Case Study-AW-Q253

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Blue Steele Toy Company
BACKGROUND
 

The Blue Steele Toy Company was founded by Derrick Zandler, Matilda Jeffries’ father, in 1985. Zandler was an industrial artist who enjoyed making stuffed animals in his spare time. His first creation, a teddy bear that he presented to Matilda on her seventh birthday, occupies a place of honor at Blue Steele Toy Company’s headquarters. In 1985, Zandler acquired an old pneumatic pump that had been used to fill lifejackets for the Navy during World War II. He modified the machine to mass produce stuffed animals, and the Blue Steele Toy Company was born.
 

The Blue Steele Toy Company produces the Mugatu Bear, a fifteen-inch teddy bear enjoyed by children and adult toy collectors around the world. The company touts the handcrafted features of the bear and advertises its product as the only teddy bear made in America. The bears are fully jointed, constructed of washable acrylic pile fabric, and stuffed with a polyester fiber filling. The toys are dressed in various accessories, such as bow ties, sports jerseys, or character and occupational costumes. Thus, the product can be personalized for numerous occasions. The Mugatu Bear is sold with an unconditional lifetime guarantee.
 

In communicating with customers, the company refers to its repair center as the “bear hospital.” A damaged bear may be returned by the customer and repaired (or replaced, at the company’s discretion) free of charge. The Blue Steele Toy Company’s 241 employees are organized into three departments: purchasing, production, and marketing. The purchasing department consists of Brint Prewitt, the purchasing manager, and a staff of ten. The department is responsible for acquiring and maintaining the supply of production materials. Todd Meekus manages 174 employees in the production department, where the manufacture and assembly of the product takes place. The marketing department is headed by Katinka Hansel.
 

She is responsible for all aspects of marketing and she supervises the nine sales clerks and 42 sales representatives that make up Blue Steele’s sales force. The remaining three employees are CEO Matilda Jeffries, her
secretary, and her secretary’s assistant. Matilda Jeffries became CEO of the company on July 1, 2003 when
her father retired.
 

PRODUCTION
 

Production begins with a large press that cuts the acrylic pile fabric into the required pattern pieces. The press-cutter machine applies 23,000 pounds per square inch of pressure to a tray of pattern stainless steel dies1 that are stamped into the fabric. The bolts2 of fabric are rolled out and layered on the cutting table. The fabric is measured at this time for length and width and inspected for fabric flaws, tears, and soiled areas. Fabric flaws create waste. Shortages in length or width may require a different cutting set-up and increase fabric waste. Additional cutting set-ups increase production time. The press-cutter machine cuts 14 layered bolts at a time, enough for 588 units. The machine produces a clean, crisp, cut edge that will not fray or ravel.
 

The fabric is also inspected for trueness of color. The Mugatu Bear is advertised as a honey bear. Thus,fabric dye lots are important for matching shades of brown. The toy animal is available also in off-white and dark brown. Off-color fabric must be scrapped or returned to the supplier. Blue Steele obtains the most economical price for specified colors by timing its fabric orders with the production runs of its suppliers.
 
Rush orders almost always increase substantially the price of the required fabric.
 
1 Dies are heavy-duty, three-dimensional patterns used to cut the fabric into parts for the bear. Dies function in a
manner similar to cookie cutters.
 
2 Fabric is shipped from the manufacturer wrapped around a cylindrical core or “bolt.” A standard bolt of fabric is
ten yards long and 72 inches wide.
2 In the next stage of production, operators of industrial sewing machines construct the six parts of the finished unit: two arms, two legs, the head, and the torso. Each piece is sewn inside-out and then turned right-side-out for assembly. Sewing is the most labor-intensive phase of the production process. Any additional sewing steps, such as logos or monograms, require additional production time.
 
In the next step, two optical-grade, acrylic eyes are attached to the head with plastic rivets. If the rivet posts are too short, the eyes may fall off later. If the rivet posts are too long, the eyes will stand out from the head, giving a nonstandard appearance. Eye color is also somewhat important. Acrylic eyes are purchased from vendors in “dark brown,” but the exact shade may vary from supplier to supplier. Defects are not discovered until the eyes are used in production. At that point, defective eyes are discarded and replaced with ones that meet specifications.
 
