Precision Timing Inc. PTI 2003 Exam CMA

ENTRANCE

EXAMINATION OCTOBER 2003

TABLE OF CONTENTS

October 2003 Entrance Examination

Page

Overview ...................................................................................... 1

October 2003 Entrance Examination Part 1

General Comments on Performance .................................... 4

October 2003 Entrance Examination Part 2

Case Question:

Backgrounder................................................................ 5

Additional Information ................................................. 24

General Comments on Performance .................................. 42

Marking Guide..................................................................... 38

Sample Response Successful Attempt ............................ 65

Markers Comments Successful Attempt ......................... 92

Sample Response Unsuccessful Attempt ........................ 97

Markers Comments Unsuccessful Attempt ................... 116

Supplement of Formulae and Tables* ................................... 121

*This supplement is provided to all candidates with each part of the examination.

Copyright 2003 by The Society of Management Accountants of Canada. All rights reserved. This material, in whole or in part, may not be reproduced or transmitted

without authorization.


Overview Purpose The purpose of the Entrance Examination is to ensure that candidates have a sound technical understanding of the various topics listed in the Entrance Examination Syllabus and suitable integrative, judgmental, analytical, strategic thinking, and written communication skills for entry into the Strategic Leadership Program.

Format, Duration and Type of Questions The October 2003 Entrance Examination consists of two parts, each of a 4-hour duration.

Part 1

Part 1 of the examination consists of multiple-choice questions grouped into 11 sections, according to the topic areas listed in the Entrance Examination Syllabus.

Part 2

Part 2 of the examination consists of one integrated, complex case. Information relating to the case was provided to candidates in two separate documents: a Backgrounder (provided to candidates two days in advance) and the Additional Information (provided to candidates at the Part 2 examination).

In total, 50% of the Entrance Examination consists of a case question and 50% consists of objective (multiple-choice) questions.

Testing Objectives, Topic Emphasis and Syllabus Coverage Overall

The October 2003 CMA Entrance Examination tests on the Entrance Examination Syllabus according to the cognitive skill level expectations reflected in Blooms Taxonomy of Educational Objectives. Categories 1 and 2 syllabus topics are tested in both the case and objective questions on the examination.

Part 1

The Part 1 testing objective is to evaluate the candidates content knowledge of the 11 major syllabus topic areas (Management Accounting, Corporate Finance, Operations Management, Information Technology, Strategic Management, International Business, Human Resources, Marketing, Financial Accounting, Taxation, and Internal Control). These topics are tested in roughly the same proportion reflected in the Entrance Examination Syllabus. The focus of Part 1 is on the first three cognitive skill levels in Blooms taxonomy, namely, knowledge, comprehension and application. The 11

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October 2003 Entrance Examination syllabus topic areas are tested directly within the context of multiple-choice questions. It should be noted that not all of the multiple-choice questions are of equal value.

Part 2

The Part 2 testing objective is to evaluate the candidates higher-order skills, i.e. judgment, integration, analysis, strategic thinking and written communication. Its focus is on the last three cognitive skill levels in Blooms taxonomy, namely, analysis, synthesis, and evaluation. These skills are tested within the context of a single strategic case.

To maximize the time available for candidates to demonstrate their higher-order skills and to facilitate their development of a well-reasoned, in-depth response to the case, candidates were provided in advance with a Backgrounder on the organization that was the focus of the case. The Backgrounder contained extensive information about the organization and its related environment so that candidates could familiarize themselves with both in preparation for the strategic analysis that they were asked to undertake during Part 2 of the examination.

On the Part 2 examination writing date, the Additional Information was provided to candidates, which included additional information about the organization and indicated what candidates were required to do. Generally, the candidates task during Part 2 was to assess the strategic options facing the organization in light of its strengths and weaknesses, interpret and use the financial and non-financial information provided in the Backgrounder and Additional Information, and write a report to management, exhibiting appropriate written communication skills, as to what the organization should do.

While the Part 2 case includes content from many of the 11 syllabus topic areas, the focus is on testing the higher-order skills mentioned above rather than testing detailed content knowledge. Thus, for the most part, content knowledge is tested indirectly on Part 2 through an evaluation of how the information included in the case is used by candidates to develop a report that demonstrates their higher-order skills.

Evaluation Candidates must pass both parts of the Entrance Examination individually in order to proceed to the Strategic Leadership Program. Candidates received an overall grade out of 100 for each part of the examination, an indication of whether they had passed each part, and an indication of how they performed relative to other candidates on each part of the examination in the form of deciles for each topic area (Part 1) and each skill (Part 2) being tested. Candidates should note that there was no correction factor on the multiple-choice questions.

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October 2003 Entrance Examination October 2003 CMA Entrance Examination Characteristics The following tables reflect the examinations major characteristics:

Part 1

Question Type Multiple Choice Number of Minutes 240 % Syllabus Coverage based on relative value of the questions (rounded)

Category 1 Management Accounting Corporate Finance Operations Management Information Technology Strategic Management International Business Human Resources Marketing Category 2 Financial Accounting Taxation Internal Control Total

24%7%7%8%5%5%6%

5% 67%

21%8%

4% 33%100%

Part 2

Question Type Integrative Case Number of Minutes 240 Syllabus Coverage Information relating to topics from most of the 11

major syllabus topic areas is included in the case. Candidates are to use this information in developing their written reports.

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Part 1 General Comments on Performance

Part 1 of the October 2003 CMA Entrance Examination consisted of 151 multiple-choice questions testing the eleven topic areas listed in the CMA Entrance Examination Syllabus. On average, candidates answered 79 of the 151 questions correctly. The results for each topic area were as follows:

Topic Area Number of Questions Average Number Correctly Answered Management Accounting 33 16.0 Corporate Finance 12 5.5 Operations Management 11 5.5 Information Technology 13 7.0 Strategic Management 8 6.0 International Business 8 4.5 Human Resources 9 5.5 Marketing 9 4.5 Financial Accounting 31 15.5 Taxation 11 5.0 Internal Control 6 4.0

Total 151 79.0 It should be noted that the questions were not all valued equally. Those that had a plus sign (+) at the beginning of the question were valued higher than the rest of the questions, and those with a minus sign (-) were valued lower than the rest of the questions.

Generally, candidates performed fairly well on the questions testing material in the following topic areas: information technology, strategic management, international business, human resources, and internal control. The weakest areas of performance were on questions testing corporate finance and taxation. Performance on question pertaining to management accounting, operations management, marketing, and financial accounting was average.

As expected, candidates performed better on questions requiring a knowledge or comprehension cognitive skill level than on questions requiring an application cognitive skill level.

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The Societies of Management Accountants of Manitoba, New Brunswick, Newfoundland, Northwest Territories, Nova Scotia, Ontario, Prince Edward Island, Saskatchewan and the Yukon, Certified Management Accountants Society of British Columbia,

The Certified Management Accountants of Alberta, Ordre des comptables en management accrdits du Qubec

October 2003

Entrance Examination

Part 2

Backgrounder Background information relating to the Part 2 case (Backgrounder) is provided to candidates in advance of the Part 2 examination date. This Backgrounder contains information about both the company and the industry involved in the case. Candidates are expected to familiarize themselves with this information in preparation for the strategic analysis that will be required during Part 2 of the CMA Entrance Examination. Candidates should note that they will not be allowed to bring any written material, including the advance copy of this Backgrounder, into the examination centre. A new copy of this Backgrounder, together with additional information about the company, will be provided at the writing centre for Part 2 of the CMA Entrance Examination. Candidates are reminded that no outside research on the industry related to this case is required. Examination responses will be evaluated on the basis of the industry information provided in the Backgrounder and the question paper (Additional Information).

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Precision Timing Inc. Backgrounder

Company History Precision Timing Inc. (PTI) was founded in 1960 by Jon Klatt, a clockmaker who had arrived in Canada in 1956 from the Black Forest area of Germany. Initially unable to find work as a clockmaker, for four years he had taken any job he could get, working as a labourer, a farm hand, and a construction worker. By 1960, he had saved enough money to start his own clockmaking company. He decided to set up operations close to his home in Winwood because the area reminded him of his former home in Germany, and because he enjoyed being able to walk to work in the morning.

Between 1960 and 1999, PTI developed from a very small operation with five workers to one with almost nine hundred employees. Sales rose sharply in that period, from $30,100 in the first year to over $109 million in 1999 (see Table 1).

