Exam 9: Absorption and Variable Costing

A cost that is relevant in one decision may not be relevant in another decision

Vertical integration is the involvement by a company in more than one of the steps from securing basic raw materials to the production and distribution of a finished product

Ahrends Company makes 70,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:Direct materials. $\quad$$\quad$ £17.80 Direct labour. $\quad$$\quad$ 19.00 Variable manufacturing overhead. $\quad$$\quad$ 1.00 Fixed manutacturing ov erhead. $\quad$$\quad$ 17.10 Unit product cost. $\quad$$\quad$ £54.90 An outside supplier has offered to sell the company all of these parts it needs for £48.50 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be £273,000 per year. If the part were purchased from the outside supplier, all of the direct labour cost of the part would be avoided. However, £8.20 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company's remaining products. -What is the net total pound advantage (disadvantage) of purchasing the part rather than making it?

The opportunity cost of making a component part in a factory with no excess capacity is the

Ellis Television makes and sells portable televisions. Each television regularly sells for £210. The following cost data per television is based on a full capacity of 10,000 televisions produced each period: Direct materials £80 Direct labour £60 Manufacturing overhead ( 70 \% variable and 30\% unavoidable fixed) £40 Ellis has received a special order for a sale of 2,000 televisions to an overseas customer. The only selling costs that would be incurred on this order would be £6 per television for shipping. Ellis is now selling 6,000 televisions through regular channels each period. What should be the minimum selling price per television in negotiating a price for this special order

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 cabiet shop will drop by £20,000 per year. What is the lowest selling price per unit that could be charged for the new cabinets and still make it economically desirable to add the new product line

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 manufacture and sale of JYMPs will have no effect on other product lines. If the company discontinues the JYMP product line, the change in annual operating income due to this decision will be a

The O.T. Company makes 35,000 motors to be used in the production of its sewing machines. The cost per motor at this level of activity is:Direct materials $\quad$$\quad$$£ 4.50$ Direct labour $\quad$$\quad$$£ 4.60$ Variable manufacturing overhead. $\quad$$£ 3.75$ Fixed manufac turing ov erhead. $\quad$$£ 3.45$ An outside supplier has offered to supply all the motors the company needs for £15 each. If O.T. Company decided not to make the motors, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided. If O.T. Company decides to continue making the motor, how much higher or lower would net operating income be than if the motors are purchased from the outside supplier

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 windows held in stock

Power Systems Inc. manufactures jet engines for the United States armed forces on a cost-plus basis. The production cost of a particular jet engine is shown below: Direct materials. £200,000 Direct labour. 150,000 Manufacturing overhead: \ Supervisor's salary. 20,000 Fringe benefits on direct labour 15,000 Depreciation 12,000 Depreciation Total cost If production of this engine was discontinued, the production capacity would be idle, and the supervisor would be laid off. The depreciation referred to above is for special equipment that would have no resale value and that does not wear out through use. When asked to bid on the next contract for this engine, the minimum unit price that Power Systems should bid is

Depreciation expense on existing factory equipment is generally relevant to a decision of whether to accept or reject a special offer for a company's product

Wright Company produces products I, J, and K from a single raw material input. Budgeted data for the next month follows: $\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\quad\text { Product }$ I J K Units produced. 1,500 2,000 3,000 Per unit sales value at split-off. £10 £12 £15 Added processing costs per unit. £2 £4 £4 Per unit sales value if processed further. £15 £15 £20 If the cost of the raw material input is £78,000, which of the products should be processed beyond the split-off point? $\quad$ $\quad$ $\quad$$\text { Product }$ I J K A. yes yes no B. yes no yes C. no yes no D. no yes yes

Gary Company produces products X, Y, and Z from a single raw material input. Budgeted data for the next month is as follows: product X Y Z Units produced. 2,500 3,000 4,000 Per unit sales value at split-off. £20.00 £22.00 £25.00 Added processing costs per unit. £8.00 £8.50 £8.00 Per unit sales value if processed further. £30.00 £30.00 £35.00 If the cost of raw material input is £150,000, which of the products should be processed beyond the split-off point? $\quad$ $\quad$ $\quad$$\text { Product }$ X Y Z A. no yes no B. no yes yes C. yes no yes D. yes yes no

Fixed costs that do not differ between alternatives are sunk costs

Managers should not authorise working overtime at a workstation that contains a bottleneck

Manor Company plans to discontinue a department that has a contribution margin of £24,000 and £48,000 in fixed costs. Of the fixed costs, £21,000 cannot be eliminated. The effect of this discontinuance on Manor's net operating income would be a(an)

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 1

Freestone Company is considering renting Machine Y to replace Machine X. It is expected that Y will waste less direct materials than does X. If Y is rented, X will be sold on the open market. For this decision, which of the following factors is (are) relevant I. Cost of direct materials used II. Resale value of Machine X

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 £90,000 increase in the contribution margin of other product lines. If Balser chooses to discontinue the JYMP line, then the change in operating income next year due to this action will be a

Fixed costs are irrelevant in a decision