After the cut pieces have been sewn together and eyes attached, the company’s unique pneumatic stuffing machine is used to blow the polyester fiber filling into the unassembled parts. Except for two replacements of the electric motor and a new power cord, this is the same machine that Derrick Zandler acquired from Navy surplus in 1985. Bags of filling are loaded into the machine hopper and mechanically fluffed to the proper loft.3 An operator places the empty arm, leg, body, or head over a stationary nozzle and uses a foot pedal to control the flow of filling. The machine operator judges whether the part has been filled correctly. Too little filling affects the firmness of the bear; too much filling is unnecessary and expensive. Inferior grade fiber filling is less expensive but can cause clumping and clogging in the hopper.
 
When this happens, production is interrupted and the operator must unclog the vacuum hose and reset the machine.Next, the arms, legs, and head are attached to the torso using three-part, snap-on, hard plastic disc joints. The disc joints allow the head and limbs to rotate and eliminate the need for sewn attachment. The plastic joints are designed to be foolproof in production and dependable for the life of the product. However, the joints cannot be removed without destroying them. Occasionally, after initial joint insertion, the parts do not fit together properly and they must be removed and replaced.
 
At the end of the construction process, a woven satin label that states “Made in America by the Blue Steele Toy Company” is attached to the back of each bear. More polyester filling is stuffed into the torso and the back seam is hand-stitched, using essentially the same “shoelace” procedure practiced by surgeons.
 
Each seam is brushed by hand to give the bear a seamless look.The production process is a continuous source of airborne polyester and acrylic fibers that must be controlled, both to protect the health and safety of the employees and to safeguard the production equipment. The company has taken several steps to control the fibers. First, an air filtration system works constantly to remove dust and fibers from the factory. Second, production employees wear dust masks while they are working with fabric or filling. Finally, regular cleaning and maintenance of the sewing, cutting,and stuffing machines is performed to prevent the fibers from building up.
 
Maintenance is especially important for the sewing machines. Machine oil and static electricity attract pile fabric lint. Lint buildup can cause lines of stitches that are uneven and seams that do not hold. The Mugatu Bear workmanship is guaranteed for life. Burst seams require rework during the production phase and during the lifetime of the product.
 
All production employees are paid a regular wage for a 40-hour work week. They receive their regular wage plus an overtime premium of one-half the regular wage rate for overtime. The cost of fringe benefits 3 Fiber filling is a loose material. Two pounds of bagged filling occupy approximately one cubic foot of space. The filling is loaded manually into a metal bin or “hopper.” Rotating sets of fork-like tines separate the strands of filling and increase the volume by incorporating air. The proper mixture of air and filling is the “loft.”
 
3 and employer taxes, such as social security, health insurance, and vacation time, adds 20.55 percent to the
cost of labor. The employees’ regular wages are charged to direct labor. The overtime premium and the fringe benefits are carried as variable overhead costs.
 
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MARKETING
 
Marketing of the product takes place at the retail level via catalogue sales and in the company’s retail store
adjacent to the factory. Retail Internet sales are a new addition to the overall marketing effort. The company
also sells wholesale to department stores, toy boutiques, and other specialty retailers. The product can be
delivered by two-to-five-day ground service, next-day air, or holiday express. The customer pays the
insurance and delivery charges. Blue Steele promises same or next-day shipment. Most orders are shipped
the same day as received.
 
When the company receives a customer’s order, an employee takes a bear of the requested color and dresses it according to the customer’s wishes. Then the bear is packaged with a protective air bag and complimentary piece of chocolate candy, and shipped in a designer box. The designer box contributes to the product image. It is intended to lend an air of status and exclusivity to the product. The box is also important to toy collectors who expect to pay or receive a price premium in the secondary market for items that are in “mint-in-box” condition. Producing the box is a custom job involving a box manufacturer and a printing company.
 
The unit cost of the box decreases with the size of the order that the company places with the manufacturer. Rush orders are more costly than normal orders. Blue Steele’s policy on sales commissions has remained stable over the past several years. Commissions of 3 percent are paid on retail store sales and sales to wholesale buyers. No commissions are paid on catalog sales. The company-owned retail outlets have proved unprofitable, so all of them, except for the factory store, have been closed in previous years.
 
The peak selling season is from Christmas to Mothers’ Day, so the company does not have much merchandise on hand at the June 30 year-end. Thus, there are no material changes in raw materials and finished goods inventories, and production volume is practically equal to sales volume. The company adopted a new incentive compensation plan that went into effect on July 1, 2007. Under this plan, each of the three department heads is rewarded based on the performance of his or her responsibility center. Performance is measured against the company’s master budget and its standard cost system. The plan was the result of several meetings with Jeffries and her managers who argued and
bargained for a plan that rewarded the managers fairly for individual contributions and achievements.
 
