Question

Managerial Analysis

Elliot & Hesse Inc. manufactures ergonomic devices for computer users. Some of its more popular products include anti-glare filters and privacy filters (for computer monitors) and keyboard stands with wrist rests. Over the past 5 years, it experienced rapid growth, with sales of all products increasing 20% to 50% each year.

Last year, some of the primary manufacturers of computers began introducing new products with some of the ergonomic designs, such as anti-glare filters and wrist rests, already built in. As a result, sales of Elliot & Hesse's accessory devices have declined somewhat. The company believes that the privacy filters will probably continue to show growth, but that the other products will probably continue to decline. When the next year's budget was prepared, increases were built into research and development so that replacement products could be developed or the company could expand into some other product line. Some product lines being considered are general-purpose ergonomic devices including back supports, foot rests, and sloped writing pads.

The most recent results have shown that sales decreased more than was expected for the anti-glare filters. As a result, the company may have a shortage of funds. Top management has therefore asked that all expenses be reduced 10% to compensate for these reduced sales. Summary budget information is as follows.

Direct materials	$240,000
Direct labor	110,000
Insurance	50,000
Depreciation	90,000
Machine repairs	30,000
Sales salaries	50,000
Office salaries	80,000
Factory salaries (indirect labor)	50,000
Total	$700,000

Instructions

Using the information above, answer the following questions.

(a)What are the implications of reducing each of the costs? For example, if the company reduces direct materials costs, it may have to do so by purchasing lower-quality materials. This may affect sales in the long run.

(b)Based on your analysis in (a), what do you think is the best way to obtain the $70,000 in cost savings requested? Be specific. Are there any costs that cannot or should not be reduced? Why?

Answer 1

(a) Reducing all costs is not the right approach to sustain. One should never compromise on the quality of the output and therefore reducing direct costs such as Direct material, Direct Labour, Machine Repairs, etc.

Direct materials: Low-quality material will destroy the quality of the product
Direct Labor: It will affect the productivity of the workers and the quality of the product as well. The workers will neither be ready to accept low wages nor extra work to reduce the number of workers.
Insurance: Underinsurance will expose the organization to huge uncertainties and risks
Depreciation: It is a non-cash expenditure and doesn't affect much. It is completely dependent on CAPEX. Since the company is investing in R&D depreciation will be high.
Machine Repairs: Machine breakdown will put the production to a complete halt and will significantly affect the productivity of the plant. Moreover high layover period will ensure huge losses for the company.
Sales Salaries: Sales have gone down so Sales salaries should be trimmed. However, that will demotivate the employees. The better way would be to restructure the same into low fixed and high variable component. Incentivizing their efforts will be the best way to cut costs as well as retain talented staff, motivating them at the same time.
Office Salaries: Office salaries are admin expenditure completely dependent on other revenue-generating departments. Since the company is going through a tough phase, little trimming of the cost in this area can be easily managed.
Factory Salaries(Indirect Labor): We have not touched the direct labor and would be recommended to divert a few idle resources to this area to manage. As it is due to low production there would be some staff who can manage a few hours here.

PART b

There are costs that cannot or should not be reduced
Sales Salaries: 20,000
Office Salaries: 30,000
Factory Salaries (Indirect Labor): 20,000