Table 1: Total Company Sales and Number of Employees for Selected Years 1960-1999

Year Sales ($000s) Employees 1960 30 5 1963 6,430 71 1968 31,512 289 1973 52,489 460 1978 67,810 565 1983 63,955 556 1988 89,689 680 1992 92,398 750 1993 94,330 760 1994 96,493 770 1995 106,988 780 1996 97,837 830 1997 128,581 899 1998 118,736 883 1999 109,361 896

Initially, Jon did not give serious attention to the threat posed by these imports, because he did not believe that people would buy such poorly constructed clocks. However, he soon discovered that he was wrong. The abundance and wide distribution of these inexpensive clocks caused Jon to have great difficulty selling quality clocks. As a result, most of the clocks produced at PTI in the first year were sold at bargain prices and the company was fortunate to break-even. It

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October 2003 Entrance Examination was a lesson Jon never forgot. Losing the company would have meant more years of back-breaking labour before being able to start over.

Recovery from that first year was difficult, as PTI faced intense competition from large companies in the Canadian market. At that time, PTI did not have the sales force, production, or marketing resources to fight against any one of the domestic clock making companies, let alone the foreign companies known for low-cost production. In desperation, Jon looked for alternative products with which PTI could compete successfully.

History of Individual Divisions

Appliance Division

Jon discovered a solution while seeking orders for clocks and clockworks. He loved to talk with potential clients and, as he was trying to secure an order with one of them, the conversation turned to other uses of clockworks. The potential client mentioned that the home appliance market was heavily protected by government tariffs on both appliances and their components, and that, consequently, the larger Canadian appliance manufacturers often bought the total domestic production of clocks and timers for appliances. This meant that it was difficult for the medium- and small-sized appliance manufacturers to find local suppliers for such components, which then had to be imported. As a result, these manufacturers paid higher prices, had difficulty finding the styles they wanted, and did not have the personal contact that a local supplier could provide.

Armed with these facts, Jon approached the local appliance manufacturer with a proposal. PTI had its first appliance-related order the next day and, thereafter, business shifted from mass-market clocks to clocks and timers for the appliance market. In the second year of operation, sales doubled. In the third year of operation, Jon obtained contracts from three other appliance manufacturers and began to tap this market in depth.

Jons recipe for success was simple: deliver the desired high-quality products without exceeding the customers upper price limit as determined by stiff market competition. To increase profits, Jon cut costs and worked to increase sales by offering to produce components for customers other product lines. For example, a contract with PTI for stove clocks and timers was an opportunity to present a prototype for a washing machine timer. Usually, Jon won the extra order.

Beyond cutting costs and expanding lines, Jons marketing strategy included making personal connections with key decision makers in each client company. Jon understood the management structure of each company and worked the organizational networks effectively. When he dealt with customers, his manner was courteous and professional, and he was knowledgeable about products. He called customers regularly and used sales-closing techniques before leaving the clients office. Such contact, although purely social at times, enabled him to become part of the client companys decision-making team. It seemed natural not only to ask Jon about the clocks and timers, but also to consult him on questions of style and function when planning a new model. Jon responded by anticipating market changes and by developing styles that reflected market trends. As a result of this initiative, manufacturers asked themselves, Why would I go elsewhere when Jon at PTI gives me exactly what I want? As PTI grew, Jons sales skills became an integral part of the company's success.

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October 2003 Entrance Examination Jons professionalism combined with his warm, personal style paid early dividends, and PTI steadily increased its share of the market for appliance timers and clocks. Initially, contracts involved timers for household stoves only. Later PTI won contracts for timers for other household appliances, such as washing machines, dryers, dishwashers, and microwave ovens. By 1972, the company had entered the timer market for commercial and industrial appliances. It was not long before PTI was supplying clocks and timers to most of the Canadian appliance manufacturers.

Jon employed other sales techniques targeted at keeping customers happy. For example, he developed a number of styles and designs at various price points for each appliance. He realized that appliance manufacturers were extremely sensitive to price and that an extra dollar spent on the timer of a stove was not automatically covered by a higher price for the product. Often, it meant a dollar less in the margin for that product. In addition, Jon was very aware of style. At a time when automobile designs changed radically almost every year, consumer perception of a modern-looking appliance changed almost as quickly. Jon kept on top of the trends by examining the top-of-the-line models from the best appliance manufacturers and making changes that reflected the direction in which he believed the styles were moving. Overall, this was a successful approach for Jon Klatt and PTI.

In the first decade of business for PTI, there was rapid growth in the appliances industry and sales increases of 100% or more per year were common. Demand remained high, partly because of strong economic conditions, a large number of residential and commercial construction projects, and widespread consumer confidence. Thereafter, sales followed economic trends: slowing down in the second half of the 1970s, declining in the recession of the 1980s and early 1990s, and rebounding strongly later in the 1990s. Through all the shifts of a changing economy, the Appliance Division remained the core of PTIs business.

Industrial Division

PTI began its second line of timing devices quite by accident. One of the original workers hired by Jon was Clint Burns, a former soldier who had been discharged from the Canadian Armed Forces at the end of the Korean War. During that conflict, Clint received extensive training with respect to explosives. When he returned to Winwood, he began to take on small jobs involving explosives in the home construction industry. However, this work was sporadic, so Clint took a steady job at PTI and continued to work occasionally on small explosive jobs. Over the next few years, conditions began to change. As a result of some well-publicized accidents, the regulations concerning the handling of explosive materials became much stricter and, as the size of jobs increased, it became more difficult for an individual to handle the necessary technical requirements on his own. However, such jobs were not beyond the capability of a small company, especially one with access to both demolition and timer expertise.

Initially, Jon did not like the idea of dealing with industrial explosives. When Clint was able to show that it could be done safely, Jon changed his mind. The fact that such jobs required little production space and provided a very healthy profit convinced him. This line of work also offered a source of income independent of the appliance manufacturing industry and an opportunity for PTI to diversify. Thus, Clint was made foreman of the new line of business. Eventually, he became PTIs first vice-president.

The financial rewards offered by demolitions contracts relating to large construction projects were hard to resist, but the technical requirements were demanding. The key to the successful use of explosives was control, not only of the force unleashed by each blast, but also of the

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October 2003 Entrance Examination sequence of blasts. Using explosives in residential construction was relatively simple when the site was clear of obstructions except for the objects to be removed. However, the simplicity of demolition was lost as jobs became larger. Safety was always an issue. The greater the amount of explosive materials used, the greater the chance of an accident. Also, explosions created with larger charges could cause property damage from flying debris. Fortunately, using several smaller charges timed to detonate simultaneously and placed strategically for maximum effect eliminated these problems.

Traditionally, detonation of charges was controlled by fuses that were vulnerable to weather conditions and had inconsistent burn rates even under the best of conditions. These factors made the use of explosives less effective and more dangerous. If a charge did not explode, a legally defined period of time had to pass before it could be considered safe to approach the charge and begin again. Such delays could cost thousands of dollars in lost time as workers and expensive equipment sat idle.

The solution was to link charges together and control detonation with high-quality timers. Demolition experts would go to a job site and set appropriately-sized charges in place, install detonation triggers, and attach either a demolition wire or radio receiver to the triggers. Then the charges were packed with sandbags to focus the force of the explosion on the structure. When preparations had been completed, the charges would be detonated at precise intervals with the aid of timers. If all went well, the object to be demolished, such as a building, would crumple into itself and collapse in a cloud of dust, causing no harm to surrounding property. Human operators could not match the precision of timers as a means of control.

In the late 1960s, the Industrial Division expanded to include the production of fireworks. Both Jon and Clint saw this as a natural extension of the explosives business. Usually, municipal fire departments handled fireworks, but did so with a great deal of uneasiness. In response, PTI produced fireworks units that were foolproof. Pressing one button initiated the opening sequence, pressing another button started the second sequence, and so on. Fireworks were popular and the revenues from this product were much more predictable than those from the demolition line. For example, it was certain that there would be fireworks displays for New Years Eve, Canada Day, and civic holidays. In addition, every municipality had fireworks displays for numerous other occasions.

Throughout the 1960s, sales of the Industrial Division increased first in the demolition line and then the fireworks line. In the early 1970s, fireworks production equalled and then surpassed demolition jobs in importance. Although the demolition line had the potential to be more profitable, the unpredictability of its revenue was troublesome. That situation changed somewhat in the early 1990s during a minor building and demolition boom in the province.

