AF2110 - Management Accounting 1
Assignment 07
PROBLEM 13–22 Sell or Process Further
(Prepared from a situation suggested by Professor John W. Hardy.) Lone Star Meat Packers
is a major processor of beef and other meat products. The company has a large amount of
T-bone steak on hand, and it is whether to sell the T-bone steaks as they are initially cut or
process them further into filet mignon and the New York cut.
If the T-bone steaks are sold as initially cut, the company figures that a 1-pound T-bone
steak yields the following profit:
If the company were to further process the T-bone steaks, then one 16-ounce T-bone steak
will yield one 6-ounce filet mignon, one 8-ounce New York cut, and two ounces of waste. It
costs $0.55 to further process one T-bone steak into the filet mignon and New York cuts.
The filet mignon can be sold for $12.00 per pound, and the New York cut can be sold for
$8.80 per pound.
Required:
1. What is the financial advantage (disadvantage) of further processing one T-bone steak
into filet mignon and New York cut steaks?
2. Would you recommend that the T-bone steaks be sold as initially cut or processed
further? Why?
PROBLEM 13–24 Accept or Reject a Special Order
Polaski Company manufactures and sells a single product called a Ret. Operating at
capacity, the company can produce and sell 30,000 Rets per year. Costs associated with
this level of production and sales are given below:
The Rets normally sell for $50 each. Fixed manufacturing overhead is $270,000 per year
within the range of 25,000 through 30,000 Rets per year.
Required:
1. Assume that due to a recession, Polaski Company expects to sell only 25,000 Rets
through regular channels next year. A large retail chain has offered to purchase 5,000
Rets if Polaski is willing to accept a 16% discount off the regular price. There would be
no sales commissions on this order; thus, variable selling expenses would be slashed by
75%. However, Polaski Company would have to purchase a special machine for
$10,000 to engrave the retail chain’s name on the 5,000 units. Polaski Company has no
assurance that the retail chain will purchase additional units in the future. What is the
financial advantage (disadvantage) of accepting the special order?
2. Refer to the original data. Assume again that Polaski Company expects to sell 25,000
Rets through regular channels next year. The U.S. Army would like to make a one-timeonly purchase of 5,000 Rets. The Army would reimburse Polaski for all of the variable
and fixed production costs assigned to the units by the company’s absorption costing
system, plus it would pay an additional fee of $1.80 per unit. Because the army would
pick up the Rets with its own trucks, there would be no variable selling expenses
associated with this order. What is the financial advantage (disadvantage) of accepting
the U.S. Army’s special order?
3. Assume the same situation as described in (2) above, except that the company expects
to sell 30,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s
order would require giving up regular sales of 5,000 Rets. Given this new information,
what is the financial advantage (disadvantage) of accepting the U.S. Army's special
order?
PROBLEM 13–27 Utilization of a Constrained Resource
The Walton Toy Company manufactures four dolls and a sewing kit. It provided the following
data for next year:
The following additional information is available:
a. The company’s plant has a capacity of 130,000 direct labor-hours per year on a singleshift basis. Each employee and piece of equipment are capable of making all five
products.
b. Next year’s direct labor rate will be $16 per hour.
c.
Fixed manufacturing costs total $520,000 per year. Variable overhead costs are $2 per
direct labor-hour.
d. All of the company’s nonmanufacturing costs are fixed.
e. The company’s finished goods inventory is negligible and can be ignored.
Required:
1. How many direct labor hours are used to manufacture one unit of each of the company’s
five products?
2. How much variable overhead cost is incurred to manufacture one unit of each of the
company’s five products?
3. What is the contribution margin per direct labor-hour for each of the company’s five
products?
4. Assuming that direct labor-hours is the company’s constraining resource, what is the
highest total contribution margin the company can earn next year if it makes optimal use
of its constrained resource?
5. Assuming next year the company makes optimal use of its 130,000 direct labor-hours,
what is the highest direct labor rate per hour that Walton Toy Company should be willing
to pay for additional capacity (that is, for added direct labor time)?
6. Identify changes the company could make to enable it to satisfy the customers’ demand
for all of its products.
