Prob.

11-32: Special Order

Award Plus Co. manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to produce 10,000 medals each
month; current monthly production is 7,500 medals. The company normally charges $225 per medal. Variable costs and fixed costs for the current activity level of 75
percent are shown below.

Award Plus has just received a special one-time order for 2,500 medals at $115 per medal. For this particular order, no variable marketing costs will be incurred.
Cathy Senna, a management accountant with Award Plus, has been assigned the task of analyzing this order and recommending whether the company should
accept or reject it. After examining the costs, Senna suggested to her supervisor, Gerard LePenn, who is the controller, that they request competitive bids from
vendors for the raw materials, since the current quote seems high. LePenn insisted that the prices are in line with those of other vendors and told her that she was not
to discuss her observations with anyone else. Senna later discovered that LePenn is a brother-in-law of the owner of the current raw materials supply vendor.

Data Solution

Current manufacturing capacity = 10,000 units per month (given) 1. Calculate both the old (i.e., prior to the special order) average cost per unit and the recalculated average
Curent production output = 7,500 units per month (given) cost per unit, including the effect of the special sales order. Are either of these two figures relevant for
Available capacity = evaluating whether to accept or reject the special order? Explain.
Normal sales price per unit = $225.00 (given)
Old (prior to special order) average cost per unit:
Current Product Costs:
Variable Costs:
Manufacturing: Average cost/unit #DIV/0! (answer rounded to two decimal places)
Labor $375,000
Material $300,000 Recalculated Average Cost, including Special Sales Order:
Marketing $187,500
Total Variable Costs $862,500 Old Total Cost/month
Fixed Costs: Special-Order Costs:
Manufacturing $275,000 Variable Costs:
Marketing $225,000 *Special order units * cost per unit
Total Fixed Costs $500,000 *Special order units * cost per unit
Total (i.e., Full Manufacturing) Cost $1,362,500 Fixed Costs? (Not relevant)
Total Costs
Information regarding the special sales order: Total Output (units) *Total output including special order
Number of units 2,500 New average cost/unit #DIV/0! (answer rounded to two decimal places)
Offer price, per unit $115.00
Neither of the above two average cost figures are relevant to the decision at hand; both include sunk costs in the form
Direct labor cost per unit = $375,000 ÷ 7,500 = per unit of fixed manufacturing overhead and fixed marketing costs. That is, these costs will likely be the same (in total)
Direct material cost per unit = $300,000 ÷ 7,500 = per unit regardless of whether the special sales order is accepted. As such, average unit costs are not relevant to this
decision.

2. Short-term profit impact of accepting the special sales order, rounded to nearest whole dollar:

Short-term profit = Revenue LESS costs

Price per unit for special order

*Sum of variable costs calculated above

Incremental cost/unit #DIV/0!

Profit per unit for special order *Special order generates a profit

Effect on short-term profit of accepting the special order:

Incremental Revenues *Sales price * units
Incremental Costs (DL + DM) *Above
Incremental operating profit (loss) $0

Since there is a positive contribution, the special-sales order should be accepted.

3. Breakeven price (two two decimal places) on special sales order:

The breakeven selling price is the price that would leave the operating profit for the company unchanged.
Alternatively, the breakeven price can be defined as the sum of "relevant costs," that is, incremental variable
costs, incremental fixed costs (if any), and opportunity cost (if any).

In the present case, relevant cost includes only incremental variable costs, as follows:

Relevant Costs:

Total Incremental Cost $0

Find price needed to cover incremental cost of $225,000

Number of Units 2,500

Breakeven selling price per unit $0.00 (rounded to two decimal places)
*There are no fixed costs, therefore the breakeven selling price per unit is equal to var cost per unit

4. Discuss at least three other considerations that Cathy Senna should include in her analysis
of the special order.

a) Is the order likely to lead to further regular business with this customer?
b) Is the order in the strategic best interest of the firm, for example: will it support or undermine the company's
desired image in the market?
c) While Award Plus has just enough capacity to complete the special order, will there be other costs in
addition to the variable manufacturing costs to complete the order (for example, special tooling or set-up
costs, etc.)

