THERMO-CHEM, INC.

*
*This case was written by Ramzi Haddad, Lehigh University.

Thermo-Chem, Inc. manufactures a specialized pressure vessel

designed to keep chemicals heated to at least 190 degrees Fahrenheit
while in transit to the point of use. The vessels are guaranteed to keep
the chemicals at this temperature and in a liquid state for at least 21
days, thus allowing the chemicals to be transported over long
distances. The high temperature is required for certain chemicals that
must be transported in a liquid state or they will solidify in the
container, forcing additional procedures and equipment for unloading
the vessel.

As an example, the chemical toluene, which is used in making

urethane foam and sheet plastics, is in a liquid state above 190
degrees Fahrenheit. Below this temperature, toluene solidifies and
must be returned to the liquid state to be removed from its container.
The traditional method of carrying this chemical to a customer’s site is
to transport it in a Teflon-lined stainless steel container. The chemical
turns quickly into its solid state once in the vessel and remains in that
state until it is delivered to the customer’s site. Once there, steam is
circulated through heating coils that are wrapped around the vessel.
This procedure, called heat soaking, requires the steam to be applied
for three days to re-liquefy the chemical. A steam source must be
readily available at or near the user’s site, requiring additional
investment in equipment. Once in a liquid state, the unloading process
requires six hours.

In the early 1980s, Global Chemicals, Inc. developed a new method

that improved costs and reduced cycle time related to delivering
toluene to user sites. The new design uses a thin-walled stainless steel
inner vessel that is wrapped in special composite insulating materials
and encased inside a vacuum chamber. Both the insulation materials
and the vacuum space provide insulating properties, which maintain
the chemical in its liquid state during transport. In addition, internal
steam heating coils are built into the vessel to allow for heat soaking
should the vessel be in transit for longer than 21 days or should it fail.
The advantages of the new design include saving 3 days in delivery
time through the elimination of the heat soaking process, unloading
the vessel in one hour instead of the traditional six hours, and
eliminating the need to provide equipment for the steam heating step.
Thermo-Chem, Inc. was started in 1990 by the two chemists who had
worked for Global Chemicals, Inc. and developed the new method. The
chemists, Dr. James Andersen and his wife, Dr. Christine Andersen, saw
an opportunity to extend this technology to other industries as well.
The concept of keeping liquids within a certain temperature range had
applications in transporting beer, wine, fruit juices, chocolates, and
various food and pharmaceutical ingredients. After studying the
market and determining that no one was even considering producing
this kind of vessel, the Andersens decided to leave Global and go into
production as a privately held company located in Chicago.

It was not long before customers from many industries were buying
vessels from Thermo-Chem. The company has enjoyed steady growth
over the past five years, despite stiff competition from Global in the
chemicals market. Thermo-Chem’s vessels are priced at around
$50,000. Trade terms currently being extended to customers are as
follows: 20 percent of the order price is required at the signing of the
contract, with the outstanding balance becoming due on a net 30
basis.

The company supplies its vessels to countries worldwide and prides

itself on its ability to custom-design the vessels to meet customer
needs. While the basic design and thermal technology applied is
essentially the same, Thermo-Chem customizes the vessels for
approximately 90 percent of all its customer orders. With competition
only from Global in the chemicals market, the entire organization has
not been pushed to keep up with current technology, to be cost-
competitive, or to provide on-time deliveries. As a consequence, most
of its customers in the foods and pharmaceuticals industries would
readily go to another supplier if one were available.

The current business atmosphere has changed in recent months and

competition is looming on the horizon. A small Canadian firm, adept in
plastics technology, has developed a special polymer tank that touts
the same functionality and guarantee for 21-day travel. The prime
costs, direct labor and materials, are substantially lower than those
required to build Thermo-Chem’s vessels. In addition, they are lighter
and easier to transport, thus allowing the vessel sizes to be larger and
increasing the quantity of liquid product that can be shipped at one
time.

Thermo-Chem’s vessels are fabricated from stainless steel, requiring

hours of welding and incurring long raw materials lead time. The cycle
time from order placement to customer delivery is between 28 and 32
weeks. This includes 8 weeks for design, 12 weeks for materials lead
time, and 8 weeks for manufacturing. The new Canadian tanks have a
much shorter cycle time of 20 weeks. They achieve this through
shorter materials lead times and the use of concurrent engineering,
and by focusing on standard designs rather than on custom made-to-
order vessels. Although focused on standard designs, the Canadian
firm does also produce a small volume of custom made-to-order
vessels.