In 1996, an entertainment line was added to the Industrial Division when PTI was awarded a contract to provide special effects for a well-known, big-budget television production company filming a weekly series about an action hero. The special effects usually involved explosions. To make the scenes more visually memorable, the number and size of the explosions were increased each week. As a result, PTIs revenues from this line grew steadily.

Consumer Division

The third division of PTI developed as a direct result of making clocks and timers for household appliances. This divisions products were sold to consumers, through wholesalers and retailers, rather than to manufacturers. Jon discovered that, although the clocks and timers in appliances

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October 2003 Entrance Examination were of good quality, their life spans were shorter than those of the appliances themselves. Therefore, he felt that it would be profitable to enter the growing replacement parts market by designing a series of replacement clocks and timers for a wide variety of appliance models. Initially, sales of these replacement clocks and timers were slow, because people used other household clocks in place of the malfunctioning ones in stoves. However, as the appliance market grew, so did the replacement parts market. Soon, orders for PTIs replacement clocks and timers began to increase. PTI also began to produce a variety of independent kitchen timers (e.g. egg timers), and eventually held a respectable share of this market in Canada.

From producing timers for the kitchen, it was a short step to manufacturing timers for other purposes. One area that Jon felt had promise was in the sporting market, where stopwatches and time clocks were used at every sporting event. After designing a line of these products, Jon convinced a distributor of school sporting goods to carry the PTI line. Although sales were not outstanding, the sporting products provided some diversification for PTI and were a regular source of revenue every spring and autumn. Fortunately, there were no other strong, domestic suppliers of the Consumer Divisions products, and comparable offerings by foreign suppliers were usually more expensive or of poorer quality.

In 1988, PTI began to manufacture another line of products in this divisionsecurity timers. Plugged into an electrical outlet, these timers turned lamps, radios, and other appliances on and off to give the appearance that someone was at home or in the office. This product line was just as profitable as the others and the sales volume was greater. Soon, PTI began producing similar timers for many other household and commercial applications, such as the timed control of air conditioners and lawn sprinkler systems.

In the early 1990s, with the growing popularity of digital clocks, PTI began to manufacture a line of high-quality, digital consumer clocks and timers (alarm clocks, wall clocks, desk clocks, panel clocks, etc.).

Hobby Clocks Division

In 1996, a hobby clock product was developed and seemed to be a great success. This product was the brainchild of Peter Burns Clint Burns son and, at that time, Vice-President of PTI and was developed because of Peters insistence that it could generate large profits. The hobby clock was simple and inexpensive, consisting of a small digital clock encased in a plastic shell. All of the components were purchased from external suppliers and the clocks were simply assembled in PTIs factory. Then, the completed clocks were shipped to a single customer. There was neither manufacturing nor sales effort related to this product.

Peter became interested in these clocks through his woodworking hobby. He enjoyed making wooden boxes and often decorated them with small clocks, thereby making them unique. Originally, Peter bought clocks for his boxes from Bison Crafts (Bison), a mail-order business located in Buffalo, New York. He had been attracted to them initially by the advertisement for these clocks in Bisons catalogue of hobby supplies (see Figure 1).

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Figure 1: Text of Bison Crafts Advertisement for Hobby Clocks January 1, 1995

Digital Clock - Watch their faces light up when you put this clock on their gift! Just a simple digital clock, but something that adds value far beyond its cost. Large manufacturers often include clocks like this and add a markup that is far greater than the cost involved. Get in on this secret and make your crafts extra special. $4.95 (in US funds)

Peter used these clocks in several of his boxes, which he then gave to family and friends as gifts, and was pleased with the results. The recipients raved about the boxes, and he noted their interest in the clocks. Obviously, the advertising copy was accurate. In addition, the clocks were easy to use. Peter simply cut a recess in the wood into which the clock would fit, and then applied glue to fix it in place. He had intended to use more clocks in his woodworking projects, but Bison unexpectedly discontinued offering the clocks in 1996.

Peter was interested enough to investigate and called Bison's offices to speak with the owner, Bill Conapaski. Within ten minutes, Bill was telling Peter about his experience with the hobby clock manufacturer, Spring Crane Clocks (Spring Crane), a low-cost producer in the Far East.

Ive got to tell you, Peter, Bill said, the loss of those clocks left a hole in my catalogue, but I sure was glad to see the last of those people. Those clocks were big sellers and made me a bag of cash, but the company just didnt treat me right.

You never knew when they would ship, they hardly ever kept their word, and you wouldnt believe how many of their clocks had defects. Some had cases that were rough or obviously malformed. Others didnt keep time accurately and a lot just didnt run, right from the start. This might sound like a minor problem, but I had to factor the defect rate into the price of the clocks because it just wasn't worth sending them back overseas.

How many were defective? asked Peter.

Hard to tell, Bill replied. They werent even consistent in that. I counted on about 15%, and thats a really big number in my mind. I factored that into the price of the clocks because I just couldnt sell the defective ones. I was always worried about the quality of the product. Most of those little clocks stopped for good in nine months or so. The quality situation got to be so bad that Id sort them by hand rather than let my customers get defective clocks.

Soon, Peter and Bill were discussing the possibility of PTI producing a replacement product for Bison. Peter assured Bill that PTI could produce a better quality clock and a case designed for ease of use by woodworkers. Within a week, Peter designed a clock with four components: case, battery, face, and electronic works. He planned to use PTIs present suppliers for most of the components and to assemble the clocks in the factory. The only component for which he did not have a source initially was the case.

With some effort, Peter found a small plastics factory located close to Winwood that had some excess capacity and expressed an interest in making the cases. Working with them, Peter

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October 2003 Entrance Examination designed a case that would fit a hole five-centimetres in diameter. The plastics company was glad to get PTIs business, because it meant that most of the factorys excess capacity would be utilized to fill orders from a reliable customer.

To use PTIs hobby clocks, the hobbyist was required to drill a five-centimetre hole into the wood, fit the plastic sleeve supplied with the clock into the hole, and slide the clock snugly into the sleeve. This system had several advantages. The clock could be removed to change a battery and a defective clock could be replaced easily. Also, because the hole was made with a simple drilling operation, this method was faster and easier than the fussing and fitting required for Spring Crane clocks.

Bill was delighted. PTIs hobby clocks were attractive and easy to use. Peter followed Jons traditional methods of dealing with major customers and called Bill often. In addition, he ensured on-time delivery and a high level of quality.

With so few components, there was little that could go wrong. Assembly consisted of inserting the electronic works and face into the case, soldering two wires, inserting the battery, and snapping the front of the case shut. Quality control was simple as well, especially since Bill indicated what he considered to be unacceptable: deformed or broken cases, and clocks that did not work. A visual inspection of the case was completed, the clock was turned on, and, if it worked, it was packed for shipment. Peter estimated that fewer than 50 of the first 10,000 clocks manufactured were rejected for shipment.

Bill was quite happy with the quality of the PTI hobby clocks. After the first shipment arrived on time, he called Peter and said, I had a look at the clocks and I couldnt find one to reject. After the first five hundred or so, it got quite boring. These clocks sold even faster than those Bill had originally carried in prior years. One marketing technique he used was to offer a 2-inch (5 cm) drill bit on the same page of the catalogue as the hobby clock. This accessory would enable the customer to drill a properly sized hole for the hobby clock. The catalogue picture of the clock was very attractive and showed one of Peters boxes with a clock insert. Bills enthusiasm for the new clocks showed through in his new advertising text (see Figure 2):

Figure 2: Text for Bison Crafts New Advertisement for PTIs Hobby Clocks January 1, 1997

Theyre back and better than ever! You folks who have been with me for a while may remember the small clocks we sold a couple of years ago. Well, weve found a Canadian supplier of these clocks who guarantees their quality. Weve been working with them and the new clocks are much easier to use. Just drill a 2-inch (5 cm) hole (see the next item on this page if you need the proper drill bit), insert the mounting sleeve, and slide the clock in. No fuss, no bother, just good results. Of course, to get the quality, we had to pay more, but this is one product thats worth the extra price. $6.95 (in US funds)

Peter was surprised by the price increase because he knew PTI was supplying the clocks to Bison at the same price as the earlier Spring Crane model. However, he was pleased that Bill was making a little extra money on this product. From PTIs standpoint, each clock was sold for

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October 2003 Entrance Examination US$2.50, and the components cost only CDN$0.50. That resulted in a margin of approximately CDN$3.00 before labour, overhead, and other costs. Furthermore, the clocks were assembled during factory slack periods and did not require an investment in any specialized machinery.

