FEADIA LIMITED As the hinterland of Central Otago was once covered in sea, it now boasts pockets of marine fossils and other organic materials. One such deposit is found in a quarry near Middlemarch. This quarry has rich deposits of diatomite, which is a sedimentary rock made from fossilised microscopic remains of water-borne single-cell algae called diatoms. Up until 2014 a small mining operation extracted the diatomite for use in fertiliser, but it could not make consistent profits and went into receivership. Recently the quarry has been purchased by a family firm, Feadia Limited, for $30 million. The family is full of optimism about the diatomite operation. Diatomite can be used not only in fertiliser but as a filter agent, insect repellent and stock food additive in agriculture, dental fillings, adhesives and many other applications. The diatomite in Feadia's quarry is of particularly high quality so it can also be used for these other more refined products. Feadia doesn't want to suffer the same fate as its predecessor and the Managing Director, David Fea, believes producing more refined products is where the firm can make its money and ensure longevity of the firm. Feadia has started quarrying operations in September this year (2018). Once the firm's employees extract the bulk diatomite from the quarry with large digger machinery, it is transported to an on-site crushing plant by truck. Here it is crushed and passed through a screen that grades it by size into large chunks ("chunks), medium sized granules ("mids) and fine-sized granules (fines"). These graded products are fed into separate bins and transported to Dunedin by truck to a fertiliser factory which uses the different grades of diatomite in different fertiliser mixes. In September, Feadia produced 80 tonnes of chunks, 100 tonnes of mids and 80 tonnes of fines. Operating costs for the month were $500,000 variable and $800,000 fixed. The firm managed to sell most of the product to the fertiliser factory but was left with closing stock of 15 tonnes of chunks, 20 tonnes of mids and 5 tonnes of fines. The fertiliser factory paid Faedia $4/kg for chunks, $5/kg for mids and $9/kg for fines. The farming economic outlook can affect the price paid for diatomite as farmer demand for fertiliser may vary. David Fea is pleased with the September operations but is keen to further refine the products and sell them. He believes the chunks can be crushed further, vitamins added, dried and pelletised, and then bagged to give stock food which could be sold for $14/kg. The mids could be dried and bagged and sold directly as garden fertiliser 1 tonne = 1000 kilograms (kg) TURN OVER 6 ACCT222 for $17/kg. Finally the fines could have other specific materials added, then dried and sterilised to produce high quality fines suitable for dental and filtering purposes. Because of their higher quality they would sell for $20.50/kg. David has estimated the costs of these further processing operations and they are presented in Exhibit 1. Exhibit 1 Estimated unit costs of the further processing operations Stock food ($/kg) Direct materials 0.75 Direct labour 3.00 Variable overheads 2.25 Garden fertiliser ($/kg) 0.50 2.00 1.50 High quality fines ($/kg) 2.50 4.00 5.50 In addition to the above costs, another building would need to be constructed. The fixed overheads of these new further processing operations would be $700,000 monthly. In addition, special equipment is required for the crushing and dust amelioration requirements when processing chunks to stock food. It could be rented at a cost of $360,000 monthly. Although drying creates a loss in volume, it does not affect the weight of products. The quantity processed each month is predicted to be similar to September's output. David Fea is aware that the local community has a mixed reaction to the firm's presence. On the one hand the community sees employment benefits but on the other it is nervous about the detrimental environmental effects (e.g. dust, water contamination, truck movements etc) that quarrying and any further processing can bring Required: (a) Allocate the operating costs for September to chunks, mids and fines using alternatively: (i) The physical measures method; and (ii) The sales value at split-off method (8 marks) (b) If the sales price for mids dropped by 30% and sales volume for mids increased by 10%, how would the allocation of costs in the 2 methods used in requirements (a) (i) and (a)(ii) change? (6 marks) (c) Which method of allocating the operating costs would you recommend Faedia adopt? Why? (2 marks) TURN OVER (d) Ignoring the possible change described in (b) and assuming Faedia uses the physical measures method of joint cost allocation, calculate operating profit for each product and in total for September. Should any of the products not be produced? (10 marks) (e) What is the breakeven tonnes of chunks, mids and fines in September? What is the margin of safety in tonnes for each product? (6 marks) (f) On the basis of quantitative results, should Faedia further process all or some of the chunks, mids and fines products? (15 marks) (g) What other considerations might Faedia need to take into account into the further processing decision? (9 marks) (h) What do you think Faedia should do in the coming year and why? (4 