Inventory and Costs

IIM Lucknow, Noida Campus MANAGEMENT ACCOUNTING II Assignment II, Daniel Dobbins Distillery, Inc (Case Analysis) Submitted By Rahul Srivastava (WMP08034) Vinay Joshi (WMP08045) abridgment Company History * Founded in 1880 in Oakwoods by Daniel Dobbins. * Major w ar is Old Trailridge Bourbon Whisky * proud quality of whisky erupt-of-pocket to the foreign iron-free spring water used in the distillation action and the curiously prepared fire-charred white oak position used in the develop mental litigate. * David Dobbins takes over in 1973. * Constant demand over the days High demand surge forecasted delinquent to maturity of Baby boom generation. Manufacturing adjoin * Ingredients controlled by laws. * caskfuls can be used solo at a time * Barrels are made through a patented figure out * Whisky has to mature for at least 4 days aft(prenominal)ward the dish out. * Stored in 50 gallon drums for mellowing in storage warehouse Maturing or agedness Process * The 5 0-gallon tympans manufactured under a unique patented process at a speak to of more than $60 per place. The put could not be reused foraging forthcoming batches of bourbon whisky solely could be sold to used barrel dealers for $1 each at the shutting of the aging full stop. The accessiond deed in 1988 necessitated the leasing of an additional warehouse at an annual packal cost of $200,000. The temperature and humidity of the warehouse space had to be controlled since the quality of the whisky could be ruined by its aging overly fast or too slowly. * A small amount of swimming was removed from re show upative put at this time and sent to the ingest laboratory for quality inspection (usually performed by skilled tasters). If the quality of the whis line was not up to standard, certain measures were taken, such as adjusting the aging process, to tot it up to standard. At this time, each barrel was similarly checked for leaks or seepage, and the required repairs were ma de. * On the average, the hatful of liquid in a barrel declined by 30% during the aging period because of evaporation and leakage. Thus, a barrel originally filled with 50 gallons of late bourbon would, on the whole, produce besides 35 gallons of aged bourbon. * The re-gauging operation was supervised by a disposal liquor value agent, since it was at this point that federal excise tax of $21 per gallon was levied on the whiskey removed from the warehouse. In 1987 and 1988, the gild sold 30,000 re-gauged barrels of whiskey, equivalent to ab go forth 43,000 barrels of original production. Excerpts from get along Meeting * Low prospect of obtaining the $3 trillion impart undeniable in light of our 1988 press release of $814,000. We have shown annual utilitys since 1974, and our realise gross sales of $42 million this year are the same as belong year, and yet we incurred a clams loss for the year. * It may appear that we are becoming less efficient in our production oper ation. * We additiond production by 50% this year, and with this append production our cost are resile to ontogenesis.You cant produce something for nothing. * Production cost must rise when production increases, but our inventory account takes care of the increase cost of deferring these product be until a future period when the product is existingly sold. * COGS did not increase in 1988, since the volume of sales was the same in 1988 as in 1987. The largest share of the increase in production cost has-been deferred until future periods, as you can see by looking at the increase in our inventory account of more than $1 million. The real agreement for our loss this year was the large increase in other costs, imperturbable chiefly of warehousing costs. The Occupancy Costs category in our P is really the summation of a group of set down accounts, including building disparagement or rent, heat, light, power, building maintenance, labor and supplies, real estate taxes, and insur ance. In addition, warehouse labor cost in addition rose substantially in 1988. * We change magnitude production, and this also means an increase in warehousing costs, since the change magnitude production has to be aged for several years.You just cant age 50% more whiskey for the same amount of money. * The inventory account can only be charged with those costs associated with the channelise production of whiskey, and our warehousing costs are handling or carrying costs, certainly not production costs. * The manufacturing process doesnt stop with the newly produced bourbon why it isnt even marketable in that form. Aging is an absolutely necessary deviate of the manufacturing process, and I think the cost of barrels and part of the warehouse labor should be treated as drive costs of the product. Warehousing and aging costs are an absolutely subjective ingredient of our final product. * Direct costs are those costs that are necessary to convert raw materials into the whiskey that goes into the aging barrels. * This is our cost of near $1 per gallon and holds the cost of raw materials going into the product such as grain, yeast, and malt the direct labor necessary to convert these materials into whiskey and the cost of any other overhead items that are needed to license the workers to convert grain into whiskey. The Problem The main issue at Daniel Dobbins Distillery, Inc. s a disagreement among the senior management with regards to the allocation of costs. Specifically, it is a distrust of whether to include Ageing Costs, Cost of Barrels, and Warehouse Expense as a part of inventory (in which case it provide be an asset that belongs to the equilibrate Sheet) or as a part of Occupancy Costs (which bequeath be listed in the Income Statement). Listing the above mentioned costs as part of the repose sheet go out overstate the assets and understate the expenses misleading the actual profitability of the society. Alternatives 1. Leave all accounts as they are. . Transfer Cost of Barrel from Other Costs in the Income Statement to the offset Sheet as a Contra-Asset that is part of stock list. Transfer Ageing Costs from the Income Statement to the quietus Sheet and list it under Long Term Contra-Assets. Break up Warehouse agitate into different temporary accounts that are spread out both on the Income Statement as well as the Balance Sheet. Evaluation of Alternatives Alternative 1 Strengths This alternative improves the Net Profit frame in the Income Statement by increasing the value of Closing Inventory in the Balance Sheet.Weaknesses Breaking up Warehouse Labor and accurately allocating the costs across the two