Financial Data for Thermo-Chem (In thousands):

1995 1994 1993

Sales 24,950 23,150 21,850

Cost of Goods Sold 19,211 16,668 14,421
Gross Profit 5,739 6,482 7,429
General & Administrative Expenses 2,994 3,009 2,622
Selling Expenses 998 1,041 874
Earnings before Income Taxes 1,747 2,432 3,933
Provision for Income Taxes 681 948 1,533
Net Income 1,066 1,484 2400
Analysis of Manufacturing Costs (In thousands):

I. Direct Materials

Flexible Budget:
Actual Costs Flexible Budget: Flexible Budget: Standard Inputs
Incurred: Actual Inputs × Actual Inputs × Allowed for
Actual Inputs × Standard Rate Standard Rate Actual Outputs ×
Period Actual Price (Purchases) (Usage) Standard Rate

1st Q 1993 1,755 1,798 1,658 1,785

2nd Q 1993 2,358 2,359 2,109 2,214
3rd Q 1993 2,557 2,558 2,478 2,499
4th Q 1993 1,968 1,954 1,971 1,969
1st Q 1994 2,104 2,103 2,099 2,046
2nd Q 1994 2,548 2,450 2,458 2,346
3rd Q 1994 2,807 2,688 2,688 2,456
4th Q 1994 2,200 2,109 2,256 2,095
1st Q 1995 2,813 2,601 2,785 2,569
2nd Q 1995 2,922 2,788 2,666 2,459
3rd Q 1995 3,065 2,955 2,872 2,548
4th Q 1995 2,712 2,488 2,771 2,398

II. Direct Labor

Actual Costs Flexible Budget:

Incurred: Flexible Budget: Standard Inputs Allowed
Actual Inputs × Actual Inputs × for Actual Outputs ×
Period Actual Price Standard Rate Standard Rate

1st Q 1993 923 981 994

2nd Q 1993 992 1,006 1,020
3rd Q 1993 1,081 1,093 1,121
4th Q 1993 970 968 973
1st Q 1994 978 966 1,098
2nd Q 1994 1,178 1,091 1,088
3rd Q 1994 1,310 1,226 1,227
4th Q 1994 1,069 1,003 1,005
1st Q 1995 1,366 1,276 1,279
2nd Q 1995 1,412 1,305 1,325
3rd Q 1995 1,551 1,439 1,422
4th Q 1995 1,319 1,233 1,231

If Thermo-Chem expects to be competitive in the very near future, it

needs to reevaluate all aspects of its business. Recently, Thermo-Chem
has engaged the services of a business consulting firm to review its
organizational structure, policies, and procedures. The following is the
summary of the consulting firm’s findings.
VENDORS
Over the past five years Thermo-Chem has depended
upon a dozen suppliers for all of the materials needed in
its manufacturing processes. However, lately the
production manager has been exclusively dealing with
two companies on the West Coast, despite the fact that
there are many cost-competitive companies within a 90-
mile radius of the plant. All suppliers have a net 30
agreement with Thermo-Chem.

THE CURRENT INFORMATION SYSTEM

Thermo-Chem’s current information system is primarily
manual with the exception of the accounting
department, which utilizes a personal computer for
record keeping tasks. The accounting department owns
a 386 SX PC, which is used to perform general ledger,
accounts receivable, accounts payable and payroll
functions for record keeping tasks. Access to the PCs is
restricted by a password code to ensure that
unauthorized users will not access the company’s
records. Only the accounting department’s employees
have the password to access the PCs. Once a month, the
hard drives of the PCs are backed up to magnetic tape to
reduce the risk of data loss.

THE ORGANIZATION’S MANAGEMENT

The Andersens own the business; however, health
problems in recent years have forced them to spend less
time with the business. They appointed a general
manager in 1992 to manage the operation. The general
manager, Steve Crawford, has been basically left on his
own to run the business. He and the product design
manager, John Preston, control all operations and consult
with each other when making most decisions. Whenever
in doubt, Crawford always defers to Preston because of
his technical expertise. Crawford feels that Preston will
always make decisions that will protect the company’s
proprietary information, thus ensuring that Thermo-
Chem will maintain market exclusivity. Unfortunately,
Preston has concentrated solely on metals and has not
expanded his knowledge into alternative materials such
as plastics. In addition, Preston “sets his own agenda,”
follows his own timetables, and only pursues internal
 projects of personal interest to him. This has caused
much conflict with the other groups in the organization,
especially in the manufacturing area.