Management and Organization It was during his high school years that Peter Burns, who was Clint Burns son, began working for PTI on a part-time and seasonal basis. After he finished high school, he went to university and continued to work at the factory during summer vacations as well as part-time during the school year. Peter started at PTI by working on the shop floor with other employees. He was not spared the less desirable tasks, such as cleaning the shop, even though his father was Vice-President. Peter studied industrial design in university and began to work full-time at PTI when he completed his studies in 1979. As he gained experience, he moved up the corporate ladder. In 1990, Clint Burns retired, and Peter Burns succeeded him as Vice-President.

Clint had continued to manage the Industrial Division until his retirement. In 1991, Jon hired Angela Lund to fill this role. Having completed a degree in engineering in 1982, Angela had gone to work for one of the firms that supplied PTI. It was through her job at this supplier that she first met Clint and Peter Burns. Angela stayed with this firm for eight years and, during the final years, enrolled in an executive MBA program. After finishing her graduate degree in 1990, she began to look for new opportunities. When Peter learned of this, he convinced Jon to make Angela the offer to join PTI.

In 1997, Jon announced his decision to step back from the role of President of PTI. Peter then became PTIs President and took the opportunity to make some changes in the structure of the senior management team. Angela became Executive Vice-President and two other vice-president positions were created for functional areas (see Exhibit 1). Jon maintained a strong presence in the company, continuing to be chief shareholder and retaining his position as Chairman of the Board of Directors.

PTI was organized into divisions and departments, with a board of directors at the top of the organizational chart. The board was composed of five seats: one each for Jon, his wife Anna, Peter, Angela, and one of the two functional area vice-presidents. The two vice-presidents alternated as board members, usually at six-months intervals.

Jim Harris, Vice-President of Finance and Administration, was hired by Jon in 1993 to assume the position of Controller. His background included a Bachelor of Business Administration degree, a CMA designation, and seven years of previous work experience in an electronics manufacturing company.

Mike Wong, Vice-President of Production, has worked for PTI since 1985. He began working as a designer in the Appliance Division immediately after obtaining an engineering degree at university. Within ten years, he had advanced to the position of Manager of the Appliance Division.

Management practices at PTI were influenced greatly by the firms history and size. Because Jon was the president for 37 years, there was strong continuity and relationships remained stable. Jon continued to be active in the company after retirement and would drop by on a weekly basis to keep in touch. He usually spent time with Peter and the vice-presidents, but it

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October 2003 Entrance Examination was not unusual for him to walk through the production areas and talk briefly with some of the production employees.

Peter welcomed Jons visits because they shared the same vision for PTIs operations, and the same, strong management and marketing skills. The nature of the business demanded that a senior executive be involved with maintaining contact with major customers and in developing products that would keep those customers happy. As a result, Jon and Peter were focused externally and were responsible for acquiring most of the large sales contracts. They depended on the other executive members and senior managers to support these marketing efforts, maintain operations, lead employees, and initiate internal analysis of issues.

Production Production at PTI was based on flexible manufacturing processes and schedules because of the nature of the products manufactured. During the period from 1996 to 1999, PTI had 620, 649, 618 and 631 production employees, respectively. Within the production divisions, there were four separate functions: design, machining, assembly, and quality control.

For most of the products of both the Consumer and Appliance Divisions, approximately the same amount of time was required to perform each of these functions due to the similarity of the products. In the Hobby Clocks Division, production time was devoted mainly to assembly. Design did not change, there was no machining of components, and quality control consisted of pressing a button to see whether or not the clock worked. The Industrial Division required a much higher quality control and individual design for each project. The manufacturing of job components was one of the least costly and time-consuming elements of this divisions operations. Most product manufacturing and assembly functions were done at client locations.

The Appliance Division required fairly straightforward production processes. PTI used a component approach to produce these products, which was typical in the appliance industry. All components were manufactured by PTI and then shipped to customers in packages called configurations. Each configuration contained the unassembled timing and clock accessories for a particular model of appliance. The client company was then responsible for assembling the timing unit and integrating it into the appropriate appliance. For PTI, the advantage of the component approach was its flexibility, because PTI could mix and match the components as required to create the necessary configurations to fill an order. For the client companies, this approach kept the price of the appliance clocks and timers low. The normal total rate of production in the Appliance Division was 340 configurations per operating hour.

Demand for the Appliance Divisions products was seasonal. PTI could build up its inventory of components during off-peak periods, but Jon soon discovered that this tied up significant amounts of working capital. Therefore, as much as possible, the problem of seasonal demand was addressed by hiring part-time help to work extra production shifts rather than by building up inventories.

Products in the Consumer Division were easily accommodated in the production processes because many of the products were simple and required no externally manufactured components. Except for the replacement clocks and timers for appliances, most of these products were inexpensive enough that PTI could build up inventories during off-peak periods without tying up too much of its working capital.

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October 2003 Entrance Examination In the early 1960s, PTI adopted a specially-designed, manual inventory system for the Appliance and Consumer Divisions. Because this system generally worked well, the company continued using it into the 1990s. On occasion, however, mistakes were made which caused shortfalls of product available for shipping.

Quality control for both the Appliance and Consumer Divisions was maintained by sampling batches randomly and determining statistically whether standards were being met. Usually, less than five percent of the products had either minor or major defects.

The hobby clocks were the simplest of all PTIs products to manufacture. Components were ordered from outside suppliers and then assembled by PTI employees. Usually, these clocks were assembled during slack production periods and placed in inventory until needed. Because no special skills were required, PTI used high school students to assemble the hobby clocks when the skilled employees were busy with other product lines. When Peter first developed these clocks, he estimated that it took less than five minutes to assemble the components, test the clock, and pack it in its plastic sleeve. Reject rates were lower than one percent because of the simplicity of the product.

The products and services of the Industrial Division differed so much from those of the others that it was illogical to manage this division in the same manner. Each of the three product lines demolition, fireworks, and entertainment had different customers, seasonal patterns of demand, and production techniques. As a result, the Industrial Division was organized around teams. Most of the production of the fireworks products took place at PTI. The timers for the explosive devices used in the demolition and entertainment lines were produced in PTIs factory, but most of the other work related to these two lines took place off-site.

Due to the use of explosives in the products and services of the Industrial Division, safety regulations stipulated that a twenty-foot space barrier with explosion and flash inhibitors be installed between the Industrial Division and other parts of the factory. Whenever explosives were to be brought into contact with timers, the regulations required PTI to complete the assembly at the job site and follow specific security procedures.

The individual nature of the products and services of this division meant that no two jobs were the same and that, as a result, most of the work was unique and could not be standardized. Quality control consisted of carefully followed, standard procedures for handling explosive material. Often, each procedure was carried out by one employee and then checked twice by different employees to eliminate the possibility of individual error. To become competent at working with explosives, employees were required to attend workshops and extensive training programs. PTI spent a great deal of money to ensure that its employees were fully trained in this field, because the nature of the work meant that any reduction in quality could be fatal.

Human Resources The main responsibilities of the Human Resources (HR) department were to maintain personnel records, issue paycheques, hire production workers, and set personnel policy within PTI. Much of the work consisted of record keeping. However, the hiring and policy-setting duties were more complex. HR policies at PTI were based on nationally accepted standards with respect to human rights, hiring, orientation, training, performance review, discipline, promotion, and termination of employment.

CMA Canada 15

October 2003 Entrance Examination Employee remuneration was based on company-wide pay scales. Non-management personnel were paid an hourly rate, and management employees were paid an annual salary. All production workers were paid a bonus based on their divisions operating income, whereas the bonuses of other employees were based on overall company income.

Performance reviews were conducted twice each year, during which employees would be provided with feedback on their accomplishments and actions during the previous six-month period. Senior managers were required to conduct these semi-annual performance reviews for all employees.

The HR department was responsible for overseeing disciplinary actions, up to the point of dismissal. HR policies included a progressive disciplinary system consisting of a verbal reprimand, a written reprimand, and a second written reprimand before further action could be taken. An employee could be fired if unsatisfactory behaviour was not changed, or if dangerous or criminal acts had taken place. However, a manager could not fire an employee unilaterally. Dismissal required the approval of the executive vice-president or president.

