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Management Accounting - Module 4

Relevant Costs!

The Special Order Pricing Decision!

involves the sale of normal or customized products at a


discounted or special price!

if idle capacity exists, lowest price = !


variable cost of special order !
+ differential fixed costs to the order/units in special
order !

if idle capacity does not exist, lowest price = above, plus!


contribution forgone from normal sales that are lost
(i.e. displaced by the special order!

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Management Accounting - Module 4

The Special Order Pricing Decision cont d!

loss of normal customers need to be assessed!

if products have short customer use life and/or repeat customers


are important, loss of normal customers may have a long-term
profitability impact!

problem solving:!
calculate the incremental income from the special order= CM
from special order - any differential fixed costs!
if positive and does not displace regular sales, accept if it can
be contained!
if positive and displaces regular sales, consider long-term
impact of lost customers!

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Problem 1 Relevant Costs (Special Orders)


Anchor Company manufactures several different styles of jewelry cases. Management estimates that
during the third quarter of 20x6 the company will be operating at 80% of normal capacity. Because
Anchor desires a higher utilization of plant capacity, the company will consider a special order. Anchor
has received special-order inquiries from two companies. The first order is from JCP, Inc., which would
like to market a jewelry case similar to one of Anchor's cases. The JCP jewelry case would be
marketed under JCP's own label. JCP, Inc., has offered Anchor $5.75 per jewelry case for 20,000
cases to be shipped by October 1, 20x6. The cost data for the Anchor jewelry case, which would be
similar to the specifications of the JCP special order, are as follows:
Regular selling price per unit

$9.00

Costs per unit:


Raw materials
Direct labor 0.5 hours @ $6.00
Overhead 0.25 machine hours @ $4.00

$2.50
3.00
1.00

Total costs

$6.50

According to the specifications provided by JCP,Inc., the special-order case requires less expensive raw
materials. Consequently, the raw materials will cost only $2.25 per case. Management has estimated that
the remaining costs, labor time, and machine time will be the same as for the Anchor jewelry case.
The second special order was submitted by the Krage Company for 7,500 jewelry cases at $7.50 per case.
Like the JCP cases, these jewelry cases would be marketed under the Krage label and have to be shipped
by October 1, 20x6. However, the Krage jewelry case is different from any jewelry case in the Anchor
line. The estimated per-unit costs of this case are as follows:
Raw materials
Direct labor 0.5 hours @ $6.00
Overhead 0.5 machine hours @ $4.00

$3.25
3.00
2.00

Total costs

$8.25

In addition, Anchor will incur $1,500 in additional setup costs and will have to purchase a $2,500 special
device to manufacture these cases; this device will be discarded once the special order is completed.
The Anchor manufacturing capabilities are limited to the total machine hours
available. The plant
capacity under normal operations is 90,000 machine hours per year or 7,500 machine hours per month.
The budgeted fixed overhead for 20x6 amounts to $216,000. All manufacturing overhead costs are
applied to production on the basis of machine hours at $4.00 per hour.
Anchor will have the entire third quarter to work on the special orders. Management does not expect any
repeat sales to be generated from either special order. Company practice precludes Anchor from
subcontracting any portion of an order when special orders are not expected to generate repeat sales.
Required: Should Anchor Company accept either special order? Justify your answer and
show your calculations.

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Management Accounting - Module 4

Make or Buy Decision!

decision to make a fabricated part or component internally,


or to purchase it from an external supplier!

qualitative factors to consider:!


quality of the component!
reliability of the supplier!
technical capabilities of the supplier!
financial strength and reputation of the supplier!
availability of production capacity to manufacture the
components!

Make or Buy Decision - cont d!

problem solving - compare the cost to buy with


the cost to make!

cost to make = !
all variable costs!
any avoidable fixed costs!
any opportunity costs of making the
component: alternative uses of space, lost CM!