The following functions report directly to the general

manager:

n Product design manager—John Preston (4 engineers

and 6 draftsmen)
n Sales manager—Scott Hayes (1 salesman)
n Controller—Larry Feldman (2 accountants, accounts
payable clerk, accounts receivable clerk, billing clerk,
mail room clerk, payroll clerk, shipping clerk,
receiving clerk)
n Production manager—Ed Franklin (4 supervisors, 55
hourly workers, 1 stockroom clerk)
n Manager of support services—Patrick Delany (1
safety, 1 MIS)

The total number of employees is 95 and production is a two-

shift operation.

SALES DEPARTMENT
The sales department is in a unique position: customers
seek out Thermo-Chem because it has cornered the
market with virtually no competition except in the
chemicals market. Therefore, only limited sales effort is
expended to promote its products. The sales department
employs one sales representative, who is compensated
on a commission basis. When a customer wishes to place
an order, the sales representative arranges for a
meeting to discuss the customer’s needs and
requirements. After determining the customer’s needs,
the sales representative meets with the product design
engineering staff to brief them on the customer’s specific
design requirements. Product design then proceeds to
create a bill of materials and a cost estimate for the
entire project. Two copies of the bill of materials are
created: the first is filed in the product design
department and the other is sent with the cost estimate
to the sales representative. The sales representative
then applies a profit mark-up to the cost estimate as he
sees fit, and then provides a written quote to the client.
When the client accepts the quote, a signed copy of the
quote is remitted back to the sales representative, who
 uses it to approve the customer’s credit and to create a
multicopy sales order. The sales order is distributed as
follows:

Sales Order Copies:

1. File copy  filed in sales office in open sales
order file
2. Customer  sent to customer
3. Invoice  sent to billing department
4. Shipping notice  sent to shipping department
5. Packing slip  sent to production with bill of
materials
6. Ledger copy  sent to billing department

PRODUCTION
In order to facilitate efficient materials management and
purchasing, the raw materials records are placed under
the direct control of the production manager. In addition,
the production manager is also responsible for the
storeroom function.
The production manager relies on the bill of materials to
check for the availability of raw materials. If the needed
items are on hand, the production manager completes a
work order form, signs it, and gives it to the storeroom
clerk. The work order is the document that authorizes
the storeroom clerk to release the required raw materials
to the production employees. The production manager
then posts the transaction to the raw materials records.
In the case where excess materials are required for the
same batch under production, no other formal
documents are needed. If materials are not available,
the production manager selects a supplier, completes a
purchase order (four copies), signs it, and distributes it
as follows:

1. First copy is sent to the supplier

2. Second copy is sent to accounts payable
3. Third copy is filed in the production department
4. Fourth copy is sent to the receiving department

A production clerk is responsible for keeping track of

direct labor, raw materials, and overhead costs for each
batch of vessels produced. When the product is
completed, the cost data is sent to the accounting
 department, where it is posted to the general ledger
accounts by an accounting clerk.

Once the project is completed, the employees who

worked on the job inspect their work, test and approve it,
and enclose the packing slip with the finished product.
The finished vessel is then transferred to the shipping
department.

SHIPPING
When the finished vessels arrive at the shipping
department, the shipping notice is used to fill out a bill of
lading (one copy) for the goods. After the vessels are
shipped to the customer, the clerk stamps the shipping
notice “shipped” and sends it to the billing department
as proof of shipment. He also gives the bill of lading to
the shipper. Finally, the clerk records the shipment in the
shipping log.

BILLING CLERK
Upon receipt of the invoice from the sales department,
the billing clerk sends the invoice to the customer. The
ledger copy is also sent at that time to the accounts
receivable clerk. After the job is completed, the billing
clerk receives the shipping notice from the shipping
department. Billing then sends the shipping notice to the
sales department, which uses it to close the open sales
order. Finally, the billing clerk records the transaction in
the sales journal.

ACCOUNTS RECEIVABLE CLERK

Upon receipt of the ledger copy (sales order) from the
sales department, the accounts receivable clerk inputs
the sales data into the customer’s account in the
accounts receivable module of the accounting package.
The ledger copy is then filed.

