Memories, Inc. Part One (cost driver and pre-determined overhead) Memories, Inc. (MI) produces souvenir figurines that are sold wholesale to gift shops. They have created a new line of dolls representing historical figures. The company's goal is to produce and sell 350,000 dolls each year. MI plans to keep approximately a one-month supply of dolls in finished goods inventory. MI will have 10 production lines. Each of the five workers on each line will be responsible for one of the five stages of production: molding, cleaning, painting, finishing, and packaging. Each of the 10 production lines can produce 20 dolls per hour. MI deals exclusively with Quality Materials, Inc. to purchase raw materials and equipment. All materials (plastic, molds, paint, etc.) are delivered within two days of ordering and MI generally holds only a one- or two- day supply in raw materials inventory. The projected materials costs are: Material cost per doll Plastic $.12 Doll molds .20 Varnish .08 Paint .30 Packaging .04 Direct labor employees are paid on an hourly basis according to hours worked. Once production-line workers finish a day's scheduled production, they are sent home. They can work a maximum of 8 hours each day without earning overtime. The overtime premium is an additional 50% of the base hourly rate of $7.50 per hour. Supervisors and other indirect labor employees are salaried. Labor Costs (estimated) Rate for direct labor $7.50 per hour (plus $2.50 per hour in fringe benefits) During the first year of operations, Memories, Inc. estimated that they would produce 346,125 dolls but actually produced 336,033. Actual direct materials costs were $248,664 and actual direct labor costs were $840,082 for 84,008 hours worked. Estimated overhead costs for the year were $191,700 while actual overhead was $193,000. Required: A. What is an appropriate cost driver for allocating overhead to dolls in Year 1? (Explain your reasoning for choosing the driver.) B. Calculate the predetermined overhead rate using the cost driver of units produced. HINT: POHR = Estimated OH / Estimated units produced C. Using normal costing, compute the cost of one of the 336,033 dolls produced in Year 1. (Round to the nearest dollar.) HINT: DM+DL+applied OH (applied OH = POHR x actual units produced. D. Was overhead over- or under-applied during the year? By how much? Why do you think this happened? Part Two (COGS, COGM two products) In its second year of operations, Memories, Inc. has decided to expand the product line by producing replicas of historic buildings. These replicas will require the purchase of new building molds at a cost of $.18 per replica. Of course, new doll molds will not be required. All other materials and prices will remain the same. The replicas require additional processing time because of the details on the buildings that limits production to 18 replicas per hour per assembly line. The replicas are not expected to affect the sales of dolls. In the second year of operations, MI expects to produce and sell about 352,800 dolls and 25,200 replicas. Increasing production is expected to increase overhead costs by 5% in Year 2. Direct labor costs per hour are not expected to change, but the number of labor hours is estimated to be 94,500. The costs of product promotion and advertising are expected to increase to $3,000 per month. All other selling and administrative costs are expected to remain the same as in Year 1. Actual production in Year 2 was 345,132 dolls and 25,200 replicas. Direct material costs transferred to Work-in-Process were $259,000 for dolls and $15,624 for replicas. Direct labor costs were $862,830 for the dolls and $70,010 for replicas, representing 86,283 and 7,001 direct labor hours, respectively. Actual overhead costs were $203,600. Required: A. Can Memories, Inc. still allocate overhead in Year 2 using the same cost driver used in Year 1? If not, what appears to be the most logical cost driver to use? (Explain your answers and support your reasoning.) B. Compute a predetermined overhead rate for MI in Year 2 using labor hours. (HINT: POHR = Estimated OH$/Estimated labor hours) C. Using normal costing and the predetermined rate from B, compute the total manufacturing cost for 345,132 dolls and 25,200 replicas produced in Year 2, as well as the cost per doll and the cost per replica. Was overhead under- or over-applied? By how much? (HINT: DM+DL+OH applied (POHR x actual labor hours) Part Three (ABC) George Jefferson, the accounting manager at MI, has just returned from a conference on activity-based costing and thinks MI should consider implementing an ABC system. George has identified five primary activities taking place in the production facilities at MI, has traced Year 2 overhead costs to each activity, and has identified a cost driver for each activity as follows: Estimated Year 2 Overhead Costs Using ABC Activity Monthly Overhead Cost Cost Driver Materials delivery and handling $4,620 Number of shipments Molding and cleaning $3,150 Number of molds Painting and finishing $5,670 Direct labor hours Packaging $1,260 Number of figurines Quality inspections $2,100 Number of inspections Based on information about production needs and the differences for each type of product (replicas are not uniform in size, dolls need more inspection, etc.) George has estimated the following activity for each cost driver: Dolls Replicas Total Number of shipments 52 108 160 Direct labor hours 87,500 7,000 94,500 Number of figurines 352,800 25,200 378,000 Number of molds 2,500 500 3,000 Number of inspections 80,000 4,000 84,000 Required: A. Using the preceding activities and cost drivers, calculate a predetermined overhead rate for each activity. HINT: Note you will have to annualize the OH costs B. Using ABC, how much estimated overhead would be allocated to a doll? to a replica? C. Compare the estimated overhead allocation using ABC to the estimated overhead allocation using direct labor hours (HINT: use POHR from Part 2B x actual labor hours above). What do you think is the cause of the differences? D. What are some of the advantages and disadvantages of using ABC in this case? E. Would you suggest that MI adopt an ABC system? Why or why not? F. Does the information provided by the ABC system give you some insight into areas of possible cost reduction? What areas have the greatest potential for cost reduction, and what are the potential impacts on the business from these cost reductions? Part Four (High-Low Method) During the first two years of operations, Memories, Inc.'s overhead costs have fluctuated