has limited knowledge, he has expressed some concerns with cost overruns and maintaining a “safety” profit margin. He would like your recommendation as to how he should respond to the proposal. You took notes during the meeting (Appendix I). You decide to draft a memo to address the issues Richard has raised.

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CPA MOCK Evaluation

Core 2 Module

Page 3

APPENDIX I NOTES FROM MEETING WITH RICHARD MAYTAG The equipment will cost $750,000 and needs to be paid for up-front. The remaining useful life of the equipment is expected to be 10 years and the relevant capital cost allowance (CCA) rate is 30%. The equipment is being sold at a bargain as it belongs to a competitor, Customized Cabinets, who is going out of business due to customers buying cheaper, prefabricated cabinets. There is one year left on the manufacturer’s warranty. Customized Cabinets was not able to find the English version of the owner’s manual since the equipment was purchased a few years ago but did locate the Spanish version of the owner’s manual. The equipment has needed a few repairs since it was purchased. Customized Cabinets hired a general repairman and, through trial and error, the equipment was fixed as the original manufacturer went out of business. Four new part-time employees would need to be hired and each would be paid an annual salary of $40,000 per year plus 15% for benefits. Those new employees could be hired in stages, two of them immediately from Customized Cabinets and two of them starting two years from now. One of the employees from Customized Cabinets speaks Spanish. The capacity increase will not be realized from a sales perspective immediately. It will increase evenly over the first three years, after which time it will remain stable for the remaining years. As a result of the additional equipment, maintenance and utilities costs will increase on average by $20,000. Richard uses an after-tax rate of return of 8% as a benchmark when considering capital investments. MKC’s tax rate is 13%. MKC’s land and building had a net book value of $250,000 at December 31, 2020. The fair market value of these assets is currently $800,000 in excess of the net book value. There is currently a $100,000 mortgage on the land and building. When MKC purchased the land and building several years ago for $400,000, it obtained a mortgage at the same time for $300,000. MKC’s accounts receivable and inventory balances were $500,000 and $225,000, respectively, as at December 31, 2020. Richard expressed some concern about the labour costs as a percentage of sales revenue (sales revenue of $5 million in 2020). Labour costs are 25% of revenues. “We have focused so much on growth that we have not realized any economies of scale on the labour side. I know there is waste, but I have not been able to isolate the cause of the inefficiency. Also, the materials costs have remained steady in 2020 at 50% of revenues." The variable overhead costs are 8% of revenues while the fixed overhead costs are 5% of revenues.

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CPA MOCK Evaluation

Core 2 Module

Page 4

APPENDIX II NEW CABINETS CONTRACT DETAILS New Cabinets will manufacture the sets of kitchen cabinets evenly throughout the year for a contract price of $1.1 million. The three-year contract is non-cancellable. MKC will supply the cabinet design and New Cabinets will manufacture the cabinets to MKC’s specifications. The cabinets will be shipped directly from New Cabinets to the customer. MKC is responsible for having the kitchen cabinets shipped out within 30 days of the cabinets being manufactured or will pay a penalty of $1,000 for each instance that the cabinets are not shipped on time.

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