Jeffries’s plan was intended to promote participation and teamwork and the managers accepted the new program enthusiastically. The plan provides for the following
 
􀁸 Brint Prewitt, the purchasing manager, will receive a bonus equal to 20 percent of the net materials price
variance, assuming the net variance is favorable. Otherwise, the bonus is zero.
 
􀁸 Katinka Hansel, the marketing manager, will receive a bonus equal to 10 percent of the excess, if any, of
actual net revenues (revenues minus both variable and fixed selling expenses) over master budget net
revenues.
 
􀁸 Todd Meekus, the production manager, will receive a bonus equal to 3 percent of the net of several variances: the efficiency (usage or quantity) variances for materials, labor, and variable overhead; the labor rate variance; and the variable and fixed overhead spending variances. Meekus receives no bonus if his net variance is unfavorable.
 
4 INTERNET SALES PROGRAM
 
“It seems that the incentive plan produced results,” said Jeffries. “Hansel had a terrific year this year. Unit
sales were more than 16 percent above budget (Table 1). She says one of the principal factors was the new
Internet sales policy she instituted and the advertising campaign to support it. We’ve never had that kind of
year in sales before.”
 
The Blue Steele Toy Company began selling over the Internet in November 2007. At the same time, the company launched a nationwide radio advertising campaign. All radio advertisements are tagged with a reference to the web site that, in turn, provides visual support for the radio advertising and an opportunity for customers to order online. As an additional incentive to attract Internet customers, Katinka Hansel proposed that Blue Steele offer a substantial discount to customers who ordered over the Internet. Because the discounted Internet price ($42.00) was still greater than the price that Blue Steele was charging its wholesale customers ($32.00), Jeffries approved the price change.
 
To boost its Internet sales, the company held special holiday sales. The Christmas and Valentine’s Day sales featured the Mugatu Bear in special seasonal costumes. Both events were immediate successes not only with Internet customers, but also with retail and wholesale customers who paid the customary prices. The 15-inch bears produced by the Blue Steele Toy Company are identical except for their color and their accessories. Although the bears may be purchased with differing accessories, the unit cost of the accessories per bear has been relatively stable over time. The average historical cost of accessories has been a very small part of the total cost of the bear, and the standard cost of accessories is computed as an average.
 
The price differences in the product reflect the company’s discounting practices and not differences in accessories.
 
The master (static) budget for the year ended June 30, 2008 was prepared before the Internet program and price change were adopted. It called for the sale of 280,000 units, allocated as follows
 
Retail and mail order 238,000 units x $49.00 = $11,662,000
Wholesale 42,000 units x $32.00 = 1,344,000
Total 280,000 $13,006,000
The expected distribution of 85 percent retail and 15 percent wholesale was based on the company’s experience in prior years. Thus, the budgeted average selling price was $46.45. Actual sales for the year were as follows
 
Retail and catalog 174,965 units x $49.00 = $8,573,285
Internet 105,429 units x $42.00 = 4,428,018
Wholesale 45,162 units x $32.00 = 1,445,184
Total 325,556 units $14,446,487
 
MATERIALS AND PRODUCTION
 
“Prewitt had a few triumphs of his own this year,” said Jeffries. “He managed to get some substantial price discounts on acrylic pile fabric, plastic joints, and polyester fiber-filling. Price discounts of 7 to 10 percent on our three main inputs add up to some real savings.” Blue Steele Toy Company’s schedule of standard manufacturing costs is reproduced in Table 2. The schedule of actual manufacturing costs for the year ended June 30, 2008 is in Table 3.
 
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“So,” Jeffries continues, “at least on the surface, it looks like marketing and purchasing had a good year, but production is another story. Todd Meekus was not part of the original Blue Steele team. He was hired from a luggage manufacturing company to learn the ropes after Jack Johnson left. Jack joined a competitor last July.”
 
“During Todd’s first week on the job, we had a freak thunderstorm and the storm drain backed up,ruining a large amount of fiber filling. The loss was uninsured. Since then, I have gotten plenty of feedback from Todd who has been struggling to keep up with production. He has complained about the substandard direct materials, deviations from standard production plans, and the amount of overtime required to meet sales demand. The plant has been operating at near to maximum capacity of 350,000 units. His people are tired. Some of them quit and had to be replaced at higher-than-standard wage rates. Todd also said that extra maintenance was required on the machinery and that, even so, they’ve experienced frequent breakdowns. He’s been vehement about stock-outs of some of the imported accessories. At one point, sales commitments made it necessary to schedule overtime to copy some of the bear outfits and make them inhouse. But he tries to be fair and responsible. He admitted that he was the person who moved some of the
plastic parts to an empty box marked ‘refuse’ that was hauled away later by the trash collectors. This is a
small place and I hear almost everything that goes on.”
 
