At Merton's monthly planning meeting in July 1988, the company's president expressed dissatisfaction with Merton's financial performance during the six-month period January-June 1988. "I know we are operating at capacity in some of our production lines," he remarked to Merton's controller and sales and production managers. "But surely we can do something to improve our financial position. Maybe we should change our product mix. We don't seem to be making a profit on our Model 101 truck. Why don't we just stop making it altogether? Maybe we should purchase engines from an outside supplier, relieving the capacity problem in our engine assembly department. Why don't the three of you get together, consider the different options, and come up with a recommendation?"

Production Possibilities and Standard Costs

The Merton Truck Company manufactured two specialized models of trucks, Model 101 and Model 102, in a single plant in Wheeling, Michigan. Manufacturing operations were grouped into four departments: engine assembly, metal stamping, Model 101 assembly, and Model 102 assembly.

Capacity in each department was expressed in manufacturing machine-hours available (net of maintenance downtime). Machine-hours available, in conjunction with machine-hours required for each truck model in each department, determined Merton's "production possibilities." For example, the company's engine assembly capacity was sufficient to assemble engines for either 4,000 Model 101 trucks per month (4,000 machine-hours available 1 machine-hour required per truck) or 2,000 Model 102 trucks per month (4,000 machine-hours available 2 machine-hours per truck), if devoted fully to either model. Of course, Merton could also assemble engines for both models: for example, if 1,000 Model 101 trucks were produced, sufficient engine assembly capacity was available for 1,500 Model 102 trucks ([4,000 - 1,000 * 1.0] / 2.0). Data on the machine-hour requirements for each truck model in each department and the monthly machine-hour availability in the departments are given in Table A. The company could sell as many trucks as it could produce.

Merton's production schedule for the first six months of 1988 had resulted in a monthly output of 1,000 Model 101 trucks and 1,500 Model 102 trucks. At this level of production, Model 102 assembly and engine assembly were operating at capacity. However, metal stamping and Model 101 assembly were operating at only 83.3% and 40% of capacity, respectively. Table B gives standard costs at this level of production; Table C gives details on overhead costs

Meeting of the Controller, Sales Manager, and Production Manager

"I have been studying the figures for standard costs for the two truck models," the sales manager began. "Why don't we just stop making Model 101 trucks? As I see it, we are losing $1,205 for each Model 101 truck we sell." (A Model 101 truck sold for $39,000, a Model 102 truck for $38,000.)

The controller objected. "The real problem is that we are trying to absorb the entire fixed overhead of Model 101 assembly over only 1,000 trucks. We would be better off increasing production of Model 101 trucks, cutting back if necessary on Model 102 production."

The production manager entered the discussion. "There is a way to increase Model 101 production without cutting back on Model 102 production," he said. "We can relieve the capacity problem in engine assembly by purchasing Model 101 or Model 102 engines from an outside supplier. If we pursue this alternative, I suggest we furnish the necessary materials and engine components, and reimburse the supplier for labor and overhead."

Table A

Machine-hours: Requirements and Availability

Table B

Standard Product Costs

Table C

Overhead Budget for 1988

1. What is the contribution toward fixed costs if only Model 101 is built?

2. What is the contribution toward fixed costs if only Model 102 is built?

3. What is the total contribution toward fixed costs using their current mix of 1000 Model 101 trucks and 1500 Model 102 trucks?

Machine-hours Required per Truck Model 101 Model 102 Total Machine-hours Available per Month Department Engine assembly Metal stamping Model 101 assembly Model 102 assembly 1.0 2.0 2.0 2.0 2.0 4,000 6,000 5,000 4,500 3.0 Model 101 $24,000 Model 102 $20,000 Direct materials Direct labor Engine assembly Metal stamping Final assembly 1,200 800 2.000 2,400 600 1,500 4,000 4,500 Overheada Engine assembly Metal stamping Final assembly 2,525 3,480 6,200 4,850 3,080 3,500 12,205 $40,205 11,430 $35,930 Total a. See Table C. Table C Overhead Budget for 1988 Total Overhead Fixed Overhead per Montha per Months Variable Overhead Unit Model 101 Model 102 Department ($ millions) ($ millions) Engine assembly Metal stamping Model 101 assembly Model 102 assembly 9.80 8.10 6.20 5.25 29.35 $4,000 2,000 1.70 2.70 2.70 1.50 8.60 $2,100 2,400 3,500 2,500 $8,500 $8,000 a. Based on a monthly production rate of 1,000 Model 101 trucks and 1,500 Model 102 trucks. b. Fixed overhead was distributed to the two truck models in proportion to degree of capacity utilization