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Problem 2 Make/Buy
Powell Dentistry Services operates in a large metropolitan area. Currently, Powell has its
own dental laboratory to produce porcelain and gold crowns. The unit costs to produce
the crowns are as follows:
Porcelain
Gold
Raw materials
$ 55
$ 94
Direct labour
22
22
Variable overhead
5
5
Fixed overhead
22
22
Total
$104
$143
Fixed overhead is detailed as follows:
Salary (supervisor)
Depreciation
Rent (lab facility)

$24,000
5,000
26,000

Overhead is applied on the basis of direct labour hours. The rates above were computed
using 5,500 direct labour hours.
A local dental laboratory has offered to supply Powell all the crowns it needs. Its price is
$100 for porcelain crowns and $132 for gold crowns; however, the offer is conditional on
supplying both types of crowns-it will not supply just one type for the price indicated. If
the offer is accepted, the equipment used by Powell's laboratory would be scrapped (it is
old and has no market value), the lab facility would be closed and the supervisor would
be laid off. Powell uses 1,500 porcelain crowns and 1,000 gold crowns per year.
Required
1.
2.
3.

Should Powell continue to make its own crowns or should they be purchased from
the external supplier? What is the dollar effect of purchasing?
Suppose that the lab facility is owned rather than rented and that the $26,000 is
depreciation rather than rent. What effect does this have on the analysis in
requirement 1?
Refer to the original data. Assume that the volume of crowns is 3,000 porcelain
and 2,000 gold. Should Powell make or buy the crowns? Explain the outcome.

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Management Accounting - Module 4

Add/Drop a Product, Service or


Department!

analyze the incremental impact on profits of


adding or dropping the product, service or
department!

consider:!
fixed cost allocations!
cannibalization of existing products!
alternative uses of space!

problem solving: calculate the incremental


income of adding or dropping: incremental CM,
avoidable fixed costs, opportunity costs (lost CM)!
6

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Problem 3 Add/Drop
Sales have never been good in Department C of Staceys Department Stores, For this
reason, management is considering the elimination of the department. A summarized
income statement for the store, by departments, for the most recent month is given below:

Sales
Variable expenses

Total
$1,000,000
574,300

Contribution margin
Fixed expenses
Salaries
Utilities
Direct advertising
General advertising 1
Rent on building 2
Employment taxes 3
Depreciation of fixtures
Insurance and property taxes
On inventory and fixtures
General office expenses
Service department expenses
Net income (loss)
1
2
3

Department
A
B
$500,000
$320,000
338,000
166,000

C
$180,000
70,300

425,700

162,000

154,000

109,700

49,000
6,200
89,000
25,000
38,000
4,900
36,000

18,000
2,600
32,000
12,500
16,000
1,800
12,000

16,000
2,000
27,000
8,000
12,000
1,600
15,000

15,000
1,600
30,000
4,500
10,000
1,500
9,000

7,900
54,000
81,000
391,000

2,300
18,000
27,000
142,200

4,000
18,000
27,000
130,600

1,600
18,000
27,000
118,200

34,700

$ 19,800

$ 23,400

$ (8,500)

Allocated on the basis of sales dollars


Allocated on the basis of space occupied
Based on salaries paid directly in each department

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The following additional information is available:


a. If department C is eliminated, the utilities bill will be reduced by $700 per month.
b. All departments are housed in the same building. The store leases the entire building
at a fixed annual rental rate.
c. One of the employees in department C is Fred Jones, who has been with the company
for many years. Mr. Jones will be transferred to another department if Department C
is eliminated. His salary is $1,000 per month. Transferring Mr. Jones to the other
department will allow that department to avoid hiring an new employee that would
have been paid $800 per month.
d. The fixtures in department C would be transferred to the other departments if
department C is eliminated. One-fourth of the insurance and property taxes in
Department C relates to the fixtures of the department.
e. The company has two service departments purchasing and warehouse.. If
Department C is eliminated, one employee in the warehouse can be discharged. This
employees salary is $800 per month. General office expenses will not change,
f. The space being occupied by department C could be subleased at a rental rate of
$48,000 per month.
g. If department C is eliminated, the company expects department As sales to increase
by 10% and department Bs sales to decrease by 5%.
Required
Do you recommend the elimination of department C. Use incremental analysis.

