Problem 13-15 (60 minutes)
1. The fixed overhead costs are common and will remain the same
regardless of whether the cartridges are produced internally or
purchased outside. Hence, they are not relevant. The variable
manufacturing overhead cost per box of pens is $0.30, as shown
below:
Total manufacturing overhead cost per box of pens ........................
$0.80
Less fixed manufacturing overhead ($50,000 ÷
100,000 boxes) ..........................................................................
0.50
Variable manufacturing overhead cost per box ...............................
$0.30
The total variable cost of producing one box of Zippo pens is:
Direct materials ..............................................................$1.50
Direct labor .................................................................... 1.00
Variable manufacturing overhead ..................................... 0.30
Total variable cost per box...............................................$2.80
If the cartridges for the Zippo pens are purchased from the
outside supplier, then the variable cost per box of Zippo pens
would be:
Direct materials ($1.50 × 80%) .......................................$1.20
Direct labor ($1.00 × 90%) ............................................. 0.90
Variable manufacturing overhead ($0.30 × 90%) ............. 0.27
Purchase of cartridges .................................................... 0.48
Total variable cost per box...............................................$2.85
The company should reject the outside supplier’s offer. Producing
the cartridges internally costs $0.05 less per box of pens than
purchasing them from the supplier.
Problem 13-15 (continued)
Another approach to the solution is:
Cost avoided by purchasing the cartridges:
Direct materials ($1.50 × 20%) ....................................$0.30
Direct labor ($1.00 × 10%) .......................................... 0.10
Variable manufacturing overhead ($0.30 × 10%) ........... 0.03
Total costs avoided .......................................................$0.43
Cost of purchasing the cartridges.....................................$0.48
Cost savings per box by making cartridges internally ........$0.05
Note that the avoidable cost of $0.43 above represents the cost of
making one box of cartridges internally.
2. The company would not want to pay any more than $0.43 per
box, since it can make the cartridges for this amount internally.
3. The company has three alternatives for obtaining the necessary
cartridges. It can:
#1
#2
#3
Produce all cartridges internally.
Purchase all cartridges externally.
Produce 100,000 boxes internally and purchase 50,000 boxes
externally.
Problem 13-15 (continued)
The costs under the three alternatives are:
Alternative #1—Produce all cartridges internally:
Variable costs (150,000 boxes × $0.43 per box) .............
Fixed costs of adding capacity .......................................
Total cost .....................................................................
$64,500
30,000
$94,500
Alternative #2—Purchase all cartridges externally:
Variable costs (150,000 boxes × $0.48 per box)...............
$72,000
Alternative #3—Produce 100,000 boxes internally, and
purchase 50,000 boxes externally:
Variable costs:
100,000 boxes × $0.43 per box ................................
50,000 boxes × $0.48 per box ..................................
Total cost.....................................................................
$43,000
24,000
$67,000
Or, in terms of total cost per box of pens, the answer would be:
Alternative #1—Produce all cartridges internally:
Variable costs (150,000 boxes × $2.80 per box) ............. $420,000
Fixed costs of adding capacity .......................................
30,000
Total cost ..................................................................... $450,000
Alternative #2—Purchase all cartridges externally:
Variable costs (150,000 boxes × $2.85 per box) ............. $427,500
Alternative #3—Produce 100,000 boxes internally, and
purchase 50,000 boxes externally:
Variable costs:
100,000 boxes × $2.80 per box ............................... $280,000
50,000 boxes × $2.85 per box................................. 142,500
Total cost................................................................... $422,500
Thus, the company should accept the outside supplier’s offer, but
only for 50,000 boxes of cartridges.
Problem 13-15 (continued)
4. In addition to cost considerations, Bronson should take into
account the following factors:
a) The ability of the supplier to meet required delivery schedules.
b) The quality of the cartridges purchased from the supplier.
c) Alternative uses of the capacity that is used to make the
cartridges.
d) The ability of the supplier to supply cartridges if volume
increases in future years.
e) The problem of alternative sources of supply if the supplier
proves undependable.
