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Case: Precision Worldwide, Inc.

Analysis for Management Accounting and Decision Making

Submitted by

MOHAMMAD NASEEM HASAN : 300778661

JAY GAIKWAD : 300807350
SANCHIT JASUJA : 300804369

CENTENNIAL COLLEGE
TORONTO, ON

Professor’s Name: GEOFFREY PRINCE

Course Name : ACCOUNTING FOR MANAGERIAL
DECISION MAKING
Course Code : ACCT-701
Date Submitted : MARCH 26, 2015
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Case: Precision Worldwide, Inc.:

Analysis for Management Accounting and Decision Making

Q1. Summarize the case in the context of Management Accounting, Decision Making and
Strategy Execution

Ans. Precision Worldwide, Inc. is a German firm. It's competitor is Henri Poulenc a French firm.
Hans Thorborg is the General Manager of the firm.  Gerhard Henk is the Sales Manager. Bodo
Eisenbach is the Development Engineer and Patrick Corrigan is the Parent Company Spokesman.

Precision Worldwide, Inc. (PWI) manufactures industrial machines and equipment for sale innumerous
countries. Repair and replacement parts account for a substantial part of the company's business.
The replacement part in question, steel rings, occur in the machines manufactured only in PWI's Frankfurt
Germany plant, but can also be used on some competitor's machines. The steel ring manufactured by PWI
average normal life of about 2 months, cost $1,107.90 per 100 to make, they sell for $1,350 per 100 at
a demand of 690 rings per week. Machines require between 2 and 6 rings to operate. Individual rings are
replaced as they wear out.

Over the years, competition had increased and now a competitor company, the French firm Henri Poulenc, has
entered the market with a superior plastic ring that replaces the steel ring. The plastic ring is less costly to
manufacture and has a longer life that last four times as long (eight months), cost $279.65 per 100 to
make and sell for the same $1,350 per 100. It can be inferred that demand for the plastic rings
will be one fourth that of the steel ring. PWI can retool their plant for $7,500 and begin
producing the plastic rings in four months. There are currently 34,500 steel rings in stock and, if
manufacturing of the steel rings stops immediately. If demand remains constant, there will be
15,100 rings remaining when the manufacturing of the plastic rings begins. Under normal
circumstances, due to cyclical demand, the plant would not be operating to full capacity during
the next two to three months.

Hans Thorborg, general manager of Precision Worldwide Inc. is worried because the plastic
rings not only have a longer life than the steel rings but are also manufactured at a lower price.
Management is concerned with the steel stock on hand, it cannot be sold or used for any other
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purpose. This case introduces the concepts of allocated costs, contribution margin, and
opportunity cost. The case introduces a number of layers of sophistication when applying the
concept of contribution margin.

The case has some issues which are as under:

The first point is that the cost of the steel should be considered zero, since it is a sunk cost with
no other use. The second issue is that allocated fixed costs are irrelevant in the short run. That
is, regardless of whether the company produces steel or plastic rings, the fixed overhead costs
will not change.

The issue is the direct labor needed to convert steel into rings. Because of the company’s policy,
the steel rings can be produced using low cost labor, which lowers the opportunity cost of
producing the steel rings to less than the cost of the plastic rings, assuming the material cost of
the steel rings is zero. The next issue is the opportunity cost of the steel rings is zero, since they
are complete with no other use. That is the out-of-pocket cost to the company for selling the
completed steel rings is zero.

Once the company computed the opportunity cost to produce steel rings, and the opportunity cost
of the already completed steel rings (zero), company faced with a final opportunity-cost issue.
That is, what will customers pay for steel rings given that they have a two-month life and plastic
rings have at least an eight-month life? If customers are willing to pay four times as much for
plastic rings, then even if we assume our steel rings have a cost of zero, we are better off selling
plastic rings because our contribution per month is higher for plastic rings than for steel rings.

Precision Worldwide is thinking about selling plastic rings in France and selling steel rings
elsewhere until customers learn they are inferior. This introduces the idea that pricing policy and
product policy can help the company in the short run but harm it in the long run.

PWI has a large inventory of steel rings and special steel. Their dilemma is to sacrifice their
inventory and introduce the plastic ring or wait until the inventory is reduced prior to introducing
the plastic ring. The opportunity cost of diminishing their inventory prior to introducing the
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plastic ring is twofold. They may lose the competitor advantage by being late to introduce a
plastic ring to their customers and they may delay taking advantage of the substantially lower
cost of the plastic ring. Hence, these are serious threats that must be considered.

