During their senior year at Clarkson College, two business students, Gerry Keating and Louis Lamont, began a part-time business making personal computers. They bought the various components from a local supplier and assembled the machines in the basement of a friend's house. Their only cost was $216 for parts; they sold each computer for $360. They were able to make three machines per week and to sell them to fellow students. The activity was appropriately called Keating & Lamont Computers (KLC). The product quality was good, and as graduation approached, orders were coming in much faster than KLC could fill them.
A national CPA firm made Ms. Lamont an attractive offer of employment, and a large electronics company was ready to hire Mr. Keating. Students and faculty at Clarkson College, however, encouraged the two to make KLC a full-time venture. The college administration had decided to require all students in the schools of business and engineering to buy their own computers beginning in the coming fall term. It was believed that the quality and price of the KLC machines would attract the college bookstore to sign a contract to buy a minimum of 1,000 units the first year for $400 each. The bookstore sales were likely to reach 2,000 units per year, but the manager would not make an initial commitment beyond 1,000.
The prospect of $400,000 in annual sales for KLC caused the two young entrepreneurs to wonder about the wisdom of accepting their job offers. Before making a decision, they decided to investigate the implications of making KLC a full-time operation. Their study provided the following information relating to the production of their computers:
Components from wholesaler.............................................. $ 160 per computer
Assembly labor........................................................................ 12 per hour
Manufacturing space rent...................................................... 1,800 per month
Utilities..............................................................................360 per month
Janitorial services..................................................................288 per month
Depreciation of equipment....................................................... 2,304 per year
Labor........................................................................ 2 hours per computer
The two owners expected to devote their time to the sales and administrative aspects of the business.
Required
a. Classify each cost item into the categories of direct materials, direct labor, and manufacturing overhead.
b. Classify each cost item as either variable or fixed.
c. What is the cost per computer if KLC produces 1,000 units per year? What is the cost per unit if KLC produces 2,000 units per year?
d. If the job offers for Mr. Keating and Ms. Lamont totaled $100,000, would you recommend that they accept the offers or proceed with plans to make KLC a full-time venture?