marks) FEADIA LIMITED As the hinterland of Central Otago was once covered in sea, it now boasts pockets of marine fossils and other organic materials. One such deposit is found in a quarry near Middlemarch. This quarry has rich deposits of diatomite, which is a sedimentary rock made from fossilised microscopic remains of water-borne single-cell algae called diatoms. Up until 2014 a small mining operation extracted the diatomite for use in fertiliser, but it could not make consistent profits and went into receivership. Recently the quarry has been purchased by a family firm, Feadia Limited, for $30 million. The family is full of optimism about the diatomite operation. Diatomite can be used not only in fertiliser but as a filter agent, insect repellent and stock food additive in agriculture, dental fillings, adhesives and many other applications. The diatomite in Feadia's quarry is of particularly high quality so it can also be used for these other more refined products. Feadia doesn't want to suffer the same fate as its predecessor and the Managing Director, David Fea, believes producing more refined products is where the firm can make its money and ensure longevity of the firm. Feadia has started quarrying operations in September this year (2018). Once the firm's employees extract the bulk diatomite from the quarry with large digger machinery, it is transported to an on-site crushing plant by truck. Here it is crushed and passed through a screen that grades it by size into large chunks ("chunks), medium sized granules ("mids) and fine-sized granules (fines"). These graded products are fed into separate bins and transported to Dunedin by truck to a fertiliser factory which uses the different grades of diatomite in different fertiliser mixes. In September, Feadia produced 80 tonnes of chunks, 100 tonnes of mids and 80 tonnes of fines. Operating costs for the month were $500,000 variable and $800,000 fixed. The firm managed to sell most of the product to the fertiliser factory but was left with closing stock of 15 tonnes of chunks, 20 tonnes of mids and 5 tonnes of fines. The fertiliser factory paid Faedia $4/kg for chunks, $5/kg for mids and $9/kg for fines. The farming economic outlook can affect the price paid for diatomite as farmer demand for fertiliser may vary. David Fea is pleased with the September operations but is keen to further refine the products and sell them. He believes the chunks can be crushed further, vitamins added, dried and pelletised, and then bagged to give stock food which could be sold for $14/kg. The mids could be dried and bagged and sold directly as garden fertiliser 1 tonne = 1000 kilograms (kg) TURN OVER 6 ACCT222 for $17/kg. Finally the fines could have other specific materials added, then dried and sterilised to produce high quality fines suitable for dental and filtering purposes. Because of their higher quality they would sell for $20.50/kg. David has estimated the costs of these further processing operations and they are presented in Exhibit 1. Exhibit 1 Estimated unit costs of the further processing operations Stock food ($/kg) Direct materials 0.75 Direct labour 3.00 Variable overheads 2.25 Garden fertiliser ($/kg) 0.50 2.00 1.50 High quality fines ($/kg) 2.50 4.00 5.50 In addition to the above costs, another building would need to be constructed. The fixed overheads of these new further processing operations would be $700,000 monthly. In addition, special equipment is required for the crushing and dust amelioration requirements when processing chunks to stock food. It could be rented at a cost of $360,000 monthly. Although drying creates a loss in volume, it does not affect the weight of products. The quantity processed each month is predicted to be similar to September's output. David Fea is aware that the local community has a mixed reaction to the firm's presence. On the one hand the community sees employment benefits but on the other it is nervous about the detrimental environmental effects (e.g. dust, water contamination, truck movements etc) that quarrying and any further processing can bring Required: (a) Allocate the operating costs for September to chunks, mids and fines using alternatively: (i) The physical measures method; and (ii) The sales value at split-off method (8 marks) (b) If the sales price for mids dropped by 30% and sales volume for mids increased by 10%, how would the allocation of costs in the 2 methods used in requirements (a) (i) and (a)(ii) change? (6 marks) (c) Which method of allocating the operating costs would you recommend Faedia adopt? Why? (2 marks) TURN OVER (d) Ignoring the possible change described in (b) and assuming Faedia uses the physical measures method of joint cost allocation, calculate operating profit for each product and in total for September. Should any of the products not be produced? (10 marks) (e) What is the breakeven tonnes of chunks, mids and fines in September? What is the margin of safety in tonnes for each product? (6 marks) (f) On the basis of quantitative results, should Faedia further process all or some of the chunks, mids and fines products? (15 marks) (g) What other considerations might Faedia need to take into account into the further processing decision? (9 marks) (h) What do you think Faedia should do in the coming year and why? (4 marks)