Question
Precision Ltd. (PL) is a private company that manufactures circular saw blades. Caroline Reynolds, the president, is concerned that PL has been losing its market
Precision Ltd. (PL) is a private company that manufactures circular saw blades. Caroline Reynolds, the president, is concerned that PL has been losing its market share, and its operating results are deteriorating. You, CPA, have been contracted to help PL resolve the production and sales issues it is currently experiencing. In the initial phase of the engagement, you begin by reviewing budgeted costs and the cost allocations used by PL. In your review of direct manufacturing costs, you note that PL has recently upgraded to computer-aided manufacturing equipment that has virtually eliminated waste and spoiled units. As a result, direct labour costs have been cut by 20% per year over the last five years. Caroline doesn't think it is possible to reduce costs any further. Caroline provided you with the standard cost report (Appendix I) that was drafted when planning for the current year's budget. This report explains how PL currently allocates overhead costs
Question PL's vice-president of manufacturing is concerned about scheduling and doesn't know how she is going to manage production, especially if the Jigsaw blades are added. She tells you, "We've been working at close to capacity, using 175,000 of the available 190,000 machine hours, and costs have been right on target. It's the scheduling of work on machines that is causing me the biggest headache. We're just managing to keep up with the sales orders, and with a new product, I'm worried we'll end up with backorders." She would like you to evaluate the best way to utilize the production capacity given the budgeted sales (including the Jigsaw blades) and maximum machine hours. She has asked you to focus on just the quantitative analysis but still provide a recommendation.
Appendix I Precision Ltd. Standard cost summary Coarse Grade Fine Grade Diamond Tip Standard unit costs: Direct materials $1.25 $ 2.25 $ 3.75 Direct labour 0.75 0.90 0.80 Overhead (Note 1) 8.25 9.90 8.80 Total manufacturing costs 10.25 13.05 13.35 Variable selling and administrative costs (Note 2) 0.35 0.55 1.10 Fixed selling and administrative costs (Note 3) 0.31 0.39 0.40 Full cost per unit $10.91 $13.99 $14.85 Labour hours per unit 0.04 0.05 0.06 Machine hours per unit 0.25 0.25 1.00 Unit sales 90,000 330,000 70,000 Selling price per unit $11.00 $14.50 $25.00 Notes: 1. Manufacturing overhead is allocated to products at a predetermined rate based on direct labour in dollars. Budgeted overhead = $4,625,500* Budgeted direct labour $420,500 = $11.00 per dollar of direct labour hour cost *90% of total overhead is composed of depreciation, regular machine maintenance, related salaries, and other fixed manufacturing costs. The remaining 10% of overhead costs is variable and includes the costs of operating the machines. 2. Variable selling and administrative costs consist entirely of sales commissions. Commission amounts per unit were negotiated with the salespeople two years ago. 3. Fixed selling and administrative costs are allocated to products at a predetermined rate based on total manufacturing costs. Budgeted fixed selling and administrative costs = $187,600 l Budgeted total manufacturing costs $6,163,500 = 3% of manufacturing costs
Appendix II Jigsaw blade line The estimated annual sales volume is 80,000 Jigsaw blades. Each blade requires 0.3 machine hours, and the wholesale selling price per blade is $10.00. The costs per blade will be: Direct materials $ 2.25 Direct labour 0.50 Overhead 5.50 Variable selling and administrative costs 1.10 Fixed selling and administrative costs 0.46 Total costs 9.81 Net income per blade $ 0.19 Overhead costs per blade have been calculated consistent with the circular saw blades that is, estimated direct labour hour cost $11.00, or $0.50 $11.00 = $5.50. Fixed selling and administrative costs comprise additional advertising costs of $18,550 that would need to be incurred to sell the Jigsaw blades.
After receiving your memo and findings, Caroline says she has been giving some thought to why the costing issues were never previously identified and assessed. She says, "Our production managers are assessed and awarded a bonus based on annual sales. As a result, they are not concerned with costs or profitability. PL needs to look at other perspectives in addition to annual sales. For example, we also want to make sure our resources are being used efficiently, our employees receive adequate training, and our customers are satisfied with the product they ultimately receive. Do you have any suggestions for a better way to measure PL's success?" Identify key goals and for each goal design an alternative way to measure the company's success by including specific metrics that Caroline should consider.
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