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Management Accounting - Module 4

The Scarce Resource Decision!

involves choosing which product to produce


when there is a shortage of a resource used in
more than one product!

if one resource constraint exists, then the


contribution margin per unit of constraining
factor is used to rank profitability of products!

if more than one constraint, must formulate and


solve a linear programming problem!

Scarce Resources - cont d!

problem solving:!
calculate the contribution margin for each
product!
divide by the units of scarce resource to obtain
the CM per unit of scarce resource!
maximize profits by meeting demand for
products which have a higher CM/unit of
scarce resource!

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Problem 4 Make/Buy + Scarce Resources


Stewart Industries has been producing two bearings, components B12 and B18, for use in
production. Data regarding these two components follow:

Machine hours required per unit


Standard cost per unit:
Direct materials
Direct labor
Manufacturing overhead
Variable*
Fixed**

B12

B18

2.5

3.0

$ 2.25
4.00

$ 3.75
4.50

2.00
3.75
$12.00

2.25
4.50
$15.00

* Variable manufacturing overhead is applied on the basis


of direct labor hours.
** Fixed manufacturing overhead is applied on the basis
of machine hours.
Stewart's annual requirement for these components is 8,000 units of B12 and 11,000 units
of B18. Recently, Stewart's management decided to devote additional machine time to
other product lines, with the result that only 41,000 machine hours per year can be
dedicated to the production of the bearings. An outside company has offered to sell
Stewart the annual supply of the bearings at prices of $11.25 per unit for B12 and $13.50
per unit for B18. Stewart wants to schedule the otherwise idle 41,000 machine hours to
produce bearings so that the company can minimize its costs (maximize its net benefits).
Required: Determine the combination of purchasing and manufacturing that will
maximize benefits.

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Problem 5 Scarce Resources


Innovate Design Inc. sells three types of heat sensitive products: Cool, Warm and Hot.
Estimated sales demand, unit selling prices and production requirements are as follows:

Estimated sales demand


Unit sales price
Production requirements per unit:
Material Y9 (in kilograms)
Heat sensitive paint (in litres)

Cool

Warm

Hot

600
$16

500
$18

400
$14

8
6

5
12

2
18

The company has existing stocks of 300 units of Cool and 200 units of Hot, but is
adopting just-in-time inventory management and expects to reduce inventory to zero by
the end of next year.
All three products use the same direct materials. In the next year, the available supply of
materials will be restricted to 5,000 kilograms of material Y9 and 12,000 litres of heat
sensitive paint. Material Y9 costs $0.95 per kilogram and the heat sensitive paint costs
$0.50 per litre. All other costs are fixed.
Required Calculate the number of units of each product Innovate Design Inc. should produce next
year to maximize company profits.

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Management Accounting - Module 4

Joint Processes / Sell or Process Further!

when a joint process results in outputs which (1)


can be sold at the split-off point AND (2) can be
processed further and sold at a higher price!

decision is whether to process further or sell at


the split-off point!

decision rule: process further if the incremental


revenues less the incremental costs of processing
further exceed the sales value at the split-off
point!

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Management Accounting - Module 4

Linear Programming!

10

Linear Programming!

used when there is more than one binding


constraint!

objective function - what we want to maximize


(CM) or minimize (costs)!

constraints are stated in terms of equations, i.e. - !


! !5X + 7Y 50,000!

solve by the graphical method!

