Stacy Cummins, the newly hired controller at Merced Home Products, Inc., was disturbed by what she haddiscovered about the standard costs at the Home Security Division. In looking over the past several yearsof quarterly income statements at the Home Security Division, she noticed that the first-quarter profits were always poor, the second-quarter profits were slightly better, the third- quarter profits were againslightly better, and the fourth quarter always ended with a spectacular performance in which the HomeSecurity Division managed to meet or exceed its target profit for the year. She also was concerned to findletters from the company’s external auditors to top management warning about an unusual use of standardcosts at the Home Security Division.When Ms. Cummins ran across these letters, she asked the assistant controller, Gary Farber, if he knewwhat was going on at the Home Security Division. Gary said that it was common knowledge in the companythat the vice president in charge of the Home Security Division, Preston Lansing, had rigged the standards athis division in order to produce the same quarterly income pattern every year. According to company policy,variances are taken directly to the income statement as an adjustment to cost of goods sold.Favorable variances have the effect of increasing net operating income, and unfavorable varianceshave the effect of decreasing net operating income. Lansing had rigged the standards so that there werealways large favorable variances. Company policy was a little vague about when these variances have tobe reported on the divisional income statements. While the intent was clearly to recognize variances on theincome statement in the period in which they arise, nothing in the company’s accounting manuals actuallyexplicitly required this. So for many years Lansing had followed a practice of saving up the favorable variances and using them to create a nice smooth pattern of growing profits in the first three quarters, followedby a big “Christmas present” of an extremely good fourth quarter. (Financial reporting regulations forbidcarrying variances forward from one year to the next on the annual audited financial statements, so all ofthe variances must appear on the divisional income statement by the end of the year.)Ms. Cummins was concerned about these revelations and attempted to bring up the subject with thepresident of Merced Home Products but was told that “we all know what Lansing’s doing, but as long as hecontinues to turn in such good reports, don’t bother him.” When Ms. Cummins asked if the board of directors was aware of the situation, the president somewhat testily replied, “Of course they are aware.”Required:1. How did Preston Lansing probably “rig” the standard costs—are the standards set too high or too low?Explain.2. Should Preston Lansing be permitted to continue his practice of managing reported profits?3. What should Stacy Cummins do in this situation?

Kathy Shorts, president of Oliver Company, was concerned with the trend in sales and profitability. The company had been losing customers at an alarming rate. Furthermore, the company was barely breaking even. Investigation revealed that poor quality was at the root of the problem. At the end of 20x5, Kathy decided to begin a quality improvement program. As a first step, she identified the following costs in the accounting records as quality related: Required: 1. Prepare a quality cost report by quality cost category. 2. Calculate the relative distribution percentages for each quality cost category. Comment on the distribution. 3. Using the Taguchi loss function, an average loss per unit is computed to be 15 per unit. What are the hidden costs of external failure? How does this affect the relative distribution? 4. Shortss quality manager decided not to bother with the hidden costs. What do you think was his reasoning? Any efforts to reduce measured external failure costs will also reduce the hidden costs. Do you agree or disagree? Explain.

At the beginning of the last quarter of 20x1, Youngston, Inc., a consumer products firm, hired Maria Carrillo to take over one of its divisions. The division manufactured small home appliances and was struggling to survive in a very competitive market. Maria immediately requested a projected income statement for 20x1. In response, the controller provided the following statement: After some investigation, Maria soon realized that the products being produced had a serious problem with quality. She once again requested a special study by the controllers office to supply a report on the level of quality costs. By the middle of November, Maria received the following report from the controller: Maria was surprised at the level of quality costs. They represented 30 percent of sales, which was certainly excessive. She knew that the division had to produce high-quality products to survive. The number of defective units produced needed to be reduced dramatically. Thus, Maria decided to pursue a quality-driven turnaround strategy. Revenue growth and cost reduction could both be achieved if quality could be improved. By growing revenues and decreasing costs, profitability could be increased. After meeting with the managers of production, marketing, purchasing, and human resources, Maria made the following decisions, effective immediately (end of November 20x1): a. More will be invested in employee training. Workers will be trained to detect quality problems and empowered to make improvements. Workers will be allowed a bonus of 10 percent of any cost savings produced by their suggested improvements. b. Two design engineers will be hired immediately, with expectations of hiring one or two more within a year. These engineers will be in charge of redesigning processes and products with the objective of improving quality. They will also be given the responsibility of working with selected suppliers to help improve the quality of their products and processes. Design engineers were considered a strategic necessity. c. Implement a new process: evaluation and selection of suppliers. This new process has the objective of selecting a group of suppliers that are willing and capable of providing nondefective components. d. Effective immediately, the division will begin inspecting purchased components. According to production, many of the quality problems are caused by defective components purchased from outside suppliers. Incoming inspection is viewed as a transitional activity. Once the division has developed a group of suppliers capable of delivering nondefective components, this activity will be eliminated. e. Within three years, the goal is to produce products with a defect rate less than 0.10 percent. By reducing the defect rate to this level, marketing is confident that market share will increase by at least 50 percent (as a consequence of increased customer satisfaction). Products with better quality will help establish an improved product image and reputation, allowing the division to capture new customers and increase market share. f. Accounting will be given the charge to install a quality information reporting system. Daily reports on operational quality data (e.g., percentage of defective units), weekly updates of trend graphs (posted throughout the division), and quarterly cost reports are the types of information required. g. To help direct the improvements in quality activities, kaizen costing is to be implemented. For example, for the year 20x1, a kaizen standard of 6 percent of the selling price per unit was set for rework costs, a 25 percent reduction from the current actual cost. To ensure that the quality improvements were directed and translated into concrete financial outcomes, Maria also began to implement a Balanced Scorecard for the division. By the end of 20x2, progress was being made. Sales had increased to 26,000,000, and the kaizen improvements were meeting or beating expectations. For example, rework costs had dropped to 1,500,000. At the end of 20x3, two years after the turnaround quality strategy was implemented, Maria received the following quality cost report: Maria also received an income statement for 20x3: Maria was pleased with the outcomes. Revenues had grown, and costs had been reduced by at least as much as she had projected for the two-year period. Growth next year should be even greater as she was beginning to observe a favorable effect from the higher-quality products. Also, further quality cost reductions should materialize as incoming inspections were showing much higher-quality purchased components. Required: 1. Identify the strategic objectives, classified by the Balanced Scorecard perspective. Next, suggest measures for each objective. 2. Using the results from Requirement 1, describe Marias strategy using a series of if-then statements. Next, prepare a strategy map. 3. Explain how you would evaluate the success of the quality-driven turnaround strategy. What additional information would you like to have for this evaluation? 4. Explain why Maria felt that the Balanced Scorecard would increase the likelihood that the turnaround strategy would actually produce good financial outcomes. 5. Advise Maria on how to encourage her employees to align their actions and behavior with the turnaround strategy.

Steve Morgan, controller for Newton Industries, was reviewing production cost reports for the year. One amount in these reports continued in to bother him – advertising. During the year the company had instituted an expensive advertisement campaign to sell some of its slower-moving products. It was still too early to tell whether the advertising campaign was successful.   There had been much internal debate as how to report advertising cost. The vice president of finance argued that advertising costs should be reported as cost of production, just like direct material and direct labor. He therefore recommended that this cost be identified as manufacturing overhead and reported as part of inventory costs until sold. Others disagreed. Morgan believed that this cost should be reported as an expense of the current period, so as not to overstate net income. Others argued that it should be reported as prepaid advertising and reported as a current asset.   The president finally had to decide…