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3. Independent of Requirement 2 above, assume that Beth Johnson, Marten's product manager, has suggested that the company could make
better use of its fan department capacity by manufacturing marine pumps instead of fans. Johnson believes that Martens could expect
to use the production capacity to produce and sell 25,000 pumps annually, at a price of $60.00 per pump. Johnson's estimate of the costs
to manufacture the pumps is presented below. If Johnson's suggestion is not accepted, Martens would sell 20,000 attic fans instead.
Information on the sales price, costs, and volume for the marine pumps follows. Note: assume that total fixed selling & administrative costs and
total fixed overhead costs will be the same, regardless of whether fans or marine pumps are produced):
Selling price per unit (pump) $60.00
Cost per unit (pump):
Electric motor $5.50
Other parts $7.00
Direct labor (@ $15/hr) $7.50 Fixed Variable
Manufacturing overhead $9.00 MOH
Selling and administrative cost $20.00 $49.00 Per Unit
Profit per pump $11.00 S&A
Number of pumps (units) per year 25,000 Per Unit

What would the total contribution margin be from manufacuturing and selling the marine pumps? Given this information,
should Martens manufacture pumps or attic fans (based solely on short-term financial considerations)?

Contribution margin = Revenue LESS Variable Costs

Unit contribution margin: marine pumps

(given)
Variable costs per unit:
(given)
(given)
(given)
(calculated)
(calculated)
Contribution margin per unit $0.00 (calculated)

Total contribution margin from making/selling the marine pumps:

Per-unit contribution margin = $0.00

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Ex. 14-26: Direct Materials and Direct Labor Variances

Schmidt Machinery Company used 3,450 pounds of aluminum in a given month to manufacture 920
units. The company paid $28.50 per pound during the month to purchase aluminum. At the beginning of the month, the
company had 50 pounds of aluminum on hand. At the end of the month, it only had 30 pounds of aluminum
in its warehouse. Schmidt used 4,200 direct labor hours (DLHs) during the month, at an average cost of $41.50 per hour.

Data

Pounds of aluminum used during the month 3,450

No. of units manufactured during the month 920
Standard lbs. of aluminum per unit produced 4
Price per lb.during the month to purchase aluminum $28.50
Standard price per lb. $25.00
Beginning inventory (lbs. of aluminum) 50
Ending inventory (lbs. of aluminum) 30
Actual direct labor hours (DLHs) worked during the month 4,200
Standard DLH per unit produced 5
Standard wage rate per DLH $40.00
Average wage rate per DLH during the month $41.50

Solution

Required 1. Calculate purchase-price variance for aluminum & determine whether variance is favorable or unfavorable

1. Purchase-price variance--aluminum: Inflow Outflow

*Find # of lbs of aluminum that was purchased Beginning inventory + Purchases - Ending = Inventory Used
AQ = ? # of pounds that was purchased
AP = $28.5 Inflow Outflow
SP = $25 *Inventory equation: Purchases = Lbs used in production + Ending inventory - Beginning inventory

Purchase-price variance = (Actual price per lb. − Std. Price per lb.) × number of lbs. purchased during the month
= U

Required 2. Calculate usage variance for aluminum & determine whether variance is favorable or unfavorable

2. Materials usage variance, aluminum:

*Find # total lbs based on actual units sold & standard lbs
SP = $25
AQ = 3450lbs # of pounds that were used
SQ = ? 4lbs * 920 units produced = 3680 lbs

Usage variance = (actual lbs. used − std. lbs. allowed for units produced) × std. price per lb. of aluminum
= F

Required 3. Calculate direct labor rate variance & determine whether variance is favorable or unfavorable

3. Direct labor rate variance

AQ = 4200 hours
AP = $41.5
SP = $40

= (Actual DL rate per hr − Std. DL rate per hr) × no. of hours worked during the period

Required 4. Calculate direct labor efficiency variance & determine whether variance is favorable or unfavorable

4. Direct labor efficiency variance

SP = $40
AQ = 4200 hours
SQ = ? 5 hours * 920 units produced = 4600 hours

= (actual DLHs worked − std direct labor hours allowed) × std. wage rate per hr.

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Problem 7-26 Cost Allocation in Health Care

Nursing Care Inc, or NCI, operates both a small nursing home and retirement home. There is a single
kitchen used to provide meals to both the nursing home and retirement home, meaning labor costs and
utilities costs of the kitchen are shared by the two homes. There is also a centralized cleaning
department that provides the cleaning services for both homes as well as the kitchen.The nursing home
serves only indigent patients who are on Medicaid. The state Department of Health and Family Services
(DHFS) reimburses NCI at Medicaid approved cost reimbursement rates. The Medicaid reimbursement
rates are based on cost information supplied by NCI. The relevant cost and allocation data for the most
recent year appears in the following table.