The HR department hired the production workers. The hiring of other employees was the responsibility of the heads of the divisions and departments. Usually, when a junior non-production position became available, the appropriate divisional or departmental head would screen the resumes and interview the candidates. The successful candidates resume would be forwarded to the HR department for a reference check and, if the results were satisfactory, an employment offer would be made to the candidate at a salary in line with company pay scales.

When a senior position became available, an attempt would be made to fill it by promoting an existing employee on the basis of demonstrable skills and qualifications. Jon adopted this policy because existing employees were known commodities, and were comfortable with the companys policies and culture. As well, it was Jons philosophy that, since the employees supported PTI, the company should, in turn, support its employees whenever possible. Peter continued to uphold this philosophy when he became PTIs President.

When it was not possible to fill a senior position from within the company, the screening and interviewing process was very thorough. For example, when Jim Harris was hired, two months elapsed between the submission of his resume and the date of his initial interview. That first interview was extensive, and he spent an entire morning with Jon in the President's office. His second interview, with both Jon and Peter, lasted most of a day. Next, Jim took a personality test and, finally, he toured the factory with Jon and Peter. Now and then during the tour, they asked, in great detail, Jims opinion about PTIs operations. At the end of the tour, Jim was invited to have dinner with the other members of the board of directors, who then used the opportunity to ask Jim questions. By the time Jim reached his home that evening, Peter had called with a job offer and a suggestion that they discuss the details of the position. When Jim asked Peter about the interview process some years later, Peter was unapologetic. We were deciding whether we could trust you with the purse strings and the management of the companys money, he said. Do you think it would have been reasonable to base that decision on a thirty minute interview?

16 CMA Canada

October 2003 Entrance Examination Finance The controller, Janice Taylor, began working for PTI in 1982 as Assistant Controller. After completing her undergraduate business degree, Janice had worked as an accountant for the federal government before joining PTI. Janice was pleasant and her work was accurate, fully analyzed, and completed on time. When Jim Harris was Controller, he had total confidence in Janice's abilities and used them to assist him in the analysis of operations and in other special projects. One of her projects with which Jim was particularly pleased was the implementation of a computerized database for the finance department that greatly simplified the task of keeping track of projects and related documents.

After Jim became Vice-President of Finance and Administration, he appointed Janice as Controller and encouraged her to pursue the CMA designation. In 1999, Janice completed her first year in the CMA Strategic Leadership Program.

Over the years, PTI financed its expanding operations with both retained earnings and long-term loans. At times, the debt:equity ratio was higher than Jon Klatt would have liked, but PTI was always able to cover the loan interest payments and maintain a good credit rating. Selected financial data for PTI for the fiscal years 1997 to 1999 are provided in Exhibit 2.

Sales and Marketing Jim developed a table that showed sales for the years 1997 to 1999 (see Table 2). This allowed him to analyze sales trends.

Table 2: PTI Sales for 1997-1999 (in $000s)

1999 1998 1997 Appliance Division 84,386 84,348 84,267 Consumer Division 14,430 25,654 31,182 Hobby Clocks 875 650 450 Demolition 927 2,821 9,440 Fireworks 3,238 2,879 2,491 Entertainment 5,505 2,384 751 Total 109,361 118,736 128,581

Appliance Division sales remained stable throughout the time period because PTI had long-term contracts with most of the appliance manufacturers in Canada. Although the lowering of tariffs with the United States had opened up a huge and attractive market for appliance products, PTI had not yet penetrated that market.

Consumer Division sales decreased during this period. Most of the change was caused by an increase in competition from both Canadian and foreign manufacturers of consumer timers and clocks.

The sales history of the hobby clocks was one of continued success. Bison Crafts bought a greater number of clocks each year.

CMA Canada 17

October 2003 Entrance Examination Jim segmented the Industrial Division sales data by product line. Sales for the demolition line were highly variable and always had been, at least since he had joined the company. It was true that 1997 was a year of strong revenues, but these came primarily from major projects involving the demolition of buildings in several entire city blocks. Sales for the fireworks product line continued to grow steadily. Sales for the entertainment line increased dramatically as a result of the success of the initial television series. This success led to a second special effects contract for another television series in 1998. Jim was conservative in his expectations regarding the entertainment line because the high revenues of television series projects in general were offset by their average life span of only four years.

With respect to the Appliance, Industrial, and Hobby Clocks Divisions, the majority of revenues came from large contracts with relatively few customers. In the Consumer Division, sales were made to wholesalers and a few, large retail chains.

Although the President of PTI was always involved in the negotiations for the major contracts, the company had a sales and marketing staff that was responsible for day-to-day customer service and made initial contact with potential new customers and distributors. As well, production staff members were involved in supporting the marketing effort by working with clients to develop products that met the customers needs.

The Factory PTIs factory was located in a 32,000 square-metre building on a main street in Winwood, near a residential area. Many of the employees lived close enough to walk to work. The city of Winwood had rail and air freight transportation facilities, and was conveniently close to the trans-Canada highway system.

Both shipping and receiving were carried out on the street side of the factory (see Exhibit 3 for factory layout). A chain fence enclosed the property. There was a company parking lot for employees and visitors at the side of the building. The administration offices were located between the three production areas to give Jon and Peter quick access to all parts of the factory. The Appliance Division took up the majority of the production space, with the Industrial and Consumer Divisions dividing the remaining space. Hobby clock production took place within the Consumer Division.

The Appliance Industry The Canadian appliance industry was protected by moderately high tariffs throughout most of its history. These tariffs were removed when the Canada-US Free Trade Agreement came into effect. In the early 1990s, the removal of tariffs had several effects, including a reduction in the number of Canadian firms in this industry from 35 in 1987 to 25 in 1997. A second effect was the concentration of production into fewer plants. In 1987, the four largest firms accounted for 75% of total production; by 1996, this figure had increased to 85%. Other effects of the Free Trade Agreement included a decline in the average number of employees per plant and an increase in production per employee. Over the period from 1987 to 1996, average productivity per employee increased by 2.2% annually.

18 CMA Canada

October 2003 Entrance Examination Canada imported more appliances than it exported. The Canadian market demand for household and commercial appliances had increased by an average of 10% annually over the last several years and was $2.9 billion in 1999. The US market was approximately twenty times larger, but recently experienced a slower growth rate than the Canadian market. In 1999, Canada exported $1 billion while importing $1.8 billion in appliances. Large trade deficits were recorded for most appliances, including clothes washing machines, microwave ovens, dishwashers, and refrigerators. These deficits were offset to some extent by surpluses in freezers.

Short-term market demand for appliances was sensitive to economic shifts, especially those with respect to interest rates, unemployment rates, and consumer confidence. Long-term market demand had been a function of other economic factors, such as household formation rates, housing starts, and income growth. During the period from 1997 to 1999, these indicators dipped in 1998, but recovered in 1999.

Economic projections showed that both the population and housing starts would grow gradually in the future. Given conditions in the economy, it was forecast that the Canadian market demand for appliances would increase by between 2.5% and 5% annually from 2000 to 2010.

The Clock and Timer Industry The Canadian clock and timer industry was small in comparison to both other Canadian manufacturing industries and the US clock and timer industry. In 1999, the Canadian industry, excluding watches, showed a trade deficit of $87 million, with exports of $30 million and imports of $117 million. Table 3 provides a summary of Canadas major trade partners in this industry in 1999.

Table 3: Canadian Trade in Clocks and Timers (Excluding Watches) in 1999

Export Market Amount ($000s) Import Source Amount ($000s)

USA 24,453 United States 49,399

Hong Kong, China 4,162 Peoples Republic of China 33,988

France 274 Mexico 8,062

Chile 196 Japan 7,131 There were numerous small companies in the Canadian industry, and only six of the companies involved in clock and timer manufacturing had sales greater than $1 million. Many of these larger companies also made watches and other products, as shown in Table 4.

CMA Canada 19


Table 4: Canadian Manufacturers of Clocks and Timers

Company Name Products 1999 Sales ($000s) Belte Watches Luxury wristwatches, jewellery 8,700

Paget Clocks Mantle clocks, wristwatches, pocket watches, underwater sport timers 2,500

Precision Timing Inc. (PTI)

Timers for appliances, consumer clocks & timers, demolition services, fireworks, TV special effects 109,361

Vandelay Electronics Inc.

