Exam 9: Absorption and Variable Costing

Farnsworth Television makes and sells portable television sets. Each television regularly sells for £200. The following cost data per television are based on a full capacity of 12,000 televisions produced each period: Direct materials £75 Direct labour £55 Manufacturing overhead ( 75 \% variable and 25\% unavoidable fixed) £48 Farnsworth has received a special order for a sale of 2,500 televisions to an overseas customer. The only selling costs that would be incurred on this order would be £10 per television for shipping. Farnsworth is now selling 7,200 televisions through regular distributors each period. What should be the minimum selling price per television in negotiating a price for this special order

In 1998 a council-owned factory began selling replacement windows to outside customers for the first time. At the time the factory was making losses and the council needed to make severe budget cuts. The new customers have helped to reduce the losses in 1999 and a return to profits is required in 2000. An order for a special type of window has been received. The factory manufactures this type of window very occasionally and there is some partially completed stock from last year. The stock relates to an order from the council that was cancelled to save costs. The special windows are typically 30% complete and some of the material can be used for the new order. The accountant still has detailed records of the work done last year. The accountant has provided the following information for the factory managers. Costs incurred last year on special windows now held in stock PVC material = £5,000 Labour = £3,000 (i) The factory was planning to sell the stock of special windows to a company in Wales for £2,000. The factory would incur delivery costs of £200. (ii) Special locks required for the new order are already in stock and were purchased in 1998 at a cost of £500. The locks could be sold for £100. The factory manager believes the locks could be used on another order if they were modified. The modifications would cost £80. The locks after modification would currently cost £400 to purchase. (iii) 500 handles are required for the order. There are 600 handles in stock and they cost £3 each from supplier X. Supplier X typically supplies over 1000 handles a month. A new supplier has been found who will supply the handles for £2.50 each. (iv) Three hundred labour hours will be required for the order. The average cost per hour is £5. As the factory is busy it is expected that one hundred of the three hundred hours will be paid at the overtime rate of £8 per hour. (v) The supervisor's cost will be £1,000. No additional supervisors will be required if the order is accepted. The £1,000 does include £100 of overtime costs that will have to be paid if the order is accepted. (vi) Specialist equipment will be required for this order. This equipment is rarely used and so it is hired out to a local company. The equipment will be required for 2 weeks. Currently this specialist equipment is hired out at £300 per week. (vii) Administrative costs have been estimated at £1,000. This is a fixed cost and is included in all estimated costs (viii) The original design costs for this type of window was £5,000 in 1998. -Calculate the relevant cost for the special locks

Generally, a product line should be dropped when the fixed costs that can be avoided by dropping the product line are less than the contribution margin that will be lost

A general rule in relevant cost analysis is

Sunk costs are sometimes relevant in decision-making.

Problem 2 The cost of making component Q which forms part of product Y is stated as follows: £ Raw material 4.00 Direct labour 8.00 Variable overhead 6.40 Fixed overhead 9.60 Total absorption cost per unit 28.00 Component Q could be brought from an outside supplier for 20. b) You are required, assuming that fixed production costs will not change to state whether the company should continue making the component Q or buy it from outside. Explain the costs you use and your reasoning.

The Rewehon department at Greenwich plc manufactures high quality toy cars for customers in the London area. Selected data from the budget for the 12 months ending 31st December is available: Budget 2000 £ Sales (90,000 units) 2,700,000 Cost of goods sold (see notes 1 and 2) 1,800,000 Gross profit 900,000 Selling general \& administrative overheads (see note 3) 650,000 Profit betore tax 250,000 Note 1. Cost of goods sold includes fixed costs of £400,000 Note 2. If production is increased from 90,000 units to 100,000 units per annum it is estimated that fixed costs will increase by £20,000 Note 3. Sales commission on the existing orders is 7.5% of sales and is included in the total cost of £650,000. All other costs are assumed to be fixed. Capacity The current capacity at the factory is 100,000 units per year. In the budget for the year the company expect to sell 90,000 units. New order After agreeing the budget a company in South Africa contacted Greenwich to discuss two orders. This is an unusual situation, as the Rewehon department has never exported before. The first order is for 10,000 units but if the selling price is reduced they will place a larger order. Rewehon have to accept only 1 order. Details of the orders are as follows: Order 1* Quantity 10,000 units Selling price £22 per unit *The sales commission for this order will increase to 10%. Additional variable shipping costs will be 5% of sales value and additional insurance to export the toy cars will be £3,000. (Also refer to note 2 above) Order 2* Quantity 20,000 units Selling price £21 per unit - **The sales commission for this order will be 10%. Additional variable shipping costs will be 5% of sales value and additional insurance costs will be £8,000. (Also refer to note 2 above) Calculate the relevant fixed costs for order 2

