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 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.

Task #1

PL currently allocates non-direct costs to product lines based on a variety of drivers (Appendix I). Caroline would like you to evaluate the current allocations and advise whether or not they are appropriate. Using your recommendations, provide the updated full cost per unit for each product line.

Task #2

The vice-president of sales thinks he can improve results by adding a new product line: Jigsaw blades (Appendix II). He is certain the Jigsaw blades will make "tons of money," but the cost and profit projections aren't supporting his claim. Caroline would like to know whether the Jigsaw blades have the potential to make a significant contribution to the company's net income. You advise Caroline that the best strategy would be to look at the incremental contribution of adding Jigsaw blades to the product line, and the two of you agree that you will perform only a quantitative analysis at this point.

Task #3

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.

Core 2 - Integrated Problem 7 Problem Appendix I Precision Ltd. Standard cost summary Coarse Fine Diamond Grade Grade 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) 0.26 0.40 0.46 Full cost per unit $10 86 $14 00 $14 91 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 = $3.075.000* Budgeted direct labour $279,500 = $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 = $184 260 Budgeted total manufacturing costs $6,142,000 = 3% of manufacturing costs CPA CHARTERED PEP 4/ 13 CPA COMPTABLES PROFESSIONAL PROFESSIONNELS ACCOUNTANTS AGREES PFPCore 2 - Integrated Problem 7 Problem 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. CPA CHARTERED PROFESSIONAL 5/ 13 ACCOUNTANTS PEP CPA COMPTABLES PROFESSIONNELS AGREES PFP