CHAPTER 2 - AN INTRODUCTION TO COST TERMS AND PURPOSES 2-22 Direct, indirect, fixed, and variable costs. California Tires manufactures two types of tires that it sells as wholesale products to various specialty retail auto supply stores. Each tire requires a three-step process. The first step is mixing. The mixing department combines some of the necessary direct materials to create the material mix that will become part of the tire. The second step includes the forming of each tire where the materials are layered to form the tire. This is an entirely automated process. The final step is finishing, which is an entirely manual process. The finishing department includes curing and quality control. Required: 1. Costs involved in the process are listed next. For each cost, indicate whether it is a direct variable, direct fixed, indirect variable, or indirect fixed cost, assuming units of production of each kind of tire is the cost object. Costs: Rubber Mixing department manager Reinforcement cables Material handlers in each department Other direct materials Custodian in factory Depreciation on formers Night guard in factory Depreciation on mixing machines Machinist (running the mixing machine) Rent on factory building Machine maintenance personnel in each department Fire insurance on factory building Maintenance supplies for factory Factory utilities Cleaning supplies for factory Finishing department hourly laborers Machinist (running the forming machines) 2. If the cost object were the mixing department rather than units of production of each kind of tire, which preceding costs would now be direct instead of indirect costs? 2-23 Classification of costs, service sector. Market Focus is a marketing research firm that organizes focus groups for consumer-product companies. Each focus group has eight individuals who are paid $60 per session to provide comments on new products. These focus groups meet in hotels and are led by a trained, independent marketing specialist hired by Market Focus. Each specialist is paid a fixed retainer to conduct a minimum number of sessions and a per session fee of $2,200. A Market Focus staff member attends each session to ensure that all the logistical aspects run smoothly. Required: Classify each cost item (AH) as follows: a. Direct or indirect (D or I) costs of each individual focus group. b. Variable or fixed (V or F) costs of how the total costs of Market Focus change as the number of focus groups conducted changes. (If in doubt, select on the basis of whether the total costs will change substantially if there is a large change in the number of groups conducted.) You will have two answers (D or I; V or F) for each of the following items: Cost Item D or IV or F A. Payment to individuals in each focus group to provide comments on new products B. Annual subscription of Market Focus to Consumer Reports magazine C. Phone calls made by Market Focus staff member to confirm individuals will attend a focus group session (Records of individual calls are not kept.) D. Retainer paid to focus group leader to conduct 18 focus groups per year on new medical products E. Recruiting cost to hire marketing specialists F. Lease payment by Market Focus for corporate office G. Cost of tapes used to record comments made by individuals in a focus group session (These tapes are sent to the company whose products are being tested.) H. Gasoline costs of Market Focus staff for company-owned vehicles (Staff members submit monthly bills with no mileage breakdowns.) I. Costs incurred to improve the design of focus groups to make them more effective 2-24 Classification of costs, merchandising sector. Band Box Entertainment (BBE) operates a large store in Atlanta, Georgia. The store has both a movie (DVD) section and a music (CD) section. BBE reports revenues for the movie section separately from the music section. Required: Classify each cost item (AH) as follows: a. Direct or indirect (D or I) costs of the total number of DVDs sold. b. Variable or fixed (V or F) costs of how the total costs of the movie section change as the total number of DVDs sold changes. (If in doubt, select on the basis of whether the total costs will change substantially if there is a large change in the total number of DVDs sold.) You will have two answers (D or I; V or F) for each of the following items: Cost Item D or IV or F A. Annual retainer paid to a video distributor B. Cost of store managers salary C. Costs of DVDs purchased for sale to customers D. Subscription to DVD Trends magazine E. Leasing of computer software used for financial budgeting at the BBE store F. Cost of popcorn provided free to all customers of the BBE store G. Cost of cleaning the store every night after closing H. Freight-in costs of DVDs purchased by BBE 2-27 Variable and Fixed Costs. Consolidated Motors specializes in producing one specialty vehicle. It is called Surfer and is styled to easily fit multiple surfboards in its back area and top-mounted storage racks. Consolidated has the following manufacturing costs: Plant management costs, $1,992,000 per year Cost of leasing equipment, $1,932,000 per year Workers wages, $800 per Surfer vehicle produced Direct materials costs: Steel, $1,400 per Surfer; Tires, $150 per tire, each Surfer takes 5 tires (one spare). City license, which is charged monthly based on the number of tires used in production: 0500 tires $ 40,040 5011,000 tires $ 65,000 more than 1,000 tires $249,870 Consolidated currently produces 170 vehicles per month. Required: 1. What is the variable manufacturing cost per vehicle? What is the fixed manufacturing cost per month? 2. Plot a graph for the variable manufacturing costs and a second for the fixed manufacturing costs per month. How does the concept of relevant range relate to your graphs? Explain. 3. What is the TOTAL manufacturing cost (VC & FC) of EACH (per) vehicle if: a) 80 vehicles are produced each month? b) 205 vehicles? c) How do you explain the difference in the manufacturing cost per unit? 2-28 Variable costs, fixed costs, relevant range. Gummy Land Candies manufactures jaw-breaker candies in a fully automated process. The machine that produces candies was purchased recently and can make 5,000 per month. The machine costs $6,500 and is depreciated using straight-line depreciation over 10 years assuming zero residual value. Rent for the factory space and warehouse and other fixed manufacturing overhead costs total $1,200 per month. Gummy Land currently makes and sells 3,900 jaw-breakers per month. Gummy Land buys just enough materials each month to make the jaw-breakers it needs to sell. Materials cost 40 per jaw-breaker. Next year Gummy Land expects demand to increase by 100%. At this volume of materials purchased, it will get a 10% discount on price. Rent and other fixed manufacturing overhead costs will remain the same. Required: 1. What is Gummy Lands current annual relevant range of output? 2. What is Gummy Lands current annual fixed manufacturing cost within the relevant range? What is the annual variable manufacturing cost? 3. What will Gummy Lands relevant range of output be next year? Calculate TOTAL annual fixed and TOTAL variable manufacturing costs for NEXT year? o (Assume that if it needs to Gummy Land could buy an identical machine at the same cost as the one it already has.) 2-32 Total and unit cost, decision making. Gayles Glassworks makes glass flanges for scientific use. Materials cost $1 per flange, and the glass blowers are paid a wage rate of $28 per hour. A glass blower blows 10 flanges per hour. Fixed manufacturing costs for flanges are $28,000 per period. Period (nonmanufacturing) costs associated with flanges are $10,000 per period and are fixed. Required: 1. Graph the fixed, variable, and total manufacturing cost for flanges, using units (number of flanges) on the x-axis. 2. Assume Gayles Glassworks manufactures and sells 5,000 flanges this period. Its competitor, Floras Flasks, sells flanges for $10 each. Can Gayle sell below Floras price and still make a profit on the flanges? 3. How would your answer to requirement 2 differ if Gayles Glassworks made and sold 10,000 flanges this period? Why? W