Panel clocks, digital clocks and timing controls for the automotive and electronic entertainment industries, clock radios, electronic games, security systems, time systems, communication systems

130,420

DKF Time & Furnishings Alarm clocks, wall clocks, travel clocks, pendulum & grandfather clocks, desk clocks, office furniture 36,450

Time Eye, Ltd. Novelty watches and clocks, kitchen timers, security timers, lamps, score clocks, custom logo watches

51,233

The US clock and timer industry was considered to be more productive than the Canadian industry. At the end of 1999, Jim investigated industry productivity for the period from 1993 to 1999. His findings are summarized in Table 5.

Table 5: Canadian Productivity Clock and Timer Industry

1999 1998 1997 1996 1995 1994 1993 Revenue per Worker ($000s) 120.5 132.5 136.6 132.5 130.8 125.9 131.7 Revenue per Production Worker ($000s) 177.2 192.1 192.3 184.0 176.6 165.7 168.9

Wages/Production Cost (%) 34.0 30.3 28.8 27.5 28.3 29.1 27.2 Material Costs/Production Costs (%) 20.4 22.7 24.3 25.1 24.5 23.6 24.0

In the seven-year period ending in 1999, Canadian revenue per worker decreased from $131,721 to $120,492, whereas revenue per worker in the United States grew from US$168,835 to US$169,875 in the same time period. However, in terms of revenue per production worker during this time period, productivity improved by five percent in the Canadian industry, whereas it increased by only one percent in the US industry.

20 CMA Canada


Exhibit 1

Precision Timing Inc. Organizational Chart As at January 1, 2000

Board of Directors Jon Klatt

Anna Klatt Peter Burns Angela Lund

Mike Wong/Jim Harris

President Peter Burns

Executive Vice-President

Angela Lund

Vice-President Production Mike Wong

Vice-President Finance & Administration

Jim Harris

CMA Canada 21


Exhibit 2

Precision Timing Inc. Selected Financial Data

For the Years Ended December 31 (in $000s)

1999 1998 1997

Current assets 86,159 85,668 79,478

Total assets 154,782 156,772 154,728

Accounts receivable 30,579 28,513 27,118

Inventory 13,583 14,315 10,953

Current liabilities 42,988 44,068 45,082

Long-term debt 17,489 19,669 21,855

Shareholders equity 94,305 93,035 87,791

Sales 109,361 118,736 128,581

Cost of goods sold 66,710 71,067 79,668

Amortization expense 7,217 8,146 9,051

Interest expense 1,049 1,180 1,311

Income tax expense 2,770 6,063 6,579

Net income 4,110 9,244 10,286

22 CMA Canada


Exhibit 3

Precision Timing Inc. Factory Layout

Adm

inis

tratio

n (2

,000

m2 )

Main Gate

Street

Shipping and Receiving (1,500 m2)

Consumer Division (4,500 m2)

Appliance Division (19,000 m2)

Industrial Division (5,000 m2)

Parking

CMA Canada 23


The Societies of Management Accountants of Manitoba, New Brunswick, Newfoundland, Northwest Territories, Nova Scotia, Ontario,

Prince Edward Island, Saskatchewan and the Yukon, Certified Management Accountants Society of British Columbia, The Certified Management Accountants of Alberta, Ordre des comptables en management accrdits du Qubec

October 2003

Entrance Examination

Part 2

Additional Information

(Time Allowed: 4 hours) Notes: i) Part 2 consists of one case question to be answered in the four hours allotted.

ii) Candidates must not identify themselves in answering the question.

iii) All answers must be written on official answer sheets. Work done on the question paper or on the Backgrounder will NOT be marked.

iv) Included in the examination envelope is a standard supplement consisting of formulae and tables that may be useful in answering the question.

v) Examination answer sheets MUST NOT BE REMOVED from the examination writing centre. All used and unused answer sheets and working papers must be sealed in the examination envelope and submitted to the presiding officer before the candidate leaves the examination room.

24 CMA Canada


Precision Timing Inc. Additional Information

Company Update Sales at Precision Timing Inc. (PTI) improved gradually during the first three years of the new millennium (see Exhibits 1, 2 and 3). Mike Wong, Vice-President of Production, oversaw the operations of the Appliance and Consumer Divisions. Sales in the Appliance Division remained steady as PTI concentrated on providing superior service to its Canadian customers. In an effort to reverse the downward sales trend in the Consumer Division, PTI established a Web site in 2000 to market this divisions products directly to consumers. Although total divisional revenues improved, administration costs related to these small-volume sales were much greater, as a percentage of revenue, than those associated with sales to wholesalers and large retail chains. For example, shipping and handling costs were higher, and it was necessary to maintain a greater variety of products in inventory.

The Hobby Clocks Division continued to be increasingly profitable. When Peter Burns became President in 1997, this division was still in its infancy. Because the hobby clock was his pet project, Peter decided to oversee the operations of this division for the first few years. This included maintaining the relationship between PTI and Bison Craft, buying components, and supervising production, quality, and invoicing. In 2000, Peter assigned responsibility for the Hobby Clocks Division to Jim Harris, Vice-President of Finance and Administration. Under Jims supervision, divisional profits continued to grow steadily. However, Jim was aware that part of the increase was due to the weakening of the Canadian dollar against the US dollar during the period from 2000 to 2002.

The operations of the Industrial Division remained Angela Lunds responsibility subsequent to becoming Executive Vice-President. Revenues from the entertainment line continued to increase. The two television series remained popular and PTI received a few small contracts to provide special effects for movie productions. Revenues from the demolition line fluctuated somewhat, but those from the fireworks line remained stable.

In August 2002, Jon Klatt died unexpectedly and his shares in PTI went to his widow, Anna Klatt. Although she had always been a great support for Jon as the company grew over four decades, she had never been directly involved in the management of the firm. None of the Klatts children had ever worked for PTI or shown any interest in becoming involved with its governance. Therefore, at Annas request, Peter Burns assumed the role of Chairman of the Board of Directors in addition to his duties as President.

Within a year, Peter decided to leave PTI to establish an industrial design firm, something he had always wanted to do. In July 2003, Peter announced his resignation, effective October 1, 2003. The board of directors agreed to appoint Angela Lund as President, and Anna Klatt agreed to act as Chairman of the Board of Directors for the next year.

CMA Canada 25

October 2003 Entrance Examination October 2003 Angela sought assistance from Jim Harris. To help her prepare for a pending board of directors meeting, Angela asked Jim to consider the various issues facing PTI. In particular, she was looking for his views on the strategic direction of the company, including whether it should continue with all of its product lines, and other issues relating to corporate strategy. She was considering promoting Jim to the position of Executive Vice-President, and wanted to assess his ability to view the organization on both a strategic and an operational level.

Angela and Jim met to discuss PTIs strategic options. Angela indicated that she had a preference for growth and intended to make sure that PTIs sales performance under her guidance would be better than while Peter was President. This was important to her because she was aware that many in the organization did not think she was capable of dealing with current and potential clients as effectively as Jon or Peter. Angelas focus was more internal and her management style formal and analytical, whereas Jon and Peter had been focused externally and had a more informal, friendly management style. Angela confided to Jim that she hoped to prove her critics wrong.

Angela called Mike Wong into the meeting so that the three of them could discuss the groundwork that she and Peter had laid over the past few months to broaden PTIs client base. Having already captured the majority of the Canadian market for appliance clocks and timers, PTI would have to look to foreign markets to expand in this area. Peter and Angela had decided to seek orders initially from small- and medium-sized US appliance manufacturers and had opened negotiations with the four companies listed in Table 1.

Table 1: Potential US Contracts for Appliance Clocks and Timers

Company Location Annual Volume Annual Revenue

(in Canadian funds) Fehr Corporation Arkansas 280,000 $12.6 million Alliance Appliances Ltd. Indiana 100,000 $4.5 million MacMillan Appliances Co. Iowa 125,000 $5.9 million Lexington Manufacturers Inc. Illinois 250,000 $11.6 million

Angela indicated that Fehr and Alliance were willing to accept unassembled configurations. However, MacMillan and Lexington would require PTI to assemble the components into a complete unit rather than package them as unassembled configurations. The assembled unit approach would increase production costs for PTI by approximately five percent, and this was factored into the contract price. The two companies were willing to pay a higher price because receiving the assembled units would decrease their respective labour costs and manufacturing turnaround time, as well as increase quality.