On receipt of the cash prelist and the remittance advice

from the mail room, the clerk reconciles the remittance
advices to the prelist to ensure completeness of the list
 and then uses the prelist to post the transaction to the
customer’s account.

Periodically, the clerk posts journal vouchers to the

general ledger accounts to reflect changes in
receivables.

MAIL ROOM
The mail room receives the customers’ checks along
with the remittance advice, which are then passed to an
administrative secretary who prepares a cash prelist
denoting the checks received. The prelist and the
remittance advices are sent to the accounts receivable
clerk in the accounting department. The administrative
secretary then proceeds to record the checks received in
the cash journal and to prepare a bank deposit slip.
Checks are usually deposited in the bank at the close of
each week. Once a month, the administrative secretary
performs a bank reconciliation.

Periodically, the administrative secretary prepares a

journal voucher and sends it to the accounts receivable
clerk for posting to the general ledger account.

RECEIVING DEPARTMENT
All goods received are first inspected and counted by the
receiving clerks. Upon completion of the inspection and
the count, a clerk prepares a receiving report indicating
both the quantity and the condition of the inventory
received. This report is then reconciled to the purchase
order to ensure exact quantity and conformity of the
goods. Copies of the receiving report are distributed as
follows:

1. First copy is filed in the receiving department

2. Second copy accompanies the goods to the
warehouse
3. Third copy is sent to accounts payable
4. Fourth copy is sent to the production manager and
serves as basis to update inventory records

ACCOUNTS PAYABLE CLERK

 Upon receipt of the invoice from the vendor, the accounts
payable clerk retrieves copies of the receiving report and
the purchase order from the pending file and reconciles
them to the invoice. He then records the transaction in the
manual purchases journal and posts it to the vendor’s
account in the computer-based accounts payable
subsidiary ledger to reflect the liability. After recording the
liability, the clerk files the invoice along with its supporting
documents in the accounts payable open file according to
due date. Finally, the clerk posts a journal voucher to the
computer-based general ledger accounts.

When the invoice is due, the accounts payable clerk debits

the vendor’s account in the accounts payable subsidiary
ledger, prepares a computer-generated check for the
invoice amount, and records the check number and
amount in the cash disbursements journal. Finally, the
clerk signs the check and mails it to the vendor.

Periodically, the clerk summarizes the entries to the cash

disbursements journal and posts journal vouchers to the
general ledger accounts.

PERSONNEL AND PAYROLL

Employees at Thermo-Chem are categorized as either
management or direct labor. Management employees are
salaried, while direct labor employees work on an hourly
basis. The payroll department utilizes time cards to verify
hours worked by factory workers. Although not required to
punch in, management employees nevertheless are
required to complete weekly time summaries indicating
hours worked.

HIRING PROCEDURES
When additional employees are needed, the head of the
respective department advertises the vacancy. Prospective
employees are interviewed by a designated employee,
usually in the same field as the potential employee. Once
an employee is hired, the payroll clerk completes W-4
forms and prepares a personnel file for that employee
indicating salary, position, and benefits.

At the beginning of each week, the payroll clerk reviews

the employment status of each factory employee. The
clerk prepares an open time card for each employee and
 gives these to the factory supervisor, who places them on
the board adjacent to the time clock. At the end of each
week, the supervisor reviews the completed time cards
including his own, initials them, and sends them to the
payroll clerk. The payroll clerk then manually calculates
regular and overtime hours for each employee. This
information is entered by the clerk into the computerized
payroll system, which prepares the payroll checks and
records the amounts in the payroll journal and employee
records. The clerk then posts the journal voucher to the
general ledger and signs the checks. Finally, he hands the
checks to the supervisor, who distributes them to the
employees.
As for management employees, the clerk enters the payroll
information into the computerized payroll system. The
system generates the payroll checks and automatically
records the amounts in the payroll journal and employee
records. The clerk then posts the journal voucher to the
general ledger and signs the checks. Finally, he distributes
the checks to the employees. Once a month, the payroll
clerk performs a bank reconciliation of the payroll account.

CASE REQUIREMENTS
1. Develop a formal organizational chart based on the information
given.

2. Design the new system in detail. The design should contain the
following items:
a. Data flow diagrams describing the system at the context
level, intermediate levels, and detailed levels.
b. A systems flowchart of the new information system,
showing automated and manual procedures.
c. A discussion of the appropriate accounting controls for the
new system.