11

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Problem 11 Linear Programming


Iris manufacturing produces two products, X and Y. The company utilizes just-in-time
inventory techniques whereby little or no raw materials, work-in-process or finished
goods inventories are maintained. Careful planning of production schedules is required to
ensure the success of the just-in-time inventory systems.
For the month of July, the sales manager estimates that the maximum demand will be
2,500 units of product X and 2,000 units of product Y. The company's contract with its
raw materials supplier stipulates that a maximum of 32,000 kilograms of direct materials
will be delivered to Iris Manufacturing during July at a cost of $1.25 per kilogram.
Employee vacations are expected to limit direct labor to 900 hours during July at a rate of
$20.00 per hour.
Price and production data for each product are as follows:

Selling Price
Raw materials
Direct labor
Variable overhead

X
$30.00 per unit
10 kg per unit
12 minutes per unit
$7.00 per DLH

Y
$32.00 per unit
8 kg per unit
18 minutes per unit
$8.50 per DLH

Required:
(a)

Formulate and solve the linear programming problem required to determine the
production mix plan that will maximize the total contribution margin during the
month of July. Calculate the optimum contribution margin for July.

(b)

How much of an overtime premium should Iris Manufacturing be willing to


pay per hour to increase its direct labor capacity by 50 hours in July?

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Problem 11
a.
X
30.00
-12.50
-4.00
-1.40
12.10

Selling price
Raw materials: 10kg x 1.25 | 8kg x 1.25
Direct labour: .2 x 20 | .3 x 20
Variable overhead: .2 x 7 | .3 x 8.50

Objective Function
Subject to:

TCM = 12.10x + 13.45y


.2x + .3y 900
10x + 8y 32,000
x 2,500
y 2,000
x 0, y 0

Y
32.00
-10.00
-6.00
-2.55
13.45

Maximize
Direct labour
Direct materials
Demand
Demand
Non-negative

Graphing the above, we get the following points:


Y
\
Y
2,500
Y 2,000
2,000

B
X 2,500

1,500

DL

1,000

500

DM

X
500

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1,000

1,500

2,000

2,500

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Point
A
B
C

X
1,500
1,714
2,500

Y
2,000
1,857
875

TCM
45,050
45,716
42,019

Point B is optimal.
b.

The direct labour constraint changes to : .2x + .3y 950


If you graph this new line, you will find that it is above the old direct labour line
and that in fact, you cannot use the extra 50 hours due to the materials constraint:

Y
\
Y
2,500
Y 2,000
DL

2,000
D

X 2,500
1,500

1,000

500

DM

X
500

1,000

1,500

2,000

2,500

We get a new point, D which it at the intersection of the direct materials and the Y
demand lines.
Point
D

X
1,600

Y
2,000

TCM
46,260

Thus, we get an incremental $46,260 - 45,716 = $544 by moving from point B to


D.

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At this point, we need the following direct labour hours:


.2 (1,600) + .3 (2,000) = 920 or an additional 20 hours
The maximum we would be willing to pay is $544/20 = $27.20 overtime premium
per hour for up to 20 hours.

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Problem 13 - Uncertainty
Enrico, a renowned pastry chef employed by a four-star hotel, has decided to leave his
job at the hotel and invest $100,000 to open his own upscale pastry shop. His preliminary
investigations have uncovered the following:
i) There is a 55% chance that the market size in the area will be 600,000 pastries per
year and a 45% chance that it will be 450,000 pastries per year.
ii) The size of market share that Enrico will capture will depend on the location of his
shop. Two possibilities are available: location A, which costs $36,000 annual rent,
and location B, which costs $8,000 annual rent. It is estimated that Enrico will
capture a 30% share of the total market if he opens a shop in location A and a 21%
share of the total market if he opens a shop in location B.
The predicted market shares are based on a selling price of $2.00 per pastry. Variable
costs are estimated to be $0.80 per pastry and fixed costs, other than rent, are estimated to
be $80,000 per year at location A and $50,000 per year at location B.
Required a. Determine at which location Enrico should open his shop.
b. How much should Enrico be willing to pay to know with certainty the total market
size?