Mike used this opportunity to seek support for his proposal that PTI expand its production capacity by moving to a new, larger facility in an industrial park outside of Winwood. Peter had rejected this suggestion previously, maintaining that the current factory had sufficient excess capacity to handle PTIs planned growth, at least for the near future. In addition, Peter had felt that the current location was ideal for employees, many of whom lived in the residential area within walking distance of PTI. Mike now indicated that the four potential US contracts would require the Appliance Division to increase its output by almost 40% and that the assembled unit

26 CMA Canada

October 2003 Entrance Examination approach would require approximately 10% more production time than the unassembled, configuration approach. He also pointed out that if the delivery requirements for the US contracts followed the same seasonal patterns as had been experienced with respect to the Canadian customers, PTI would be required to build up large amounts of inventory during slow periods.

The size of the new plant would be 40,000 square metres. Mike proposed that the size of the Appliance Division be increased from the 19,000 square metres in the current plant to 25,000 square metres in the new plant. The remaining additional 2,000 square metres could be divided among administration, shipping and receiving, and the other two production divisions. The existing equipment could be moved to the new plant. To fill the additional 6,000 square metres in the Appliance Division, new manufacturing and assembly processes could be installed. Mike estimated that this would increase the number of configurations that could be produced in the Appliance Division by 38%, i.e. from the current level of 340 per operating hour to 468 per operating hour.

Angela was not convinced that a larger facility was necessary. The current production equipment still had a useful life of ten more years, and the plant had never reached full capacity. On the other hand, Angela was concerned that the poor image conveyed by the buildings run-down exterior might cause some of the potential US clients to reject PTI as a supplier. She asked Jim to evaluate Mikes proposal as well as investigate other options.

At the end of the meeting, Angela asked Jim to prepare a report for her consideration on the strategic direction of PTI and any other issues requiring her attention. She indicated that she would send Jim a memo that would convey some thoughts and information for him to consider in addition to his own analysis (see Exhibit 4).

Jims Preliminary Research First, Jim determined that the cost of building the new plant proposed by Mike would be approximately $15 million, and that the additional production and assembly equipment for the Appliance Division would cost $12.5 million. The salvage value of the existing land and building would be $2 million. If PTI leased the new plant instead, the annual lease costs would be $1.5 million.

Next, Jim looked for alternatives that would accommodate Angelas plan for sales growth. Jim knew that not all of PTIs operations required the same amount of space. For example, only 25% of the Industrial Divisions floor space was used for production. The remainder served as a buffer zone to comply with safety regulations. As well, in the Consumer Division, 30% of the production space was devoted to the manufacture of replacement clocks and timers for appliances, and only five percent to the production of hobby clocks.

Demand and production were not constant throughout the year for any of the divisions. As well, each division differed in average daily factory utilization, with the Appliance Division operating at an average of 15.4 hours per day in 2002, the Consumer Division (including production of hobby clocks) at nine hours, and the Industrial Division at 12 hours. Normally, the upper limit on production was 16 hours per day, seven days per week. Currently, 8 hours per day were set aside for cleaning and maintenance, unless a deadline had to be met. In that case, the line in question was run for two and a half 8-hour shifts and then intensive maintenance was done in the next four hours, making 20 hours per day the actual upper limit. Usually, August was a slow

CMA Canada 27

October 2003 Entrance Examination month; therefore, many of the employees took their vacations in August and production lines were shut down on a rotating basis. During periods of peak demand, production lines often ran for two or two-and-a-half shifts per day.

In the Consumer Division, the production line devoted to replacement clocks and timers for appliances only ran for one shift per day, on average. Jim determined that this line could be used if necessary, at no additional fixed cost, to produce products for the Appliance Division. Jim estimated that the production line in the Consumer Division could produce appliance configurations at a daily rate of 192 per 8-hour shift (i.e. 24 per operating hour).

Renovating PTIs existing building to bring its appearance to an acceptable level would cost $1 million. The factory layout could be improved and the Appliance Divisions equipment could be replaced with more efficient equipment at a net cost of $4 million. Jim estimated that these changes would result in a 20% increase in the Appliance Divisions production capacity, without having to hire more production workers.

Jim prepared a list of other considerations, as follows:

Both shipping and receiving take place at the same set of loading doors. This has caused traffic tie-ups at the main gate, and trucks often have to wait in line for the opportunity to load finished goods or unload supplies. Originally, a separate set of loading bays had been installed at the side of the factory. Although these doors still remain, they were no longer used after the parking lot was moved to that location.

Zoning regulations do not allow for expansion into the company parking lot. As well, on either side of the plant, neighbouring buildings belonging to other companies preclude expansion of the existing facility.

The manual inventory tracking system has not always provided accurate and timely information. This has occasionally resulted in having to schedule overtime to fill shortages in scheduled shipments.

With business expansion, the selling and administration function would expand also.

Some of the Appliance Divisions customers have been investigating whether it would be to their advantage to order assembled units instead of unassembled configurations. These customers have asked PTI to provide them with prices and samples of assembled units.

Sales of fireworks are expected to grow by 10% annually over the next decade.

In the Appliance Division, total accounts receivable has been increasing over the past few years. In 2002, the average length of time that receivable accounts remained outstanding for each division are as follows:

Appliance 4.9 months Consumer 1.8 months Hobby Clocks 1.1 months Industrial 2.0 months

PTIs income tax rate is 40%, its short-term interest rate is 8% and its long-term interest rate is 6%.

The average exchange rate for US dollars for the first three quarters of 2003 was 1.44 (i.e. US$1.00 = CDN$1.44).

28 CMA Canada

October 2003 Entrance Examination Selected 2002 financial ratios for the North American clock and timer industry are as follows:

Asset turnover .90 Profit margin 4.5% Debt-to-total assets .62 Rate of return on assets 4.3%

Other Events Returning to his office after lunch, Jim listened to the following message that had been left on his voice mail by Bill Conapaski of Bison Crafts:

Jim, I want to talk with you as soon as possible. The company that used to produce hobby clocks for me is willing to knock their price down to $2.28 in US currency. They can supply as many as I can handle and Im going with them unless you can match their price. I know weve got a contract, but I dont think you really want to go to court if it's going to take three years to get a decision. Let me know soon what youre going to do. I know youre holding 200,000 units in inventory and you dont want to get caught without your only customer.

Jim was troubled by this message. He knew that the quality of PTIs product was far superior to those of Bisons other suppliers and wondered whether the time was right to find another buyer for PTIs hobby clocks. He sent the following e-mail to Janice Taylor, Controller:

Janice, please do a quick search of the top tool and craft companies in the US and Canada. I need names and contacts. I also want to find out whether they are interested in the hobby clock product and when their catalogues go to press.

Jim

Janice did the requested work immediately and provided Jim with the information presented in Table 2.

Table 2: Potential Hobby Clocks Customers

Company Interested in Our Product? Date Catalogue Goes to Press

Contact Name

Diamond Mine Crafts Yes 150,000 units Friday Chris Raitt Garnet Tools Yes 60,000 units 2 weeks Garnet MorrisWhitesmith Crafts and Tools No NA NA Spring Mountain Tools Yes 150,000 units past, but will use inserts June Connor Porcupine Crafts Yes 250,000 units monthly Tom Cohen

CMA Canada 29

October 2003 Entrance Examination While considering these matters, Jim noticed a report on quality practices in his in-basket. He had asked Sean MacDonald, Assistant Controller, for this report a few weeks earlier. He read the following opening paragraph:

There are three kinds of quality in the world: Japanese, American, and German. In Japan they use stats to determine if the products are good through the process. They call this method Statistical Process Controls. In Germany the engineers check each product like car motors to make sure they are working good...

Jim observed that the rest of the paper was of the same, low quality. He had given Sean this assignment to keep him occupied, because Sean had a tendency to loiter and disturb his co-workers, including Jim, when he did not have enough to do. Sean had hesitated a great deal about doing this assignment because he was not confident in his writing abilities and did not have experience in conducting this type of research. Jim was not altogether surprised that the report was poor, particularly since Sean had approached him several times with questions regarding the research that Jim felt had obvious answers.

This report was very troubling to Jim. He had a lot of work to do and no time to look after Sean. Sean was error prone, did not share the finance department's values, and more than once had been heard to say, I work to live, not live to work." In reality, he appeared to have more in common with several production employees who seemed to share his lack of motivation. When Jim spoke with him about the poor quality of the report, Sean mentioned that he had not received the help he needed from Jim, so he just did the best that he could.