REQUIRED
 
1. a. Using the information in the case and Tables 1-5, prepare a flexible budget for the Blue Steele Toy Company for the year ended June 30, 2008. Analyze the company’s total master (static) budget variance for the year. Compare the flexible and master (static) budgets and prepare a schedule showing the sales volume variance. Compare the actual results and the flexible budget, and prepare a schedule showing the flexible budget variance. Subdivide the flexible budget variances into the appropriate price (rate or spending) and efficiency (usage or quantity) variances for materials, labor,and variable overhead.
 
b. Compute the bonuses earned in fiscal 2008, if any, by Brint Prewitt of the purchasing department, Katinka Hansel of the marketing department, and Todd Meekus of the production department. 2. a. You will be assisting in the investigation of certain variances. Using the information provided, formulate some likely explanations for the observed variances.
 
b. Comment on the advantages and disadvantages of the incentive compensation plan as it applies to department heads. What is the appropriate role of the budget in performance evaluation?
 
3. Prepare a memo to Matilda Jeffries with recommendations to improve profitability for next year. Be specific, and reference any relevant variances if and when necessary. Also include any recommendations regarding modifications to the incentive plan, if any.
 
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TABLE 1
Blue Steele Toy Company
Preliminary Statement of Divisional Operating Income
for the Year Ended June 30, 2008
Actual
Master (Static)
Budget
Master-Budget
Variance
Units sold 325,556 280,000 45,556 F
Retail and catalog (174,965 units) $8,573,285 $11,662,000 $3,088,715 U
Internet (105,429 units) 4,428,018 0 4,428,018 F
Wholesale (45,162 units) 1,445,184 1,344,000 101,184 F
Total revenue 14,446,487 13,006,000 1,440,487 F
Variable production costs:
Direct materials
Acrylic pile fabric 256,422 233,324 23,098 U
10-mm acrylic eyes 125,637 106,400 19,237 U
45-mm plastic joints 246,002 196,000 50,002 U
Polyester fiber filling 450,856 365,400 85,456 U
Woven label 16,422 14,000 2,422 U
Designer Box 69,488 67,200 2,288 U
Accessories 66,013 33,600 32,413 U
Total direct materials 1,230,840 1,015,924 214,916 U
Direct labor 3,668,305 2,688,000 980,305 U
Variable overhead 1,725,665 1,046,304 679,361 U
Total variable production costs 6,624,810 4,750,228 1,874,582 U
Variable selling expenses 1,859,594 1,218,280 641,314 U
Total variable expenses 8,484,404 5,968,508 2,515,896 U
Contribution margin 5,962,083 7,037,492 1,075,409 U
Fixed costs:
Manufacturing overhead 658,897 661,920 3,023 F
Selling expenses 5,023,192 4,463,000 560,192 U
Administrative expenses 1,123,739 1,124,000 261 F
Total fixed costs 6,805,828 6,248,920 556,908 U
Operating incomea $(843,745) $788,572 $1,632,317 U
a The actual operating income reported in Table 1 is a preliminary figure that has not been adjusted
for fiscal 2008 bonuses, if any.
 
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TABLE 2
 
Blue Steele Toy Company
Schedule of Standard Costs: Fifteen-Inch Mugatu Bear
Normal Capacity: 280,000 units Quantity Standard
Allowed Input Cost
Per Unit Price Per Unit
Direct materials
Acrylic pile fabrica 0.02381 bolts $35.00/bolt 0.8333
10-mm acrylic eyes 2 eyes $0.19/eye 0.3800
45-mm plastic joints 5 joints $0.14/joint 0.7000
Polyester fiber filling 0.90 lbs. $1.45/lb. 1.3050
Woven label 1 label $0.05/each 0.0500
Designer box 1 box $0.24/each 0.2400
Accessoriesb various 0.1200
Total direct materials 3.6283
Direct labor
Sewing 0.50 hours
Stuffing and cuttingc 0.30 hours
Assembly 0.30 hours
Dressing and packaging 0.10 hours
Total direct labor 1.20 hours $8.00/hour 9.6000
Variable manufacturing overheadd 1.20 DLH $3.114/DLH 3.7368
16.9651
Fixed manufacturing overhead 1.20 DLH $1.97/DLH 2.364
$19.3291
 
a One bolt of fabric is 10 yards long by 72 inches wide. Fabric for 42 finished units can be cut from one bolt.
b The cost of accessories varies from 7 cents per unit for a bow tie to 45 cents per unit for fisherman’s gear.
The standard of 12 cents per unit reflects the historical assortment of accessories chosen by customers.
 