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Management Accounting - Module 4

Decision Analysis under Uncertainty!

12

Uncertainty!

typically involves setting up a pay-off table:!

States

State 1

P = x

State 2

P = 1 - x

Expected

Payoff

Action 1

Action 2

13

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Management Accounting - Module 4

Uncertainty Example!
Jacques operates a hot dog stand on Sunday mornings in the
market. Every Friday he has to let the market management
know whether or not he will set up his stand inside or outside.
If he sets up inside, the rent is $100 for the day. If he sets up
outside, the rent s $200 for the day. Each hot dog sells for $2.00
and variable costs per hot dog are $0.50. It is 3:00 on Friday
afternoon and Jacques has one hour to decide where the stand
will be located. The Weather Network s forecast of rain is 30%
for Sunday. He estimates sales volumes to be the following: !

Rain
No Rain

Inside

Outside

300

180

70

400

14

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Accelerated Program
Week 18
Suggested study plan for this week:
Primary List
1.

Review what we did in class on Saturday.

3.

Relevant Costing (ch 12)


MCQ + all problems - I would not necessarily
do these all in one week, but I would spread
them out over time.
Special Order: 2, 4, 5, 8, 12, 13
Make vs. Buy: 1, 10, 11,
Add/Drop: 3, 6, 15
Scarce Resource: 7, 14

Secondary List

Prepare the following for next Saturday:


IC6 Oceanic Airlines
IC7 - Altaco
IC8 - Sportway
IC9 Fisher Manufacturing
IC10 Piston Co.
2.

Linear Programming (ch 13)


MCQ + 1, 2, 3
4, 5, 6, 7
In-Class Problem 12 Baxter - will be taken
up in class next Saturday.
Also note that the notes go into way more detail
than what I cover or what is expected from you on
the Entrance Exam. I would only read pages 4561. Read the rest only if you have an interest in
this stuff.

3.

Uncertainty (ch 14)


In-Class Problem 14 Jackson will be taken
up in class next Saturday.

4.

Prepare the Week 18 Quiz.

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Problem 6 Add/Drop
Profits have been decreasing for several years at Oceanic Airlines. In an effort to improve
the company's performance, consideration is being given to dropping several flights that
appear to be unprofitable. A typical income statement for one such flight (flight 482) is
given below (per flight):
Ticket revenue (175 seats x 40%
occupancy x $200 ticket price)
Less variable expenses ($15 per person)

$14,000
1,050

100.0%
7.5

Contribution margin

12,950

92.5%

Less flight expenses:


Salaries, flight crew
Flight promotion
Depreciation of aircraft
Fuel for aircraft
Liability insurance
Salaries, flight assistants
Baggage loading and flight preparation
Overnight costs for flight crew and assistants at destination
Total flight expenses

1,800
750
1,550
6,800
4,200
500
1,700
300
17,600

Net operating loss

-$4,650

The following additional information is available about flight 482:


a.
Members of the flight crew are paid fixed annual salaries, whereas the flight
assistants are paid by the flight.
b.
One-third of the liability insurance is a special charge assessed against flight 482
because in the opinion of the insurance company, the destination of the flight is in
a "high-risk" area. The remaining two-thirds would be unaffected by a decision to
drop flight 482.
c.
The baggage loading and flight preparation expense is an allocation of ground
crews' salaries and depreciation of ground equipment. Dropping flight 482 would
have no effect on the company's total baggage loading and flight preparation
expenses.
d.
If flight 482 is dropped, Oceanic Airlines has no authorization at present to
replace it with another flight.
e.
Depreciation of aircraft is due entirely to obsolescence. Depreciation due to wear
and tear is negligible.
f.
Dropping flight 482 would not allow Oceanic Airlines to reduce the number of
aircraft in its fleet or the number of flight crew on its payroll.
Required
Prepare an analysis showing what impact dropping flight 482 would have on the airline's
profits.