Quality was an issue that Jim had been hoping to address for some time. Whether PTI stayed at the old factory or moved into a new one, the company needed to bring quality under control. This was especially true in the Consumer Division, which had recently experienced the return of an inordinate number of sports and security timers due to defects. Jim knew that physical inspection had become lax and wondered whether a different approach would be better. More people could be assigned to quality control, but this approach would require hiring eight additional employees and would increase the production times for these products by five percent.

Required: As Jim Harris, develop an integrated report for Angela 's consideration, advising her on the strategic direction that should be taken after fully analyzing each option, complete with recommendations and an implementation plan, and addressing other issues and concerns requiring her attention. In undertaking this task, you will need to take into consideration your background knowledge of the company as well as the additional information provided above.

30 CMA Canada


Exhibit 1

PTI Sales for the Years 1998-2002 ($000s)

2002 2001 2000 1999 1998

Appliance 85,687 85,223 84,983 84,386 84,348

Consumer 22,810 21,735 18,335 14,430 25,654

Hobby Clocks 1,200 1,100 980 875 650

Demolition 750 1,264 664 927 2,821

Fireworks 3,553 3,172 3,679 3,238 2,879

Entertainment 7,979 7,632 7,002 5,505 2,384

Total 121,979 120,126 115,643 109,361 118,736

Exhibit 2

Precision Timing Inc. Selected Financial Data

For the Years Ended December 31 (in $000s)

2002 2001 2000 1999 1998

Current assets 97,590 94,267 89,750 86,159 85,668 Total assets 165,189 160,489 155,534 154,782 156,772 Accounts receivable 40,568 37,331 33,059 30,579 28,513 Inventory 15,892 15,523 15,195 13,583 14,315 Current liabilities 39,091 39,231 39,002 42,988 44,068 Long-term debt 13,439 14,650 16,225 17,489 19,669 Shareholders equity 112,659 106,608 100,307 94,305 93,035 Sales 121,979 120,126 115,643 109,361 118,736 Cost of goods sold 72,943 72,196 69,386 66,710 71,067 Amortization expense 5,587 6,125 6,839 7,217 8,146 Interest expense 810 880 974 1,049 1,180 Income tax expense 6,034 5,534 4,668 2,770 6,063 Net income 9,051 8,301 7,002 4,110 9,244

CMA Canada 31


Exhibit 3

Precision Timing Inc. Divisional Gross Margin

For the year ended December 31, 2002 (in 000s)

Appliance Consumer Hobby Clocks Industrial Total

Revenue $85,687 $22,810 $1,200 $12,282 $121,979 Variable production costs: Material 11,617 3,101 170 932 15,820 Labour 17,432 4,484 210 2,076 24,202 Overhead 8,738 2,254 105 2,076 13,173 Other 1,142 738 7 443 2,330 Total variable costs 38,929 10,577 492 5,527 55,525 Contribution margin 46,758 12,233 708 6,755 66,454 Fixed production costs 12,253 3,164 79 1,922 17,418 Gross margin $34,505 $ 9,069 $ 629 $ 4,833 $ 49,036

Notes: 1. Sales volumes in 2002 were as follows:

Appliance 1,904,150 configurations Consumer 2,162,140 configurations & units Hobby Clocks 310,000 units

2. Hobby clocks were sold at US$2.50 per unit. The average exchange rate in 2002 was

US$1.00 = CDN$1.55.

3. Overhead is a function of direct labour dollars.

32 CMA Canada


Exhibit 4

Angela's Memo October 6, 2003 JimHere is some information that may be useful to you.

Today, 90% of the ownership of PTI is in Anna Klatts hands. Mrs. Klatt is in her seventies, and has expressed some interest in financial planning for her familys wealth. In addition, I have learned recently that Time Eye Ltd., a Canadian firm in our industry with approximately $55 million in annual sales, may be available for purchase. These facts suggest to me that we may want to consider going public with PTI. What are the important considerations in contemplating such a move?

One of the television series, for which we provide special effects, will most likely be cancelled by the end of 2003. This contract accounted for 40% of last years entertainment revenues. There is also a chance that the other television series will be cancelled by the end of 2004. We have not received any new movie contracts this year, nor any enquiries from the major television producers. I estimate that it would cost approximately $1 million annually to keep the entertainment work unit together while we try to find them new work. It is unknown how long it would take to find another television series contract, but the longer we are out of this market the harder it will be to get back into it. I estimate that the probability of our finding another television series is 25% in the first year, 15% in the second year, 10% in the next year, and next to nothing thereafter.

I have spoken with Matt LeBlanc from the provincial Economic Development Department and he indicated that the government will give us $3 million in subsidies if we build the new plant proposed by Mike, but not if we lease it. I understand there are two approaches to accounting for this subsidy according to GAAP: financing and income. Matt seemed to think we should use the financing approach, but did not provide a reason for this opinion.

I have been reading about productivity in the clock and timer industry. In Canada, the industry average revenue per production worker has increased by about 10% over the past three years. At PTI, the average revenue per production worker has increased by only five percent over the same period. If we want to remain competitive, we must be more productive.

I know that you intended to speak with Peter about designing a version of the hobby clock that could be attached to a Velcro component, but you put this idea aside when Peter announced his resignation. I remember you telling me that you believed these new clocks could be used in a variety of hobby crafts other than woodworking and could match the sales of the hobby clock. I have done some research and determined that the variable costs for the Velcro clocks would be 10% lower than those for the hobby clocks since they would not require a mounting ring.

I have heard from several of our administrative support staff that we are not spending enough time and resources on their development. A lot of them do seem rather unmotivated and perhaps underemployed. These people are important to us, especially now that we may be busier than ever, and we do not want to lose them. What do you think? Is this a legitimate complaint or just more whining?

CMA Canada 33


Part 2 General Comments on Performance

The Part 2 case is based on a company by the name of Precision Timing Inc. (PTI) that manufactures clocks and timing devices for a wide range of applications. The Appliance Division has captured a majority of the Canadian market for appliance clocks and timers. The Consumer Division sells miscellaneous timing devices to consumers through wholesalers, retailers, and, more recently, through a Web site. The Industrial Division is comprised of a demolition line that implodes buildings, an entertainment line that provides special effects to television and movie productions, and a fireworks line. The smallest division is the Hobby Clocks Division, which manufactures small inexpensive clocks for use by hobbyists.

The company was founded by Jon Klatt in 1960, who died in August 2002 leaving 90% of the company to his widow, Anna. Neither Anna nor her children are interested in taking over the business, but are concerned with the familys financial planning, making a public offering of PTIs shares a viable alternative for the company.

Peter Burns, a long-time senior manager of PTI, initially took over Jons role at PTI, but recently left the company to pursue his own interests. Consequently, in spite of her lack of knowledge of the company, Anna Klatt found that she must take over the role as chairman of the board, at least temporarily. Angela Lund, the previous executive vice-president, was appointed President, and expressed an objective to increase the growth of the company. Several opportunities for the various divisions have presented themselves to help support this growth objective. As well, some recent threats have appeared that could hamper achieving this objective.

As the companys vice-president of finance and administration, the examination writer is expected to use an appropriate strategic approach to analyze the companys situation, assess its strategic options in light of its strengths and weaknesses, interpret and use the financial and non-financial information provided in the Backgrounder and Additional Information, and write a formal report to the president, exhibiting appropriate written communication skills. The report should advise the president on the strategic direction that should be taken, complete with recommendations and an implementation plan. This case provides an opportunity for the examination writer to demonstrate judgment skills on a number of different levels. There are several options for growth and related issues to consider, and there are several important operational issues that also require attention. Analysis of the relevant operational issues should be appropriately integrated into the various sections of the report.

Overall, performance on this examination was acceptable. Most responses reflect an effort to use the strategic planning process, focus mainly on the various strategic alternatives and the major operational issues, and present a report in a reasonably acceptable format. The responses generally reflect a good understanding and familiarity of the information provided in the Backgrounder, and an ability to draw on this

34 CMA Canada

October 2003 Entrance Examination information to identify many of the internal strengths and weaknesses of the company and, to a lesser extent, its external opportunities and threats.

In general, the responses are focused on the issues provided in the Additional Information; however, in many responses, some of the historical information provided in the Backgrounder is treated as though it is still relevant, despite the updated information provided in the Additional Information. The better responses include a comprehensive and balanced analysis of both the internal and external environments, and demonstrate extensive use of the information learned from the environmental analysis in the evaluation of the strategic alternatives and business issues.

The average response reflects an attempt to follo

Documents

Precision Timing Inc. PTI 2003 Exam CMA