Q2. Identify and discuss 3 key issues for Hans Thorborg’s consideration.

Ans. There are many considerations which should be taken into account by Hans Thorborg
before making any decision regarding the functionality of the PWI. Some of the considerations
which he has to take into account while making decisions are as follows:

1. Eisenbach came with an idea to Thorborg about distributing the plastic ring only in the
markets where there was competition. Hans Thorborg should seriously consider some
fact before starting distribution to only some markets. In a market there are ‘n’ number of
buyers and customers and if any of the customers come to know that PWI are distributing
steel rings to them but are selling plastic rings which are cheap and they also have four
times the wearing property of the steel ring to other markets and not to them than this will
damage the reputation and image of PWI to no ends. “Customer is considered as a king”
in the market and if they don’t get the best option while others are getting it than this will
be injustice to them and it will create a bad goodwill for the company. It will be
profitable for PWI to sell the plastic rings but at the same time it can create a negative
image as well. Thorborg will have to consider all this facts and will have to make a
decision whether to making the plastic rings available in only selected markets or to
everyone.
2. The second issue for Hans Thorborg was the size of the inventory which they had to
make the steel rings. Henk had suggested that the inventory should be sold or if not than
thrown away to make place for the plastic rings. The inventory size was very huge as
there were many finished steel rings left. This was a big issue because they didn’t know
what do with the inventory which was available to them. The large inventory could be
sold to customers in markets where there was huge demand of steel rings or they will
have to drop down the prices of steel rings and sell it at breakeven price or even less than
the breakeven price to attract customers and if they introduce the plastic rings at
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competitive price in the market than it will compensate for the loss caused by the
inventory of the steel rings. The introduction of the plastic ring could prove to be
profitable to PWI as their production cost was low than the steel rings so the profit
margin was more and also plastic ring was not provided by many manufacturers so there
was competitive advantage. Hans Thorborg will have to look the all aspects before
making any decision regarding what to do with the excess inventory.

The third issue for Hans Thorborg can be that his company was not innovating something new
which could have proved to be cost effective for PWI and also would have made them the
market leader. PWI never tried to do something innovative or out of the box to make their
company different from others, they did not try something new to substitute the steel rings which
would have also lowered the manufacturing cost. PWI was a worldwide company and wasn’t
able to capture the market by providing equipment which was efficient and also durable. Their
lack of ability to adapt to new situations is a big issue for Thorborg. PWI has been in the
business of manufacturing industrial machines and equipment for the last 90 years but other new
manufacturers were coming with low-priced parts which were used in machines. If PWI would
have been a little bit innovative in their approach than they would have reached the untapped
segments of the market and would have had a good competitive advantage than others. This issue
should be considered by Thorborg for the future so that they become a company who are always
trying to do something new in their approach and always trying to deliver the best to their
customers and become a force to reckon with.

Q3. What are some challenges and implications (at least three)? Discuss these from a
Managerial Accounting and Management Decision Making perspective.

Ans. PWI is a manufacturing company which manufactures industrial machines and equipment
to various countries. They have been caught in a tight situation as many competitors are offering
products which are efficient and effective and which are raising many questions about the PWI’s
creditability. There market situation is imposing many hurdles to PWI and there are many
challenges ahead of them which they will have to address in order to revive their image in the
market. Some of the challenges are as follows:
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1) One of the biggest challenge in front of PWI is to enter the market of plastic rings as soon
as possible because only one company is providing plastic rings in the market and it is
expected that no other company will be able to manufacture the plastic rings for a
considerable time. So it is an open market and if PWI will be able to introduce this ring to
the market quickly than it will increase their market share and increase their profit margin
and will be good for their overall business. They can also extend their customer base by
start selling the plastic rings.
2) The second challenge is that if they start plastic ring production right away that what will
they do with the excess inventory. The book value of the inventory itself is exceeding
$390,000 and after conducting a survey PWI found out that the special steel cannot be
sold even for scrap. PWI will have to find measures to overcome this inventory and
clearing it before they start the plastic ring production because if the inventory is thrown
away than it will take quite some time for PWI to recover the loss. They can make
contracts with companies by providing them steel rings at attractive rates, they can also
use the special steel to produce another equipment which is in demand instead of steel
rings but throwing away so much inventory will not make sense for a reputed company
like PWI and they will have to find a way to utilize the inventory fully.
3) The third challenge is whether to distribute the plastic rings in selected areas. It is a very
big challenge for PWI to start supplying plastic rings in some parts while supplying steel
rings I other parts. In table A we can clearly see that the total cost to produce 100 plastic
rings is very less when compared to steel rings. So it is a challenge for PWI if they should
start selling plastic rings in some areas to earn hug profit margins and continue to sell the
steel inventory till it lasts. It can backfire also because customers can feel discriminated if
they come to know that PWI is selling plastic rings in certain markets so in one hand they
earn profits while on the other hand it can diminish their image.
4) There is also conflict in suggestions in the company as everyone is giving a suggestion
which is contradicting the suggestion given by others. Bodo Eisenbach is a Development
Engineer of the firm while Gerhard Henk is the Sales Manager, their views and
suggestions are opposite than that of Patrick Corrigan who is from PWI’s parent
company. Hans Thorbrorg will first have to alien everyone’s thoughts and prepare a plan
or the policy to face the dilemma the company is facing so that they if everyone works
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according the plan than the issue of substituting plastic rings and the inventory issue can
solved more swiftly.