Data Solution
Annual 1. Management of NCI currently allocates the kitchen and cleaning department costs based on the number of residents
operating cost in each home. Determine the amount of service department costs assigned to each of the homes using this allocation
Cleaning Department $ 90,000 base. Round percentages off to four decimal places in your calculations.
Central kitchen $ 120,000

Kitchen Nursing home Retirement home *Only allocate kitchen and cleaning costs to the nursing home and retirement home --> Direct method
Square feet of space 1000 2000 3000 i.e. No inter-service department allocation
Number of residents n/a 6 4 Allocate based on number of residents

Nursing home Retirement home Total

Service Departments Production Departments 0
Cleaning department Nursing Home
Central Kitchen Retirement home Cleaning costs assigned <-- cost to assign
Kitchen costs assigned <-- cost to assign
Total $ -

2. DHFS auditors believe the step method of allocation should be used by first assigning cleaning costs based on
square feet and then kitchen costs based on number of residents. Determine the amount of service department costs
assigned to each of the homes using this allocation method.

*Step Method - First assign cleaning department, then assign kitchen department

Step 1: Cleaning Department - Square feet

Kitchen Nursing home Retirement home Total

-

<-- cost to assign

Step 2: Kitchen - number of residents

<-- cost to assign

0 0 0

$ -
$ -
Total assigned $ -

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Exercise 9-32: Degree of Operating Leverage (DOL)

TastyKreme and Krispy Kake are both producers of baked goods, but each has followed a different production strategy. The differences in their
strategies resulted in differences in their cost structure, as shown in the following table:

Data
TastyKreme Krispy Kake
Estimated sales in units 20,000 15,000
Unit price $ 6.00 $ 8.00
Variable cost per unit $ 3.00 $ 3.00
Total fixed costs $ 30,000 $ 45,000

Sales volume change -10%

Solution

1. Compute the operating income and degree of operating leverage (DOL) for each company.
Operating Income = CM - fixed costs
DOL = CM / Operating Income
TastyKreme Krispy Kake
Estimated sales in units 20,000 15,000

*CM = Sales - Variable costs

DOL *CM/Operating income

Operating leverage - refers to extent of fixed costs in structure of org. Higher the operating leverage, the greater the risk.
Degree of operating leverage tells us the sensivity of operating income to changes in sales volume. (For every change in sales quantity, how much does income change)

2. Assuming sales volume for each company will decline by 10%, and their cost structures will not
change, compute the percentage and dollar amount of the change in operating income for each
company.

Percentage change in sales volume -10% -10%

DOL 0.00 0.00
Percentage change in operating income *Tells us the sensitivity of operating income to changes in sales volume

Old income $ - $ -
Dollar change in operating income

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Exercise 10-32: Retailer Budget

D. Tomlinson Retail seeks your assistance in developing cash and other budget information for May, June, and
July. The company has the following guidelines in budget preparations, and expects to have the following
balances at the end of April:

Data Solution
Cash $100,500 1. Prepare schedules showing budgeted merchandise purchases for May and June.
Accounts receivable $437,000 Beg Inv + purchases - Ending Inv = Units Sold
Inventories $309,400 Purchases = COGS + Ending Inv - Beg Inv
Accounts payable $133,055 Ending inv: 130% of next month's sales

Budget preparation guidelines D. Tomlinson

Budgeted Merchandise Purchases: May and June
Collection of credit sales:
Within discount period in month of sale 60% May June July
Outside of discount period, but before eom 25%
Second month following month of sale 9%
Uncollectible accounts 6% COGS
100% End Inv
Cash discount allowed for collections within discount period 3%
Purchases and expenses: Beg Inv
Paid in month incurred 54% Purchases
Paid in month following month of purchase 46%

Target ending inventory, as % of next month's sales (in units 130% 2. Prepare a schedule showing budgeted cash disbursements during June.
Cost per unit of inventory $20.00 Cash disbursements = Inventory Purchases + S&A expenses
SG&A Expenses:
Total (as percentage of current month's sales) 15.00% SG&A expenses: 15% of current month's sales
Portion of total expense represented as depreciation $2,000 Depreciation = $2,000 per month (non-cash)

Actual and projected sales follow: Budgeted Selling, General, and Administrative (SG&A) expenses:
May June
Month Dollars Units
March $354,000 11,800
April $363,000 12,100
May $357,000 11,900
June $342,000 11,400
July $360,000 12,000
August $366,000 12,200
Payment for purchases & expenses:
54% in month incurred, 46% in following month
D. Tomlinson Retail
Budgeted Cash Disbursements for June
May June
*Calculated Above
*Calculated Above

*54% paid in month incurred

*46% payment from last month's owed

3. Prepare a schedule showing budgeted cash collections during May.

**Assume all sales are made on credit and billed at end of the month
May collections = April sales + March sales

D. Tomlinson Retail
Cash Collections May
From last month's (April) credit sales

($363,000) × 60% × 97% = *April Sales: $363,000

$363,000 × 25% =

From credit sales two months ago (i.e., March)

Collection of credit sales made in March $354,000 × 9% = *March sales: $354,000

Total cash collections $0

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