from month to month. Although overhead appears to go up and down according to the number of figurines produced each month, the accounting manager has noticed that this is not always the case. For example, in the fourteenth month of operations, the manufacturing facility was closed for almost 10 days because of severe weather and production for that month was very low. However, overhead costs were only reduced by 25% from the prior month. In an effort to estimate overhead costs for Year 3, George has collected the following information for the past 24 months of operation and has asked for your assistance in analyzing the data. Month Figurines Produced Total Overhead Costs 1 25,784 $17,200 2 25,897 $17,300 3 25,750 $17,450 4 26,352 $17,600 5 27,567 $17,950 6 28,492 $18,125 7 27,398 $17,900 8 28,112 $17,955 9 29,499 $18,507 10 28,879 $18,295 11 29,344 $18,325 12 29,399 $18,550 13 30,879 $19,825 14 15,167 $14,800 15 28,379 $18,732 16 29,765 $19,832 17 30,334 $19,965 18 30,761 $19,786 19 31,300 $20,359 20 31,804 $20,149 21 31,795 $20,508 22 32,016 $20,489 23 32,379 $21,166 24 32,675 $20,852 Required: A. Analyze the data, with and without month 14, using the high-low method. Estimate both the fixed costs and variable cost per unit and create the cost equation with and without month 14. Does the data from the 14th month impact the accuracy of the cost equation? B. Should the accounting manager consider using a different independent variable instead of number of figurines? What would you suggest? C. For Year 3, MI estimates January production of 33,000 figurines. Based on that expected production, how much overhead would you estimate MI will incur in January. (Use High-Low method without month 14 data) Explain your answer. Part Five (CVP Analysis) During the third year of operations, Memories, Inc. estimates that 415,000 figurines (385,000 dolls and 30,000 replicas) will be produced. Direct material costs per unit are $.74 per doll and $.62 per replica. Direct labor costs are $2.51 per doll and $2.78 per replica. Monthly fixed selling and administrative costs are $15,300 while monthly fixed manufacturing overhead is $2,851. The variable overhead cost is $.55 per figurine. Sales price for the replicas is $5.25 each and the sales price for the dolls is $5.00 each. Required: (For each independent question, refer to the original information above.) A. Compute the break-even point in Year 3 for the figurines. How many dolls and how many replicas must be sold to break-even? HINT: annualize fixed costs HINT: Use Weighted Average Contribution Margin sales mix % = 92.77% dolls 7.23% replicas) B. What options does MI have to reduce the break-even point? Discuss both the quantitative and qualitative factors that must be considered with each option. C. How many dolls and replicas, respectively, would MI need to sell in Year 3 to earn a before-tax profit of $150,000? D. If its tax rate is 30 percent, how many figurines does MI need to sell in Year 3 to earn an after-tax profit of $150,000? E. How will the break-even point change if the sales mix changes to 80 percent dolls and 20 percent replicas? F. What would happen to the break-even point if labor costs increased by 10 percent for each type of figurine (go back to the sales mix of 92.77% / 7.23%) G. What would happen to the break-even point if MI increased the sales price of replicas to $5.50 and dolls to $5.25 (go back to original to original labor costs and original sales mix of 92.77% / 7.23%)? Part Six (Special Order) In March of Year 3, Memories, Inc. receives a special order from a local museum to purchase 5,000 dolls and 3,000 replicas for a special exhibit. Required: A. Assuming that MI has sufficient excess capacity, what is the minimum price the company would be willing to accept for this special order? Part Seven (Budgets) Memories, Inc., needs a cash budget for Year 3 and has provided you with the following information. Sales are all on account (no cash) and are estimated to be collected over a three-month period, with 70 percent collected in the month of sale, 25 percent collected in the next month, and 4 percent collected in the third month. The remaining 1 percent is estimated to be uncollectible. December and November sales from Year 2 were $201,638 and $185,000, respectively. Because of the lag in collecting cash from sales on account, MI delays payment on some of its purchases of materials. MI estimated that 60 percent of each month's material purchases are paid in the month of purchase and 40 percent in the following month. The accounts payable balance for materials at the end of Year 2 was $20,000. MI requires a minimum balance of $40,000 in cash at the end of each month. The company will use its line of credit when needed to bring the balance up to that minimum level. For any money borrowed, the interest rate is 6 percent compounded annually. For simplicity, you can assume that cash is borrowed on the first day of the month and that loan repayments are made at the end of the month. The loan payable balance at the end of Year 2 was zero. The cash balance at the end of Year 2 was $40,000. Memories, Inc. plans to exercise the option on the leased production equipment in March (see Part Seven). The purchase price on the equipment will be $153,450 with payments of $3,260.36 per month. MI also plans on expanding the existing production space in May at a cost of $200,000. The company would like to finance the expansion out of current earnings and so will use the line of credit, if necessary, in May. The expansion will cause fixed manufacturing overhead to increase by $10,000 per month, starting in May. To remind you, the following costs still hold: Direct material costs $.74 per doll and $.62 per replica Direct labor costs $2.51 per doll and $2.78 per replica Fixed selling and admin costs $15,300 per month Fixed manufacturing overhead costs $2,851 per month Variable overhead costs $.55 per figurine Sales price $5.00 per doll and $5.25 per replica Required: A. Prepare a cash receipts budget for Year 3, assuming estimated sales of 385,000 dolls and 30,000 replicas. HINT: Start with annual sales revenue = units x $ per unit; then use the % below to estimate monthly sales. The following chart shows the monthly distribution of these sales: January 8.3% July 8.5% February 9.2% August 9.8% March 10.3% September 7.5% April 7.6% October 9.1% May 8.0% November 7.2% June 6.9% December 7.6% B. Prepare a cash disbursements for product costs budget for Year 3. HINT: DM+DL+VOH+FOH (note that FOH changes during the year for the purchase of the equipment)