The Tingey Company has 500 obsolete microcomputers that are carried in inventory at a total cost of £720,000. If these microcomputers are upgraded at a total cost of £100,000, they can be sold for a total of £160,000. As an alternative, the microcomputers can be sold in their present condition for £50,000. -The sunk cost in this situation is

The Rewehon department at Greenwich plc manufactures high quality toy cars for customers in the London area. Selected data from the budget for the 12 months ending 31st December is available: Budget 2000 £ Sales (90,000 units) 2,700,000 Cost of goods sold (see notes 1 and 2) 1,800,000 Gross profit 900,000 Selling general \& administrative overheads (see note 3) 650,000 Profit betore tax 250,000 Note 1. Cost of goods sold includes fixed costs of £400,000 Note 2. If production is increased from 90,000 units to 100,000 units per annum it is estimated that fixed costs will increase by £20,000 Note 3. Sales commission on the existing orders is 7.5% of sales and is included in the total cost of £650,000. All other costs are assumed to be fixed. Capacity The current capacity at the factory is 100,000 units per year. In the budget for the year the company expect to sell 90,000 units. New order After agreeing the budget a company in South Africa contacted Greenwich to discuss two orders. This is an unusual situation, as the Rewehon department has never exported before. The first order is for 10,000 units but if the selling price is reduced they will place a larger order. Rewehon have to accept only 1 order. Details of the orders are as follows: Order 1* Quantity 10,000 units Selling price £22 per unit *The sales commission for this order will increase to 10%. Additional variable shipping costs will be 5% of sales value and additional insurance to export the toy cars will be £3,000. (Also refer to note 2 above) Order 2* Quantity 20,000 units Selling price £21 per unit - **The sales commission for this order will be 10%. Additional variable shipping costs will be 5% of sales value and additional insurance costs will be £8,000. (Also refer to note 2 above) Calculate the minimum price for order 1

The Kelsh Company has two divisions--North and South. The divisions have the following revenues and expenses: North South Sales. £900,000 £800,000 Variable expenses. 450,000 300,000 Traceable fixed expenses. 260,000 210,000 Allocated common corporate expenses. 240,000 190,000 Net operating income (loss). £(50,000) £100,000 Management at Kelsh is pondering the elimination of North Division. If North Division were eliminated, its traceable fixed expenses could be avoided. The total common corporate expenses would be unaffected. Given these data, the elimination of North Division would result in an overall company net operating income of

Joint costs are not relevant to the decision to sell a product at the split-off point or to process the product further

The Cabinet Shoppe is considering the addition of a new line of kitchen cabinets to its current product lines. Expected cost and revenue data for the new cabinets are as follows:Annual sales. $\quad$$\quad$ 5,000 units Selling price per unit. $\quad$$\quad$ £180 Variable costs per unit: Production. $\quad$$\quad$ £120 Selling. $\quad$$\quad$ £15 Avoidable foed costs peryear: Production. $\quad$$\quad$ £40,000 Selling. $\quad$$\quad$ £80,000 Allocated common fixed costs per year. $\quad$$\quad$ £45,000 -If the new cabinets are added, it is expected that the contribution margin of other product lines at the cabinet shop will drop by £20,000 per year. If new cabinet product line is added next year, the increase in net operating income resulting from this decision would be

