Cost Accounting for Decision-making Home Assignment
3. Personal preference of Peter to ride on his own bike or Hilary’s one
(1 mark each, max: 2) (Total: 10 marks) Question 3
(a) In the view that fixed overheads are unavoidable, Fenny Company should not accept the offer because it can save $3* per unit if the lenses are manufactured internally instead of making
external direct purchase. (5 marks)
*Workings:
Make Buy
$ $
Direct materials 8
Direct labor 9
Variable overhead 5
Purchase price 25
Total costs 22 25
(b) Since the incremental cost of using the production capacity of other type of lens is approximately
$4 per unit (i.e. the fixed overheads), the maximum external acceptable purchase price would be
$26 per unit. (3 marks)
(Total: 8 marks) Question 4
(a) Component A B C Total
($000) ($000) ($000) ($000) Direct materials (15,000 x $60 / 30,000 x $75 / 60,000 x $30) 900 2,250 1,800 4,950 Direct labor (15,000 x $120 / 30,000 x $135 / 60,000 x $60) 1,800 4,050 3,600 9,450 Variable overhead (15,000 x $30 / 30,000 x $45 / 60,000 x $15) 450 1,350 900 2,700
Specific fixed overhead 15 75 90 180
3,165 7,725 6,390 17,280
General fixed overhead 450
Total manufacturing costs 17,730
(6 marks)
(b) Component A B C Total
($000) ($000) ($000) ($000) Payment to the supplier
(15,000 x $90 / 30,000 x $315 / 60,000 x $150)
1,350 9,450 9,000 19,800 Additional carriage inward
(15,000 x $1 / 30,000 x $1 / 60,000 x $1) 15 30 60 105
Additional indirect labor 38
General fixed cost ($450,000 - $280,000) 170
Total outsourcing costs 20,113
(5 marks) (c) An extra cost of $2,383,000 ($20,113,000 - $17,730,000) would be incurred if all the components are outsourced, therefore the company should not do so. (3 marks) (d) The manufacturing costs for A is $3,165,000 {15,000 x $(60 + 120 + 30) + $15,000}, which is greater than the outsourcing costs of $1,365,000 {15,000 x $(90 +1)}, therefore the company should outsource A.
The manufacturing costs for B is $7,725,000 {30,000 x $(75 + 135 + 45) + $75,000}, which is less than the outsourcing costs of $9,480,000 {30,000 x $(315 +1)}, therefore the company should produce B.
The manufacturing costs for C is $6,390,000 {60,000 x $(30 + 60 + 15) + $90,000}, which is less than the outsourcing costs of $9,060,000 {60,000 x $(150 +1)}, therefore the company should produce C.
If the company wants to maximize the profit, the company should outsource A and produce B and C, and the total costs will be $15,968,000 as shown below:
$’000
Purchase price for A (15,000 x $90) 1,350
Manufacturing costs for B and C
{30,000 x $(75 + 135 + 45) + 60,000 x $(30 + 60 + 15) + $75,000 +$90,000} 14,115
General fixed cost 450
Additional carriage inward (15,000 x $1) 15
Additional indirect labor 38
Total costs 15,968
(6 marks)
(e) Qualitative factors which would influence the decision to make or buy are:
1. Dependability of suppliers: Whether the external supplier can be relied upon for the delivery of goods at a specified time.
2. Availability of resources: Whether there is any limitation on the company to have access to the available resources to make the components intenally.
3. Quality control of purchased goods: Whether it would be difficult for the company to have control over the quality of the goods purchased.
4. Technology and personnel: Whether the company has the required special technology and personnel to produce the components.
5. Trend of future costs of production: Whether the future costs of production of the component from the supplier would increase relative to the cost of production by the company.
(5 marks) (Total: 25 marks) Question 5
(a) A ($) B ($) C ($) D ($)
Selling price 15 18 10 4.5
Direct materials (4.5) (3.5) (2.5) (0.8)
Direct labor (6) (8) (4) (1.6)
Variable manufacturing overheads (VOH) (W1) (1.2) (1.6) (0.8) (0.32)
Contribution margin 3.3 4.9 2.7 1.78
Contribution margin per DLH 22 24.5 27 44.5
Ranking 4 3 2 1
(6 marks) (W1) Direct labor required for A: $6 / $40 = 0.15 per unit
Direct labor required for B: $8 / $40 = 0.2 per unit Direct labor required for C: $4 / $40 = 0.1 per unit Direct labor required for D: $6 / $40 = 0.04 per unit VOH for A = $8 x 0.15 = $1.2
VOH for B = $8 x 0.2 = $1.6 VOH for C = $8 x 0.1 = $0.8 VOH for D = $8 x 0.04 = $0.32
(b) Product Hour required / unit Units Hours
D 0.04 hour 125,000 5,000
C 0.1 hour 24,000 2,400
B 0.2 hour 10,000 2,000
A 0.15 hour 8,000 1,200
Total hours required 10,600
The company does not have enough production capacity to fulfil the expected sales since the total number of hours required for producing all the four products is 10,600, while the production capacity of the compant is only 10,000 hours.