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Problem 7 Special Order


Altaco, Ltd. manufactures one product in its Edmonton factory. The general manager,
Ellen Simpson, has just received a special request from a customer for 10,000 units of
this product to be produced and delivered this month. The customer has suggested a
selling price of $3.00 per unit. Simpson is unsure whether she should accept this offer.
The company normally produces and sells 50,000 units per month and capacity is at
70,000 units per month. The normal selling price is $4.00 per unit.
Simpson approached Frank Giterman, the plant accountant, with the issue. Giterman was
unable to provide a proper analysis at that time because he had a meeting to attend.
However, in quickly reviewing his files, he provided the following schedule of cost
information:
Level of Activity
(units of production per month)
40,000
50,000
60,000
70,000

Average Unit Cost


$3.675
3.500
3.383
3.41

As he rushed off for his meeting, Giterman indicated that if production exceeds 62,000
units per month, an additional supervisor must be hired and costs will increase by $7,700
per month.
Required:
Note: All requirements are independent situations. Expected activity levels do not include
the 10,000 units.
1.
2.
3.

Assume that the company already expects to be working at a level of 50,000 units
for the month. Calculate the minimum price the company could charge for this
special order without reducing its expected net income.
If the company expects to produce and sell 55,000 units this month, calculate the
minimum price the company could charge the customer for this special-order job
without reducing its expected net income.
Assume that the company expects to produce and sell 65,000 units this month.
Should the manager accept the customer's order? Support your decision with
appropriate calculations.

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Problem 8 Make/Buy
Sportway, Inc., is a wholesale distributor supplying a wide range of moderately priced
sporting equipment to large chain stores. About 60 percent of Sportway's products are
purchased from other companies, while the remainder of the products are manufactured
by Sportway. The company's Plastics Department is currently manufacturing molded
fishing tackle boxes. Sportway is able to manufacture and sell 8,000 tackle boxes
annually, making full use of its direct labour capacity at available workstations.
Following are the selling price and costs associated with Sportway's tackle boxes.
Selling price per box
Costs per box:
Molded plastic
Hinges, latches, handle
Direct labour ($15/hour)
Manufacturing overhead
Selling and administrative expenses
Profit per box

$86.00
$ 8.00
9.00
18.75
12.50
17.00

65.25
$20.75

Because Sportway believes it could sell 12,000 tackle boxes if it had sufficient
manufacturing capacity, the company has looked into the possibility of purchasing the
tackle boxes for distribution. Maple Products, a steady supplier of quality products,
would be able to provide up to 9,000 tackle boxes per year at a price of $68 per box
delivered to Sportway's facility.
Bart Johnson, Sportway's product manager, has suggested that the company could make
better use of its Plastics Department by manufacturing skateboards. To support his
position, Bart has a market study that indicates an expanding market for skateboards and
a need for additional suppliers. He believes that Sportway could expect to sell 17,500
skateboards annually at a price of $45 per skateboard. Bart's estimate of the costs to
manufacture the skateboards follows:
Selling price per skateboard
Costs per skateboard:
Molded plastic
Wheels, hardware
Direct labor ($15/hour)
Manufacturing overhead
Selling and administrative expenses
Profit per skateboard

$45.00
$5.50
7.00
7.50
5.00
9.00

34.00
$11.00

In the Plastics Department, Sportway uses direct labor hours as the application base for
manufacturing overhead. Included in the manufacturing overhead for the current year is
$50,000 of factory-wide, fixed manufacturing overhead that has been allocated to the
Plastics Department. For each unit of product that Sportway sells, regardless of whether
the product has been purchased or is manufactured by Sportway, an allocated $6 fixed

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overhead cost per unit for distribution is included in the selling and administrative
expenses for all products. Total selling and administrative expenses for the purchased
tackle boxes would be $10 per unit.
Required
In order to maximize the company's profitability, prepare an analysis based on the data
presented that will show which product or products Sportway, Inc., should manufacture
and/or purchase. It should also show the associated financial impact. Support your answer
with appropriate calculations.

