618 Part 2 MonagenentAccoutttirtg

EXHIBIT 1 Effects ofVariable Costing

Dir
birt
15,
gra
ran
the
Full Variable Full Variable Dir
Costing Costirrg Costing sup
Sales revenues $865,428 $86 ,710 $93i,71 0 duc
Cost of sales at standard 484,6,40 21,758 36y,367 kee
Standard gross margin 380,788 527,911 409,952 343 l foo
Production cost variances:i
Labor (t6,2s9) por
(16,2s9) r 4)
(1 1,8 (11,814),
Material -t2,41
8,972 9,972.:;;
Overhead volu 1, (63,77g .:.t: 75
Overhead sio:
2,832:::L
Actual gross 527,672 163 it tr
568,333.:',:
Fixed overhead 192,883 192,881 the
administrative 301,250 310,35] 31 0,35 fro
before taxes $ 33,539 $ 3s,812 $ 654A9 lTlu
* Parenthescs denote rrnfavorable (debit) ton
me
to
har
The only asset acaount e in accounting and owners'equityii
side, only Retained not permitted for in- rlrf
come tax pol
gre
As of f uly 31 , ,..!
co!
Full rec
Costing me
$1,684,291 $1,1 3 $1,583,81 7 $1,r03,016:i ma
earnrngs 3,112,980 2 2,892 3,131 ,602 2,6s0,801::il eirl
drt
SrEi g '.';:.-::
:tii
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nul
alf
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Di'
Case 19-5 an(

Lynch's Chicken Ranch, Inc.* col

ter
John Lynch, owner and president of Lynch's Chicken Still, John was not convinced that Gary'.s ideas for hav- Br
Ranch, was not looking forward to the staff rneeting to ing the other divisions share his problem were in the vel
be held at 1:00. He knew that Gary Dawson, manager best interest of the company. :'. ge:
of the Egg Division, wanted again to raise the issue of tlla
i
sharing costs across divisions. Because of a 20 percent pft
increase in the cost of chicken fee( Gary s division COMPANY OPERATIONS AND ,,:]

