Forest Hill Paper Company Case Study

Register to read the introduction… Forest Hill traditionally applied overhead to its products as a function of material costs. Management believed using “material costs” as an allocation base made sense because thicker products (containing more material per lineal foot than thinner products) required more machine time to process as they demanded slower machine speeds. Additionally, drying time and energy consumption increase with thicker basis weights. (See Exhibit 1 for material costs associated with each product, or grade.) Thus, unit level (or volume-related) drivers made sense for applying certain types of overhead to products. However, other important costs were incurred without respect to volume. For example, grade changes induce instabilities into the manufacturing process that result in scrap until the process resumes stability. On average, production engineers estimate that approximately one-half reel is lost to scrap each time a grade change is made. Just as discrete-part manufacturers incur machine setup costs between production runs of two different products, scrap produced following grade changes is a predictable cost of production. Some of the pulp can be recovered by recycling the scrapped paper, termed “broke” paper. Thus, the grade change cost figures presented in Exhibit 2 include only depreciation, labor, energy, and lost chemicals associated with grade changes. Recently, some managers at the company began questioning the long-standing strategic policy of producing a full product line. Because selling prices and profit margins significantly varied across the product mix, some managers questioned whether the company’s assets were being used to the greatest advantage. Currently Forest Hill was experiencing demand in excess of its production capacity. A sample representing significant categories of grades is presented in Exhibit 1. The sample …show more content…
(Prove the overhead rate is 105% of material cost.) Calculate the volume-based (traditional) cost per reel for grades A-D identified in Exhibit 1. What is the cost for Forest Hill to conduct a grade change? What is the cost for Forest Hill to slit a reel of paperboard? As shown in Exhibit 1, only products A and C are routinely slit. For purposes of your analysis, assume the slitting equipment must be set up and adjusted between each reel slit. Calculate the new volume-based overhead rate after removing grade change and slitting costs. Determine the activity-based costs for grades A-D Prepare a table that illustrates the percentage change in costs between the volume-based system and the strategic activity-based system. What conclusions can you draw from your analysis? As a consultant to Forest Hill, what actions would you