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Problem 9 Relevant Costs


Fisher Manufacturing Co. produces and sells its product AA100 to well-known cosmetics
companies for $940 per ton. The marketing manager is considering the possibility of refining
AA100 further into finer perfumes before selling them to the cosmetics companies. Product
AA101 is expected to command a price of $1500 per ton, and AA102 a price of $1700 per ton.
The maximum expected demand is 400 tons for AA101 and 100 tons for AA102.
The annual plant capacity of 2400 hours is fully utilized at present to manufacture 600 tons of
AA100. The marketing manager proposed that Fisher sell 300 tons of AA100, 100 tons of
AA101, and 75 tons of AA102 in the next year. It requires four hours of capacity to make one ton
of AA100, two hours to refine AA100 further into AA101, and four hours to refine AA100 into
AA102 instead. The plant accountant has prepared the following cost sheet for the three products:
COSTS PER TON
AA100
AA101
Direct materials:
Chemicals and fragrance
AA100
Direct labor
Manufacturing support:
Variable
Fixed
Total manufacturing costs
Selling support:
Variable
Fixed

Proposed sales level


Maximum demand

AA102

$560
0
60

$ 400
800
30

$ 470
800
60

60
120
$800

30
60
$1,320

60
120
$1,510

20
10

30
10

30
10

$830

$1,360

$1,550

300 tons
600 tons

100 tons
400 tons

75 tons
100 tons

Required (a)
(b)

(c)

Determine the production levels for the three products under the present constraint on
plant capacity that will maximize operating income.
Suppose a customer is very interested in the new product AAl0l. It has offered to sign a
long-term contract for 400 tons of AA101. It is also willing to pay a higher price if the
entire plant capacity is dedicated to the production of AA101. What is the minimum price
for AA101 at which it becomes worthwhile for Fisher to dedicate its entire capacity to the
production of AA101?
Suppose, instead, that the capacity can be increased temporarily by 600 hours if the plant
is operated overtime. Overtime premium payments to workers and supervisors will
increase direct labor and variable manufacturing support costs by 50% for all products.
All other costs will remain unchanged. Is it worthwhile operating the plant overtime? If
the plant is operated overtime for 600 hours, what are the optimal production levels for
the three products? Show details to your calculations.

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Problem 10 CVP Analysis / Regression / Relevant Costs


The Piston Co. is a firm operating in the automotive industry. The controller had decided
to use regression analysis to predict manufacturing overhead for next year's budget.
She ran a number of regressions based on data from the company's most recent ten-year
history. Partial outputs from two of the regressions run by the controller are as follows:

Dependent variable
Independent variable

First
Regression

Second
Regression

Overhead
Cost

Overhead
Cost

Machine
Hours

Direct
Labour Hours

0.72
4.5
18.54

0.94
11.7
10.62

r2
t value
b coefficient
Required a)

Which regression would you choose and why?

b)

For inventory costing purposes, the Piston Co. used an overhead allocation rate
based on machine hours for its four main product lines. Recent gross margin
statements are as follows:
A
Selling price per unit
Cost of goods sold:
Materials
Labor @ $16/direct labor hour
Overhead @ $20/machine hour
Gross margin per unit

Product
B

$100

$115

$128

$155

12
32
20
64

16
24
40
80

25
40
30
95

30
32
60
122

$ 36

$ 35

$33

$33

Using the results of the second regression run by the controller and the following
additional data, determine the number of units of each of the four product lines (at
standard mix) that the Piston Co. will need to sell in order to achieve its target of a
9% after-tax return on sales. The company's effective tax rate is 40%.