financial disputations may not be feasible. Opportunities Choosing this alternative immediately improves its adventures of securing the $3,000,000 loan from the bank. Threats Carrying out this alternative poses the risk of the party getting unfavorable press which may have a shun impact on its reputation. Another threat is that this alternative could be use by senior management as a way of screen inefficiencies, bad expenses, overstating retained earnings, and understating expenses.Alternative 2 Logically Inventory costs include all the direct costs bear on in the production process till the finished goods (ready for sale). As in this process ageing is an essential part of the manufacturing process, the cost of barrels and warehousing should be treated as direct costs otherwise it will affect the Income Statements for the subsequent years thereby misleading the actual profitability of the company. Other costs involved are Occupancy Costs Factory Building (Used for warehousing also) which is rented.Warehouse Labor & supervisor cost. Depreciation Warehouse Equipment. All these costs will tarry in COGS and Costs of Barrel used during the year at$63,00 per barrel will be added to (asset) Inventory and because closing inventory(Effect in balance wheel Sheet Closing Inventory value increase ) will shoot up and hence Net Profit Figure(in P&L statement) will also improve upon by the same amount. At the end of four years of aging process, barrels are removed and dumped into re-gauging tanks.Hence, all these costs will be added to (asset) Inventory and hence closing inventory (Effect in balance Sheet Closing Inventory value increases) will shoot up and hence Net Profit Figure (in P&L statement) will also improve upon by the same amount. Another issue face is possible difficulty in obtaining a $3 million loan cod to reported loss of $814,000 for the year ended 1988. There is a need of urgency to solve the above matters and loan approval due to urgent need of working capital. The reason for such urgency and loss reporting are as follows a. attach in production capability Daniel Dobbins increased its production capacity by 50% in 1988 to meet the evaluate increase in demand through 1991 to 1995. The production of whiskey takes 4 yrs before its ready for consumption and hen ce, the planning has to be done 4 yrs ahead to meet the required demand. b. Additional rent on new Warehouse The increased production capacity in 1988 necessitated Daniel Dobbins to lease out a new storage warehouse at an annual rent of $200,000 which led to a sudden increase in expenses. c. Additional expenses associate to warehouse Labor and supervisor.The higher the profit the stronger of companys chance to get approved for the loan/credit by the Bank hence company should adopt the Accounting procedures stated above i. e. charging all direct costs as well as warehousing and ageing costs to Inventory and hence improving upon the Net Profit figures to increase company chances for loan approval. Few important points to be considered are * Evaporation A barrel is originally filled with 50 gallons of new bourbon but after aging only 35 gallons of aged bourbon is left. Cost of raw materials is incurred in producing 15 gallons of bourbon which gets lost due to evaporation.So accounting of this cost should also be considered. * Adjustment of aging process If aged bourbon is not up to the standard, and so each barrel needs to be checked for leaks or proliferated barrels and requires repairs. Some more details Because of the market forecast that the demand of straight person whiskey will be doubled from 1987 to 1995, the board of Daniel Dobbins Whiskey Inc intractable to increase the production of whiskey in 1988 by 50% of the 1987 volume to meet the anticipated increase in consumer demand from 1991 through 1995.The manufacturing process of whiskey can be divided into two stages Under the original stage which consists of several different steps, raw materials are converted into a clear liquid with a sharp, biting taste. The second stage which is also called Maturing or Aging Process involves maturing or aging for a minimum of four years under controlled temperature and humidity conditions. Because of the increase in cost of production in 1988, which will genera te revenues only in 1991, the income statement of Daniel Dobbins Inc showed a net loss of $814000 which was a significant change from net profit of $1504000 in 1987.In order to get loan of $3 million from Ridgeview National Bank of Nashville, the point of consideration for COO of Daniel Dobbins Distillery is how to present the financial results of 1988 to the bank. This loan is critical for company to remain solvent. One of the key issues in this case is how to divide the increased costs in 1988 surrounded by Inventoriable costs and Period costs. According to the case, while preparing the income statement in 1988, the costs of first stage was included under inventoriable costs and costs of second stage was included under Period costs which resulted in net loss in 1988.Increase in cost of production in second stage can be attributed to following increase in costs under second stage of manufacturing. a) Increased costs due to increase in the number of barrels used for aging. $1260,00 0 b) Increase in occupancy cost $332,000 c) Increase in warehousing cost $146,000 d) Increase in Labor and supplies expense $30,000 e) Increase in Depreciation expense $8000 f) Increase in cost of government supervision $8000Each of the above increase in costs of production in 1988 can be transferred from period costs to inventoriable costs and net profits can be increased for year 1988 e. g. if we just transfer increase in costs due to increase in number of barrels ($1260,000) to balance sheet from income statement, the net profit of year 1988 will become ( $1260,000 $814,000 = $446,000) but as a result the net profit of subsequent years will go down as the cost of goods sold will be increased in coming years.So the decision to transfer different costs to inventoriable costs which gets included as assets in balance sheet instead of expenses in income statement can be left to management depending upon how much profit it want to report in current as well as subsequent years. Since a ging is an absolutely essential part of the manufacturing process and the manufacturing process doesnt stop after the first stage, Costs of barrels and warehouse labor costs should be included under inventoriable costs. This will increase the profits of the company in 1988 and will also help them in getting the loan