Question
To help illustrate the source of these distortions to senior management, Peterzon decided to develop a simple four-product model. He decided it would be helpful
To help illustrate the source of these distortions to senior management, Peterzon decided to develop a simple four-product model. He decided it would be helpful if the actual production costs of the four products were known a priori (see Table A).
A | B | C | D | |
Material cost | 15 | 5 | 10 | 5 |
Direct labor | 30 | 5 | 15 | 10 |
Variable overhead | 15 | 7.5 | 5 | 7.5 |
Variable Cost | 60 | 17.5 | 30 | 22.5 |
Fixed Cost | 10 | 10 | 12,500 | 12,500 |
Product lines A and B used identical equipment that could each produce 1,000 units of A or B. Product lines C and D used identical equipment that could each produce 1,000 units of C or D. He then calculated the direct labor allocation rate that the existing single burden rate cost system would generate assuming that each product sold a thousand units, the maximum that could be produced, and that each direct labor hour cost $5. Under this scenario, the costs incurred would be:
Variable Product Overhead | Labor Hours Per Unit | Variable Overhead/unit | No. Units | Total Labor Hours | Total |
A | 6 | 15 | 1 | 6 | 15 |
B | 1 | 7.5 | 1 | 1 | 7.5 |
C | 3 | 5 | 1 | 3 | 5 |
D | 2 | 7.5 | 1 | 2 | 7.5 |
Total | 4 | 12 | 35 |
and the new allocation rate:
Variable overhead | 35,000 |
Fixed Overhead | 45,000 |
Total Cost to be Allocated | 80,000 |
Labor Hours ($60,000/5) | 12,000 |
Allocation rate/hour | $6.67 |
Using this allocation rate per hour, Peterzon calculated the standard cost of the four products.
Product | A | B | C | D |
Material | 15 | 5 | 10 | 5 |
Labor | 30 | 5 | 15 | 10 |
Allocated Cost | 40 | 6.67 | 20 | 13.33 |
Standard Cost | $85 | 16.67 | 45 | 28.34 |
If the firm set out to make a 40% mark-on,b then it would want to charge the following prices for the four products:
Product | A | B | C | D |
Standard Cost | 85 | 16.67 | 45 | 28.34 |
40% Mark-on | 34 | 6.67 | 18 | 11.34 |
Selling Price | $119 | 23.34 | 63 | 39.68 |
Mark-on % = profit/cost
If industry selling prices were established using actual production costs and a 40% mark-on, they would be:
Product | A | B | C | D |
Standard Cost | 70 | 27.5 | 42.5 | 35 |
40% Mark-on | 28 | 11 | 17 | 14 |
Selling Price | $98 | 38.5 | 59.5 | 49 |
By comparing the "industry" prices to the firm's costs and assuming that the firm had to match industry prices, Peterzon could determine which products would appear profitable.
Selling Price | 98 | 38.5 | 59.5 | 49 |
Standard Cost | 85 | 16.67 | 45 | 28.34 |
Profit | 13 | 21.83 | 14.5 | 20.66 |
Markup | 15% | 131% | 32% | 73% |
CCI had recently adopted a policy of discontinuing all products whose mark-ons were under 25%. Under this policy, product A would be dropped and additional product B manufactured. Assuming the firm could sell all of product B that it could manufacture, then the sales would be
Budgeted | A | B | C | D |
Current Volume | 1,000 | 1,000 | 1,000 | 1,000 |
Actual Volume | 0 | 2,000 | 1,000 | 1,000 |
The unused production capacity was used to produce an additional 1,000 units of B.
The resulting product mix was so different from the starting mix that Peterzon decided to recalculate the allocation rate per hour to determine if it had been affected:
Costs Incurred ($ thousand)
Variable Product Overhead | Labor Hours/Unit | Variable Overhead/ Unit | No. Units | Total Labor Hours | Total |
B | 1 | 7.5 | 2,000 | 2,000 | 15,000 |
C | 3 | 5 | 1,000 | 3,000 | 5,000 |
D | 2 | 7.5 | 1,000 | 2,000 | 7,500 |
Total | 4,000 | 7,000 | 27,500 |
and the new allocation rate:
Variable Overhead : 27,500
Fixed Overhead: 45,000
Labor Hours ( 35,000/5) : 7,000
Allocation rate/hour: $10.36
Question: Alternatively if the rule was to drop the product with the lowest contribution margin, which product would you drop? Please fill out the tables below for the remaining products:
Variable product overhead | Labor hours per unit | variable overhead/unit | no. of units | total labour hours | total |
Total |
New allocation rate: | |
variable overhead | |
fixed overhead | |
total cost to b allocated | |
labor hours | |
Allocation rate ($per hour) |
Do not fill out the column for dropped off product.
Standard costs ($) | A | B | C | D |
Material Cost | ||||
Direct Labor | ||||
Variable Overhead allocation | ||||
Fixed overhead allocation | ||||
Standard full cost | ||||
Selling price based on actual costs with 40% mark on (given in the case) | ||||
Selling price based on standard costs with 40% mark on (given in the case) |
Do not fill out the column for dropped off product.
Analysis table | A | B | C | D |
Mark on % (actual cost based selling price-standard full cost)/standard full cost) | ||||
contribution margin (actual cost based selling price-variable cost) |
Based on above analysis which product(s) will drop off? Why? Explain briefly.
Based on above fill out the table below for total production and sale ($):
Do not fill out the column for dropped off product.
Gross profitability table based on production | A | B | C | D | Total |
Number of units produced | |||||
Revenue based on actual cost price | |||||
Total variable cost | |||||
Contribution margin | |||||
Fixed costs | |||||
Gross margin |
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