If PWI selects to sell both the rings at the same time till the inventory of steel rings gets over
than Thorborg will have to setup two different departments for the steel and plastic rings. The
labor cost and also the cost of new machinery and equipment will increase. They will have to
prepare and establish new policies for the production and price the rings accordingly. The overall
cost will also be much higher for the production of these rings. This will be a challenge for PWI
to concentrate on the production and pricing of both the types of rings and to supply the
appropriate rings in the correct markets till the steel rings inventory lasts.

Q4. Based on 2 and 3 above what action should Hans Thorborg take? Discuss.

Ans. On reviewing the 2 and 3 there would be some necessary action that needs to be taken as
first of all Hans should make a strategy long term and short term strategies. In long strategy,
Hans should sell the steal rings until its manufacture of plastic rings were not ready for market.
Then sell out both plastics and steel rings. Sell the steel at low cost due to its short life than a
plastic ring. Sell out at low cost and manufacture the steel ring until it’s all steel stock would be
finished and clear out from sales after finished all the stock from the plant than manufacture and
sell only plastic ring.

The Hans Thorborg, should instruct its development team engineer, Bodo Eisenach to begin with
process of making the plastics rings and continuous the process until the plastics ring should
available for markets. When a situation arrive where the plastics rings is fully available then he
should instruct its sales department head or sales manager (Gerhard Henk) to sell plastic ring
only and creates a threatened to market about the steel rings or create a situation in the market a
negative impact of steel ring so that its cost of selling would reduce in respect to all other
markets. With the following action concern the customer would noticed about the available of
new plastic ring in markets and the choice is also given in steel or plastics. In short term
strategy, During the slow growth economic rate, Hans should instruct about the production
department to concentrate of manufacturing on steel rings at low labor rate so that it’s all stock
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of steel would be finished at faster rate with low input cost. And during the high economic rate
concentrate on making the plastic rings.

Regular monitoring on steel ring whether it’s manufacturing or selling in market. If a point
arrives where the steel ring sales would uncertain or uphold than at that situation producing steel
should be stopped and treat all remaining steel would be as scrapped as defective. The company
spoke person Patrick Corrigan suggest the company to maximum utilization of steel stock
remaining whether selling in market by penetrate or at low cost. The above instruction by Hans
would give an enough justification to Patrick for remaining steels.

Both strategy will work at different situation depend upon the current market situation and At
last, when the company will finally sell the plastic ring only and the market of steel rings got
finished by completely replace by plastic rings then remaining steel would consider as sunk cost
and I think the Hans should take an advantage of low growth session where the labor work at low
rate so during off session they can sell as much as its inventory steel when it possible or when
they get the chance to sell in market.
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Works Cited
Precision Worldwide Inc Case Solution Essays . (2015, March 25). Retrieved from
http://www.studymode.com/subjects/precision-worldwide-inc-case-solution-page1.html

Case Analysis For Precision Worldwide, Inc. (n.d.). Retrieved March 25, 2015, from
http://www.markedbyteachers.com/university-degree/business-and-administrative-
studies/case-analysis-for-precision-worldwide-inc-considering-the-option-of-continuing-
production-of-steel-rings-or-switching-to-plastic-rings.html

Precision Worldwide, Inc. (n.d.). Retrieved March 24, 2015, from

http://www.bestessaytips.com/samples_file/Case%20study.pdf

Precision Worldwide, Inc. Case Study. (n.d.). Retrieved March 24, 2015, from
http://www.scribd.com/doc/56020792/Precision-Worldwide#scribd