Problem 13-16 (30 minutes)
1. Incremental revenue:
Fixed fee (10,000 pairs × 4 mk per pair) .......................
40,000 mk
Reimbursement for costs of production:
(Variable production cost of 16 mk plus fixed
overhead cost of 5 mk equals 21 mk per pair;
10,000 pairs × 21 mk per pair) ..................................
210,000
Total incremental revenue ............................................
250,000
Incremental costs:
Variable production costs (10,000 pairs × 16
mk per pair) .............................................................
160,000
Increase in net operating income ....................................
90,000 mk
2. Sales revenue through regular channels
(10,000 pairs × 32 mk per pair) ...................................
320,000 mk
Sales revenue from the army (above) ..............................
250,000
Decrease in revenue received .........................................
70,000
Less variable selling expenses avoided if the
army’s offer is accepted (10,000 pairs × 2 mk
per pair) .....................................................................
20,000
Net decrease in net operating income with the
army’s offer.................................................................
50,000 mk
Problem 13-20 (45 minutes)
1. Only the avoidable costs are relevant in a decision to drop the
Kensington product line. These costs are:
Direct materials ..............................................................
£ 32,000
Direct labor ....................................................................200,000
Fringe benefits (30% of labor) ........................................ 60,000
Variable manufacturing overhead .................................... 30,000
Royalties (5% of sales) ................................................... 24,000
Product-line managers’ salaries ....................................... 8,000
Sales commissions (10% of sales) ................................... 48,000
Fringe benefits (30% of salaries and commissions) .......... 16,800
Shipping ........................................................................ 10,000
Advertising .................................................................... 15,000
Total avoidable cost ........................................................
£443,800
The following costs are not relevant in this decision:
Cost
Reason not relevant
Building rent and maintenance
All products use the same facilities; no
space would be freed up if a product
were dropped.
Depreciation
All products use the same equipment
so no equipment can be sold.
Furthermore, the equipment does not
wear out through use.
General administrative
expenses
Dropping the Kensington product line
would have no effect on total general
administrative expenses.
Problem 13-20 (continued)
Having determined the costs that can be avoided if the Kensington
product line is dropped, we can now make the following
computation:
Sales revenue lost if the Kensington line is dropped..........£480,000
Less costs that can be avoided (see above) ..................... 443,800
Decrease in overall company net operating income if
the Kensington line is dropped......................................£ 36,200
Thus, the Kensington line should not be dropped unless the
company can find more profitable uses for the resources
consumed by the Kensington line.
2. To determine the minimum acceptable sales level, we must first
classify the avoidable costs into variable and fixed costs as
follows:
Variable
Fixed
Direct materials ..............................................................
£ 32,000
Direct labor ....................................................................
200,000
Fringe benefits (30% of labor) ........................................
60,000
Variable manufacturing overhead ....................................
30,000
Royalties (5% of sales) ...................................................
24,000
Product-line managers’ salaries ....................................... £ 8,000
Sales commissions (10% of sales) ...................................
48,000
Fringe benefits
(30% of salaries and commissions) ...............................
14,400
2,400
Shipping ........................................................................
10,000
Advertising .................................................................... 15,000
Total cost .......................................................................
£418,400 £25,400
The Kensington product line should be retained as long as its
contribution margin covers its avoidable fixed costs. Break-even
analysis can be used to find the sales volume where the
contribution margin just equals the avoidable fixed costs.
Problem 13-20 (continued)
The contribution margin ratio is computed as follows:
CM ratio =
=
Contribution margin
Sales
£480,000 - £418,400
= 12.83% (rounded)
£480,000
And the break-even sales volume can be found using the breakeven formula:
Break- even point =
=
Fixed expenses
CM ratio
£25,400
= £198,000 (rounded)
0.1283
Therefore, as long as the sales revenue from the Kensington
product line exceeds £198,000, it is covering its own avoidable
fixed costs and is contributing toward covering the common fixed
costs and toward the profits of the entire company.