CASE 13–34 Make or Buy; Utilization of a Constrained Resource
TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in
the chemical industry. One of the company’s products is a heavy-duty corrosion-resistant
metal drum, called the WVD drum, used to store toxic wastes. Production is constrained by
the capacity of an automated welding machine that is used to make precision welds. A total
of 2,000 hours of welding time is available annually on the machine. Because each drum
requires 0.4 hours of welding machine time, annual production is limited to 5,000 drums. At
present, the welding machine is used exclusively to make the WVD drums. The accounting
department has provided the following financial data concerning the WVD drums:
Management believes 6,000 WVD drums could be sold each year if the company had
sufficient manufacturing capacity. As an alternative to adding another welding machine,
management has considered buying additional drums from an outside supplier. Harcor
Industries, Inc., a supplier of quality products, would be able to provide up to 4,000 WVDtype drums per year at a price of $138 per drum, which TufStuff would resell to its customers
at its normal selling price after appropriate relabeling.
Megan Flores, TufStuff’s production manager, suggested that the company could make
better use of the welding machine by manufacturing bike frames, which would require only
0.5 hours of welding machine time per frame and yet sell for far more than the drums.
Megan believes that TufStuff could sell up to 1,600 bike frames per year at a price of $239
each. The accounting department has provided the following data concerning the proposed
new product:
The bike frames could be produced with existing equipment and personnel. Manufacturing
overhead is allocated to products based on direct labor-hours. Most of the manufacturing
overhead consists of fixed common costs such as rent on the factory building, but some of it
is variable. The variable manufacturing overhead has been estimated at $1.35 per WVD
drum and $1.90 per bike frame. The variable manufacturing overhead cost would not be
incurred on drums acquired from the outside supplier.
Selling and administrative expenses are allocated to products on the basis of revenues.
Almost all of the selling and administrative expenses are fixed common costs, but it has
been estimated that variable selling and administrative expenses amount to $0.75 per WVD
drum whether made or purchased and would be $1.30 per bike frame.
All of the company’s employees—direct and indirect—are paid for full 40-hour workweeks
and the company has a policy of laying off workers only in major recessions.
Required:
1. Would you be comfortable relying on the financial data provided by the accounting
department for making decisions related to the WVD drums and bike frames? Why?
2. Assuming direct labor is a fixed cost, compute the contribution margin per unit for:
a. Purchased WVD drums
b. Manufactured WVD drums.
c. Manufactured bike frames.
3. Assuming direct labor is a fixed cost, compute the contribution margin per welding hour
for:
a. Manufactured WVD drums.
b. Manufactured bike frames.
4. Assuming direct labor is a fixed cost, determine the number of WVD drums (if any) that
should be purchased and the number of WVD drums and/or bike frames (if any) that
should be manufactured. What is the increase (decrease) in net operating income that
would result from this plan over current operations?
As soon as your analysis was shown to the top management team at TufStuff, several
managers got into an argument concerning how direct labor costs should be treated when
making this decision. One manager argued that direct labor is always treated as a variable
cost in textbooks and in practice and has always been considered a variable cost at TufStuff.
After all, “direct” means you can directly trace the cost to products. “If direct labor is not a
variable cost, what is?” Another manager argued just as strenuously that direct labor should
be considered a fixed cost at TufStuff. No one had been laid off in over a decade, and for all
practical purposes, everyone at the plant is on a monthly salary. Everyone classified as
direct labor works a regular 40-hour workweek and overtime has not been necessary since
the company adopted Lean Production techniques. Whether the welding machine is used to
make drums or frames, the total payroll would be exactly the same. There is enough slack,
in the form of idle time, to accommodate any increase in total direct labor time that the bike
frames would require.
Required:
5. Assuming direct labor is a variable cost, compute the contribution margin per unit for:
a. Purchased WVD drums.
b. Manufactured WVD drums.
c. Manufactured bike frames.
6. Assuming direct labor is a variable cost, compute the contribution margin per welding
hour for:
a. Manufactured WVD drums.
b. Manufactured bike frames.
7. Assuming direct labor is a variable cost, determine the number of WVD drums (if any)
that should be purchased and the number of WVD drums and/or bike frames (if any)
that should be manufactured. What is the increase (decrease) in net operating income
that would resulting from this plan over current operations?
8. What do you think is the correct way to treat direct labor cost in this situation— as
variable or as fixed? Explain.