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Additional data:
Fixed manufacturing overhead costs
Fixed selling costs
Standard product mix
(e.g., Product A accounts for 3 of every 10 company
products sold)
c)

$335,000
$ 50,000
A:B:C:D = 3:1:2:4

It is expected that, next year, the Piston Co.'s production capacity of 30,000
machine hours will be reached. Demand for each of the four product lines next
year is estimated as follows:
A
B
C
D

Units
5,000
1,500
3,500
7,000

Determine the optimal production strategy for the Piston Co. (i.e., how many units
of each product line should be produced and sold?). Use the data and assumptions
provided in part (b). (Ignore standard mix.)

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Problem 12 Linear Programming


Baxter, Inc., manufactures two industrial products, X-10, which sells for $90 a unit, and
Y-12, which sells for $85 a unit. Each product is processed through both of the
company's manufacturing departments. The limited availability of labor, material, and
equipment capacity has restricted the firm's ability to meet the demand for its products.
The production department believes that linear programming can be used to routinize the
production schedule for the two products. It has the following weekly data:
Amount Required
per Unit Weekly
X-10
Y-12
Direct material:
Supply limited to 1,800 pounds at $12 per pound
Direct labor
Department 1: Supply limited to 10 people at 40 hours
each at an hourly cost of $6
Department 2: Supply limited to 15 people at 40 hours
each at an hourly rate of $8
Machine time
Department 1: Capacity limited to 250 hours
Department 2: Capacity limited to 300 hours

4 pounds

2 pounds

2/3 hour

1 hour

1.25 hours

1 hour

0.5 hour
0 hours

0.5 hour
1 hour

Baxter's overhead costs are accumulated on a plantwide basis and are assigned to
products on the basis of the number of direct labor-hours required to manufacture the
product. This base is appropriate for overhead assignment because most of the variable
overhead costs vary as a function of labor time. The estimated overhead cost per direct
labor-hour follows:
Variable overhead cost
Fixed overhead cost
Total overhead cost per direct labor-hour

$6
6
$12

The production department formulated the following equations for the linear
programming statement of the problem:
A = Number of units of X-10 to be produced.
B = Number of units of Y-12 to be produced
Objective function to minimize costs:

Minimize 85A + 62B

Constraints:

4A + 2B 1,800 pounds
2/3A + 1B 400 hours
1.25A + 1B 600 hours
A 0, B 0

Material
Department 1 labor
Department 2 labor
Other

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Required
a.
b.
c.

The formulation of the linear programming equations prepared by Baxter's


production department is incorrect. Write a brief memo to management
explaining what errors were made in its formulation.
Formulate and label the proper equations for the linear programming statement of
Baxter's production problem.
Solve the linear program.

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Problem 14 - Uncertainty
Jackson, Inc., manufactures and distributes a line of toys. The company neglected to
keep its doll house line current. As a result, sales have decreased to approximately
10,000 units per year from a previous high of 50,000 units. The doll house was recently
redesigned and is considered by company officials to be comparable to its competitors'
models. Joan Blocke, the sales manager, is not sure how many units can be sold next
year, but she is willing to place probabilities on her estimates. Blocke's estimates of the
number of units that can be sold during the next year and the related probabilities are as
follows:
Estimated
Sales in Units

Probability

20,000
30,000
40,000
50,000

.10
.40
.30
.20

The units will sell for $20 each.


The entire year's sales must be manufactured in one production run. If demand is greater
than the number of units manufactured, sales will be lost. If demand is below supply, the
extra units cannot be carried over to the next season and must be discarded The disposal
costs of discarding one doll house is $2 per doll house.
Variable costs are as follows:
Manufacturing
Selling

$8
2

Fixed costs are $140,000 for production volumes of 20,000 to 30,000 and $160,000 for
volumes of 40,000 and more.
The company must decide on the optimal size of the production run.
Required
1.
2.

Based on the above information, optimal size run do you recommend?


If the company could hire a consultant that could predict with a high degree of
accuracy what the sales in units would be, what is the most you would be willing
to pay this consultant?

CMA Accelerated Program 2011

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