To maximize its profits, the company should produce 125,000 units (5,000 hours) of D, 24,000 units (2,400 hours) of C, 10,000 units (2,000 hours) of B, and 4,000 units (10,000 – 5,000 –
2,400 – 2,000 = 600 hours) of A. (4 marks)
(c) Because the additional capacity would be used to produce A, the company should be willing to pay up to $66 per hour ($40 usual rate plus $22 contribution margin per hour for A) for additional
labor time. (2 marks)
(d) The company may consider to ask the labor to work overtime; add another shift; expand the workforce; outsource part of the work to external suppliers; and eliminate wasted labor time in
the production process etc. (3 marks)
(Total: 15 marks)
Question 6
(a) This order will consume 720 {6 x (6000 / 50)} machine hours per month for three months. Since there is excess capacity of 1,000 {5,000 × (100% − 80%)} machine hours per month, Shiny Company can accept this order without expanding its current capacity. (3 marks) (b) The company only has to charge the incremental variable costs per box for this order because it
has enough capacity to handle this order.
$
Direct material 5
Direct labor 7
Variable manufacturing overhead 4
Additional cost of repacking 1
Minimum price to be charged for this order 17
Therefore, the minimum price for this order is $17 per box. (5 marks) (c) Factors that the company should consider before making a final decision:
- The company should determine whether the estimate costs are accurate as they are average costs in the past only.
- The company should also consider how its regular customers might react to the lower price offered to the retail shop.
(2 marks) (Total: 10 marks)
Question 7
(a) Impact of dropping Model 003 on operating income:
$’000 Reduction in contribution margin:
Model 003 (70)
Model 002 (12.5)
Cost savings:
Utilities expense 50
Wages and salaries 28
Advertising expense 11
Increase in operating income 6.5
Therefore, Model 003 should be dropped because the company can increase the income by
$6,500. (6 marks)
(b) Impact of increasing advertising expense on operating income:
$’000 Increase in contribution margin ($70,000 x 50%) 35
Increase in advertising expense (32)
Increase in operating income 3
From (a), if the company drops Model 003, the operating profit will be increased by $6,500.
From (b), if the company increases the advertising expense on Model 003, the operating profit will be increased by $3,000. As a conclusion, the company still should drop Model 003.
($6,500 > $3,000 by $2,500) (6 marks)
(Total: 12 marks) Question 8
(a) If the company purchases the new machine and disposes the old one:
$ Difference in disposal value at the end of 5 years ($60,000 - $3,000) 57,000 Decrease in annual operating costs {5 $(50,000 – 35,000) 75,000 Decrease in rework cost (160,000 x 0.02 x $0.5 x 5) 8,000
Disposal value of the old machine at present 40,000
Purchase cost for new machine (170,000)
Net benefit 10,000
Pleasure Company should replace the old machine with the new one because it can gain a net
benefit of $10,000. (7 marks)
(b) The purchase cost of the old machine is a sunk cost. (1 mark) (c) Other factors need to consider:
(1) Will sales be increased because of a lower defective rate after using the new machine?
(2) Does the company have enough cash to purchase the new machine? (2 marks) (Total: 10 marks)
Question 9
$ Sales value after further procession ($23 x 450) 10,350
Sales value at present ($15 x 500) (7,500)
Incremental revenue 2,850
Further processing cost (2,600)
Net benefit 250
The company should further process C03 into D04 as the net benefit is $250 for each ton of cotton.
The allocated cost of $80,000 is not relevant in this decision. (5 marks) (Total: 5 marks) Question 10
(a) $
Material X (Irrelevant cost) 0
Material Y 90,000
Direct labor 80,000
Net cost of machinery ($100,000 - $40,000) 60,000
Total relevant costs 230,000
Contract price 350,000
Contribution 120,000 (8 marks)
(b) The sales manager should go ahead to tender this project because the company can earn $120,000
more of profit with the tender price at $350,000. (2 marks)
(c) The sales manager should not take the advice from the production managers to set the tender price at $350,000 because:
(i) The costs calculated in (a) do not represent incremental cash flows arising from undertaking the contract.
(ii) Assume the company has enough capacity, supervision costs and overheads are irrelevant for determining the contribution for the project
(iii) Any sales revenue in excess of $230,000 will provide an additional contribution which will result in an increase in profits.
(iv) The competitor is prepared to accept the order at $250,000, then a tender price slightly below
$250,000 would be appropriate.
(v) If the tender price is set at $250,000, then there is still a profit of $20,000 ($250,000 -
$230,000) from the project.
(2 marks each, max: 6 marks) (d) Before accepting the project, the following qualitative factors should be considered.
(i) Is there sufficient spare capacity to undertake the project?
(ii) Is the oversea customer credit worthy?
(iii) Does the workforce have the necessary skills to undertake the project?
(iv) Is the contract likely to result in repeat sales from the oversea customer?
(4 marks) (Total: 20 marks)