was now showing losses and, consequently, Gary and ECONOMICS .-r
his employees would not be earning a bonus this year. Lynch's Chicken Ranch, Inc., located outside Modesto,:
California, was a privately owned, vertically integrated.
* Copyright @ 2006 by agricultural producer. The company was organizedjrj
Kenneth A. Merchant and Leslie R.
Porter. into three divisions: Eggs, Feed, and Fertilizer. The Egg
 Chapter 19 Standard Costs, Vaiable Costing Systems, Quality Costs, and
r':Division, managed by Cary Dawson, ran a 250,000
bird chicken coop fromwhich it received an average of
15,000 dozen eggs per day. These eggs were washed,
graded, packaged, and'sold for a price that typically
ranged between 601 and 801 per dozen, depending on
the size of the eggs and market conditions,'The Egg
Division bought Z0-week-old laying_ hens_ from outside
zuppliers for $3.50-$4.00 each. When the hens'pro-
ductivity declined and it was no longer economical to
keep them. typically I -1% years lateq they were sold to
,food processors,
particulady soup makers, for l2l per
pound (approximately 50p per hen).
19 In total, the chicken flock consumed between 28 and
72, 75 tons ofcorn and soybeans per day. The Feed Divi-
i:1 sion, managed by Ron Johnson, grew this grain and sold
33,! it to the Egg Division at market prices. A by-product of
83i the feed operation was corn mulch, which was made
:1,. from dried and mulched corn plants and cobs' This
9:' mulch was sold to the Fertilizer Division for $30 per
ton. This price just covered the Feed Division's incre-
mental cost of preparing the mulch, but Ron was happy
to have this break'even business because he used to
have to pay to have the plants and cobs hauled away'
Each chicken produced an average of a quarter
pound ofdroppings per day. In the past, disposal ofthe
g.eat quantity ofmanure produced by a large flock had
io.t ut much as $250,000 per year. But disposal had
recently become much easier because of the develop-
ment o1 the Brill digester, a device that converted the
'manure into an odorless substance that could be used
either for fertilizer or cattle feod. Converted chicken
droppings were valuable because they contained many
mrtrients including, for example, more protein than
alfalfa" In 1988, John Lynch formed a new Fertilizer
Division to capitalize on this new business opporhrnity
and hired Judy Smith to manage it.
Employees of the Egg Division cleaned the chicken
coop and loaded the manure into a special bin, the con-
tents of which were then dumped into one of the seven
'Brill digesters the ranch owned. The digester con-
I verted the manure into dry, odorless flakes' Each di-
I gester cost $40,000 and was able to handle 10 tons of
trn ., every two days. Judy explained the conversion
process further:
Our digesters are designed with two containers,
each about seven feet wide and four feet deep' We
load the first with chicken droppings and an equal
portion of corn mulch. Large paddle wheels, dri-
,"n by an electric motor, rotate the mixrure slowly,
and heating elements warm it to botween 150 and
JointCosts 619
170 degrees. The heat evaporates most ofthe
moisture and eliminates the unpleasantness. The
second container is used to spin the material to &y
it completely. The whole process takes 48 hours.
The finished product was then eitherbagged as fer-
tilizer, to be marketed under the Lynch's Pride brand
name, or as cattle feed supplement. Prices fluctuated
significantly, so the division bagged whatever product
had the higher margin at the time. The demand for
both products outstripped capacity, so the division had
to hold little or no finished goods inventory.
THE STAFF MEETING
The main issue for discussion at the February staff
meeting was a conflict that had arisen because of in-
creases in the cost ofchicken feed. The issue was pro-
voking heated discussions because it had direct effects
on division manager bonuses. The division managers'
base salaries were set at levels slightly below industry
averages, but the managers'total compensation pack-
ages were fully competitive because they were given
the opportunity to earn significant bonuses based on
division profits.
Here is a shortened paraphrase of the discussion
that took place at the staff meeting:
Gary: Well, as you are all surely aware, the drought
in the Midwest has severely affected the market
price ofcorn and soybeans' Because ofthis and the
artificial way that we keep our books, the Egg Divi-
sion is going to show a loss this year. That's not fair'
I propose that we make two changes- First, because
our corn yields were not affected by the drought,
Ron should forgo the increase in the price he
charges us. Second I don't think it is fair that my
division should pay for all of the cost of manufac-
turing while the Fertilizer Division gets all the prof-
its. I think we should apportion the costs between
the two divisions. As we all know, 40 percent of
the nutrients in the food goes straight through the
chicken, and it's these nutrients that Judy is market-
ing. Therefore, I think she should pick up 40per-
cent ofthe cost ofthe food' I think she should also
pay her fair share ofthe cost ofproducing her raw
material, and those include the depreciation of the
chickens and the costs of operating the coop' The
same 40 percent apportioning rule is probably as
good here as any.
Judy: Gary I'm getting tired of this discussion'
You're crazy if you think I'm going to pay for your
620 Paft2 ManagementAccounting

inability to make a profit. I,m already giving you a my labor cost by laying off my third shift and half
$200,000 kick to your bottom-line by removing the of my second shift. With these cuts, I should be able
manure for free. By all rights, I should be charging to at least break even. Next year, if prices are more
you. I

flock.
reasonable. I'll rebuild the .

Ron: Cary, if you don't want to pay market price Ron: I have no problem with that. ',i
for my grain, that's fine. If you don,t want it, some-
Judy: Wait a minute. you can't do that. If you oii
one else will buy it. But I'm not going to let you
the flock by 40 percent, I won,t have the ,ofur" ii
stick me with your problem. In the year before last,
need to cover my fixed costs. you can'tjust think of:
when there was a bumper crop and grain prices
your o]v1 self; you've got to think of the companyi
were depressed, I don't remember you offering to
pay me a bonus then.
as a whole. Right, J.L.? :r.

John: I don't know right now. Let me get Ricardo,l

Gary: If I've got to go this alone, I'm going to cut
[Lynch's controller] to do an analysis of the optionci
my losses. Right now I'm losing about 6l on every
flat of eggs I sell. Olsen Farms'managers want to
Let's discuss.this again next week. ,,,

expand their flock, and they are willing to pay me

$ 1 .75 for my l% *Z-year-old layers. That's an aver- Question
age of 25( each over book value for the 100,000 :i,

layers in this group. I'll sell those layers and reduce What should John Lynch do?