C Less than 0.01 hour per unit is spent cutting the fabric. Therefore, hours spent in the cutting operation are not
separately recorded. They are included with hours spent operating the pneumatic stuffing machine because
both operations are usually performed by the same employees.
 
d Variable and fixed overhead are allocated to production on the basis of standard direct labor hours allowed.
Standard amounts are computed at normal capacity of 280,000 units. Maximum practical capacity is
350,000 units of production attainable in consideration of planned maintenance and scheduled down time
for holidays. Normal capacity is the long-run average productive output that smooths out seasonal, cyclical,
and other variations in customer demand.
 
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TABLE 3
 
Blue Steele Toy Company
Schedule of Actual Manufacturing Costs
for the Year Ended June 30, 2008
Quantity Input Total
Used Price Cost
Direct materials
Acrylic pile fabric 7,910 bolts $32.4174/bolt $256,422
10-mm acrylic eyes 661,248 eyes $0.l9/eye 125,637
45-mm plastic joints 1,937,023 joints $0.127/joint 246,002
Polyester fiber filling 344,165 lbs. $1.31/lb. 450,856
Woven label 328,447 labels $0.05 each 16,422
Designer box 315,854 boxes $0.22 each 69,488
Accessories various 66,013 a
Total direct materials 1,230,840
Direct labor
Sewing 189,211 hours
Stuffing and cutting 104,117 hours
Assembly 121,054 hours
Dressing and packaging 34,615 hours
Total direct labor 448,997 hours $8.17/hour 3,668,305
Overtime premium 103,787 hours $4.085/hour 423,970
Other variable manufacturing overhead 1,301,695 b
Fixed manufacturing overhead 658,897
$7,283,707
 
a The actual input price for accessories is derived by dividing the actual cost of $66,013 by units sold (325,556), yielding an average accessories cost of approximately $0.203 per bear.
 
b The actual input price for variable overhead is obtained by dividing the total variable overhead ($1,301,695 + $423,970) by actual direct labor hours worked, yielding a price or rate of approximately $3.84 per direct labor hour.
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TABLE 4
 
Blue Steele Toy Company
Schedule of Actual Manufacturing Overhead Expenditures
for the Years Ended June 30, 2004 through 2008
2008 2007 2006 2005 2004
Units produced 325,556 271,971 252,114 227,546 201,763
Variable overhead:
Payroll taxes and fringes $840,963 $524,846 $467,967 $413,937 $356,150
Overtime premiums 423,970 24,665 2,136 1,874 1,965
Cleaning supplies 4,993 6,842 6,119 5,485 4,996
Maintenance labor 415,224 256,883 232,798 244,037 216,142
Maintenance supplies 27,373 15,944 12,851 15,917 14,323
Miscellaneous 13,142 11,244 9,921 8,906 7,794
Total $1,725,665 $840,424 $731,792 $690,156 $601,370

Fixed overhead:
 
Utilities $121,417 $119,786 $117,243 $116,554 $113,229
Depreciation-machinery 28,500 28,500 28,500 28,500 28&n
 
,5
00
Depreciation-building 88,750 88,750 88,750 88,750 88,750
Insurance 62,976 61,716 57,211 55,544 54,988
Property taxes 70,101 70,101 68,243 68,243 66,114
Supervisory salaries 287,153 274,538 275,198 269,018 254,469
Total $658,897 $643,391 $635,145 $626,609 $606,050
 
TABLE 5
Blue Steele Toy Company
Schedule of Actual Selling Expenses
for the Years Ended June 30, 2008 and 2007
2008 2007
Units sold: 325,556 271,971
Variable expenses:
Packing and shipping $1,580,089 $1,015,913
Commissions 129,080 216,116
Catalogs, brochures, and samples 150,425 65,658
Total $1,859,594 $1,297,687
Fixed expenses:
Salaries $2,734,868 $2,345,121
Advertising and promotion 2,288,324 2,086,021
Total $5,023,192 $4,431,142
 
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