Safad Systems, Inc, manufactures and sells small engines to other manufacturing companies who install them in their products. Safad currently produces all the components used in these engines but is considering an offer from foreign supplier who proposes to supply a starter (one of the components) used in these engines. Safad's production is constrained by the capacity of an automated specific machine as a total of 1,200 machine hours are available annually. Each starter requires 0.8 hours of machine time; annual production is limited to 1,500 starters. Currently, this machine is used exclusively to make the starters. The following financial information concerning starters are available: Starters Selling price per starter Cost per starter Direct materials Direct labor ($18 per hour) Manufacturing overhead Selling and administrative expense Margin per starter $92.4 26.7 2.7 1.89 9.24 67.55 Safad management expects that they can sell 2,300 starters annually if the company had sufficient capacity. Instead of purchasing an additional machine, management has contacted a foreign reliable supplier who offered to supply Safad up to 1,080 starters at $72 per unit, which Safad can sell to its customers at its normal selling price. Mohammad Jamal, Safad' production manager, has suggested that the company could make better use of the machine by producing another product (BCB), which requires only 0.12 hours of machine time per unit. Mohammad believes that Safad could sell up to 2,100 BCB units per year to customers at a price of S39 per unit. The following data gas been provided by accounting department concerning BCB: BCB Selling price per frame Cost per frame: Direct materials Direct labor ($18 per hour) Manufacturing overhead Selling and administrative expense 39 10.5 13.5 3.9 3735 1.65 Margin per unit B units could be manufactured using the with equipment and personnel. Manufacturing of the manufacturing overhead is estimated at The BC overhead is allocated on the basis of direct labor-hours. Most fixed, but some of it is variable. The variable manufacturing overhead has been $0.63 per starter and $0.36 per BCB. Selling and administrative products on the basis of sales. Although most of the selling and administrative expenses are fixed, it has been estimated that variable selling and administrative expenses amount to S0.51 per starter and would be $0.24 per BCB. The normal workweek for full-time employees (direct and indirect) is considered to be 40 hours. expenses are allocated to Required: 1. Shall Safad use the margins of starters and BCBs in the decision of producing the BCB? Explain. 2. Compute the contribution margin per unit for: a. Purchased starter. b. Manufactured starter. c. Manufactured BCB. 3. Determine the number of starters (if any) that should be purchased and the number of Starters and/ or BCBs (if any) that should be manufactured. What is the change Safad's net income that would result from this plan over current operations? When you presented your analysis to the Safad's top management, two managers got into an argument about treating direct labor costs when making this decision. While one manager argued that direct labor should be treated as a variable cost, another manager argued that direct labor should be considered a fixed cost. Whether the machine is used to make starters or BCBs the total salaries and wages would be the same. There is enough idle time, to accommodate an increase in total direct labor time that the BCBs would require. 4. If you treated direct labor as a fixed cost in requirements (2) and (3) above, redo them making the opposite assumption (treating it as a variable cost). If you treated direct labor as a variable cost, redo your analysis treating it as a fixed cost. S. What do recommend Safad to treat direct labor-as a fixed cost or as a variable cost? Explain