In 1998 a council-owned factory began selling replacement windows to outside customers for the first time. At the time the factory was making losses and the council needed to make severe budget cuts. The new customers have helped to reduce the losses in 1999 and a return to profits is required in 2000. An order for a special type of window has been received. The factory manufactures this type of window very occasionally and there is some partially completed stock from last year. The stock relates to an order from the council that was cancelled to save costs. The special windows are typically 30% complete and some of the material can be used for the new order. The accountant still has detailed records of the work done last year. The accountant has provided the following information for the factory managers. Costs incurred last year on special windows now held in stock PVC material = £5,000 Labour = £3,000 (i) The factory was planning to sell the stock of special windows to a company in Wales for £2,000. The factory would incur delivery costs of £200. (ii) Special locks required for the new order are already in stock and were purchased in 1998 at a cost of £500. The locks could be sold for £100. The factory manager believes the locks could be used on another order if they were modified. The modifications would cost £80. The locks after modification would currently cost £400 to purchase. (iii) 500 handles are required for the order. There are 600 handles in stock and they cost £3 each from supplier X. Supplier X typically supplies over 1000 handles a month. A new supplier has been found who will supply the handles for £2.50 each. (iv) Three hundred labour hours will be required for the order. The average cost per hour is £5. As the factory is busy it is expected that one hundred of the three hundred hours will be paid at the overtime rate of £8 per hour. (v) The supervisor's cost will be £1,000. No additional supervisors will be required if the order is accepted. The £1,000 does include £100 of overtime costs that will have to be paid if the order is accepted. (vi) Specialist equipment will be required for this order. This equipment is rarely used and so it is hired out to a local company. The equipment will be required for 2 weeks. Currently this specialist equipment is hired out at £300 per week. (vii) Administrative costs have been estimated at £1,000. This is a fixed cost and is included in all estimated costs (viii) The original design costs for this type of window was £5,000 in 1998. -Calculate the relevant cost for the design costs

Any cost that is avoidable is relevant for decision purposes

Balser Company manufactures and sells a product called JYMP. Results of last year for the manufacture and sale of JYMP's are as follows: Sales ( 8,000 . J Y M P s at £120 each). £960,000 Less costs: Variable production costs. 464,000 Sales commissions (15\% of sales). 144,000 Salary of product line manager. 100,000 Fixed product line advertising. 160,000 Fixed manutacturing overhead. 132,000 Total costs. 1,000,000 Net operating loss. £(40,000) -Balser anticipates no change in the operating results for JYMP in the foreseeable future. Balser is reexamining all of its product lines and is trying to decide whether or not to discontinue the manufacture and sale of JYMPs. Total fixed manufacturing overhead costs would not be affected by a decision to drop any one product line. Assume that discontinuing the JYMP line would result in a £158,000 increase in the contribution margin of other product lines. How many JYMPs would have to be sold next year for the company to be as well off as if it just dropped the line and enjoyed the increase in contribution margin from other products?

Talboe Company makes wheels that it uses in the production of children's wagons. Talboe's costs to produce 200,000 wheels annually are as follows: Direct materials £40,000 Direct labour. 60,00 Variable manufacturing overhead 30,000 Fixed manufacturing overhead Total An outside supplier has offered to sell Talboe similar wheels for £0.80 per wheel. If the wheels are purchased from the outside supplier, £25,000 of annual fixed manufacturing overhead would be avoided and the facilities now being used to make the wheels would be rented to anther company for £55,000 per year. - What is the highest price that Talboe could pay the outside supplier for each wheel and still be economically indifferent between making or buying the wheels?

The Tingey Company has 500 obsolete microcomputers that are carried in inventory at a total cost of £720,000. If these microcomputers are upgraded at a total cost of £100,000, they can be sold for a total of £160,000. As an alternative, the microcomputers can be sold in their present condition for £50,000. -What is the net advantage or disadvantage to the company from upgrading the computers rather than selling them in their present condition?

When there is a production constraint, a company should emphasise the products with

Peluso Company, a manufacturer of snowmobiles, is operating at 70% of plant capacity. Peluso's plant manager is considering making the headlights now being purchased from outside supplier for £11.00 each. The Peluso plant has idle equipment that could be used to manufacture the headlights. The design engineer estimates that each headlight requires £4.00 of direct materials, £3.00 of direct labour, and £6.00 of manufacturing overhead. Forty percent of the manufacturing overhead is a fixed cost that would be unaffected by this decision. A decision by Peluso Company to manufacture the headlights should result in a net gain (loss) for each headlight of

Decision problems are faced by a company which produces a range of products and the data is as follows: Problem 1 The normal selling price of a product is £22 and the full absorption cost per unit is as follows: £ Raw materials 8.00 Direct Labour 4.00 Variable overhead 3.20 Fixed overhead 4.80 Total absorption cost per unit 20.00 There is the possibility of supplying a special order of 2,000 units of product x at £16 each. If the order were not accepted, the normal budgeted sales would not be affected and the company has the necessary capacity to produce the additional units. a) You are required, assumed that fixed production costs will not change, to state whether the company should accept the special order above. Explain the costs you use and your reasoning.