Example Ltd plans to produce 5,000 units of Product A and 2,000 units of Product B. Product A requires direct material costing $15 per unit and direct labour costing $35 per unit. A unit of Product A is produced using 3 machine hours in the machining department and 5 labour hours in the finishing department. Product B requires direct material costing $23 per unit and direct labour costing $50 per unit. A unit of Product B is produced using 3 machine hours in the machining department and 7 labour hours in the finishing department.
Example Ltd produces one product and applies manufacturing overhead to products on the basis of direct labour hours. The standard cost card is as follows:
The managers of Example Ltd budgeted the monthly fixed cost as $100,800 and applies fixed overhead costs at $8.75 per direct labour hour.
During October, 15,000 units were produced. The costs associated with October’s operations were as follows:
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Material purchased: 76,000 kgs at $0.50 per kg
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$ 38,000
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Material used in production: 72,000 kgs
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Direct labour: 10,000 hours at $27.50 per hour
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$ 275,000
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Variable manufacturing overhead costs incurred
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$ 162,000
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Fixed manufacturing overhead costs incurred
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$ 110,000
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Required:
1. Calculate the following variances for October, indicating whether each is favourable or unfavourable.
(a) Direct material price variance and quantity variance.
(b) Direct labour rate variance and efficiency variance.
(c) Variable overhead spending variance and efficiency variance.
(d) Fixed overhead budget variance and volume variance.
2. Prepare the journal entries to record:
(a) The purchase of direct materials.
(b) The use of direct materials in production.
(c) The closing of direct material variances to cost of goods sold.
Section 3: Capital expenditure and sustainability
One of Example Ltd’s main competitor has been inciting a price war as they managed to import cheap products that are well below Example Ltd’s full product cost. A production manager of Example Ltd’s has proposed investment in advanced technology to reduce labour costs while increasing production volume and product consistency.
Information about the proposed project is as follows:
· $5,600,000 investment in new equipment is required. The equipment has an estimated useful life of 8 years and no residual value.
· The existing equipment can be sold for a current market value of $200,000.
· The new equipment will be able to automate parts of production, assembly and inspection, making eight employees redundant. There is an estimated cost savings of $420,000 per year from the job cuts.
· Expected incremental revenue of $550,000 per year due to greater production volume and higher product quality and consistency.
· There will be additional maintenance costs of $100,000 per year.
Example Ltd requires a rate of return of 8%. Ignore tax implications.
Required:
1. Compute the following for the proposal (present value tables are available on the next page):
(a) Net present value.
(b) Payback period.
(c) Accounting rate of return with initial investment as the denominator.
2. Describe three qualitative considerations that the managers should consider in making the decision.
Section 4: Cost-Volume-Profit analysis
Example Ltd produces and sells two products. Information about the expected sales volume, selling price and variable cost per unit of the products are as follows:
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Product A
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Product B
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Budgeted monthly sales
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3,750.00
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2,250.00
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Selling price per unit
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12.00
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25.00
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Variable cost per unit:
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Direct material
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4.80
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11.00
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Conversion costs
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4.00
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6.00
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The expected monthly fixed cost is $16,400. Ignore income taxes.
Required:
1. Assume that only Product B was sold. Compute the following:
(a) Break-even in dollars.
(b) Target sales volume in units, assuming a target profit of $8,000.
(c) Safety of margin in dollars.
2. Assume that both products were sold. Calculate the total number of products that need to be sold to break-even.
Section 5: Budgets
Example Ltd is preparing their budget for the upcoming quarter, commencing 1 January. The following historical and projected month-end balances are available:
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30 Nov
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31 Dec
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31 Jan
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28 Feb
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31 Mar
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Cash sales
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240,000
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260,000
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250,000
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250,000
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270,000
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Credit sales
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120,000
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130,000
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128,000
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128,000
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135,000
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Credit purchases
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200,000
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220,000
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210,000
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210,000
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240,000
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Other operating costs
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90,000
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90,000
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122,000
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123,000
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123,000
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Additional information:
· Closing balance for cash at the end of the quarter (31 Dec) is $50,000.
· Other operating costs excludes depreciation. Straight-line depreciation is $8,000 per month.
· 50% of other operating costs are paid for in the month incurred and the remainder paid in the following month.
· 80% of credit sales is received in the month after sale, 10% two months after sale and the balance is considered uncollectable.
· 75% of purchases is paid in the month after purchase and the remaining is paid two months after purchase.
· Example Ltd has placed an order for a new machine that will cost $30,000. The scheduled payment date is in March.
· The store's cost of goods sold is 60% of its sales revenue.
Required:
Prepare the cash budget for January and February. Include the opening and closing cash balances, cash receipts and cash payments.
[Additional practice] Section 5: Relevant costs and benefits
Example Ltd manufactures three types of products: Product A, Product B and Product C. Prior month revenue and cost data are as follows:
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Product A
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Product B
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Product C
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Total
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Sales
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400,000
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360,000
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100,000
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860,000
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Variable expenses
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180,000
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150,000
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60,000
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390,000
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Contribution margin
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220,000
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210,000
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40,000
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470,000
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Fixed expenses
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|
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Advertising
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50,000
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54,000
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41,000
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145,000
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Depreciation of special equipment
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40,000
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35,000
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20,000
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95,000
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Line supervisors' salaries
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7,000
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6,000
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6,000
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19,000
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General factory overhead
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90,000
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72,000
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28,000
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190,000
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Total fixed expenses
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187,000
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167,000
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95,000
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449,000
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Net operating income
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33,000
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43,000
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(55,000)
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21,000
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Management is concerned about the continued losses from Product C and wants a recommendation as to whether the line should be discontinued.
Advertising expense is traceable to each product line. The special equipment used to produce Product C has no resale or reuse value. If Product C is dropped, the line supervisors will be discharged. General factory overhead is allocated to each product line.
Required:
1. Assume that elimination of Product C will not affect the sales of the other product lines. Would you recommend the product line be discontinued? Support your answer with relevant cost and benefit analysis.
2. Assume that elimination of Product C will result in a 2% decrease in the production and sales of Product A and 2% decrease in the production and sales of Product B. Would you recommend the product line be discontinued? Support your answer with relevant cost and benefit analysis.
Section 6: Pricing
Example Ltd provides two packaged services (Bundle A and Bundle B) and customised services tailored to the need of clients. On average Example Ltd receives 90 orders for Bundle A and 40 orders for Bundle B. The company’s capacity is limited by its available labour hours, where only 16,700 labour hours are available each year.
Each Bundle A is priced at $33,000, incurs in variable costs of $28,000 and requires 140 labour hours. Each Bundle B is priced at $72,000, incurs in variable costs of $65,000 and requires 150 labour hours.
For customised jobs, Example Ltd determines the price using time and material pricing. Budgeted information relating to this accounting period is as follows:
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Labour rate, including on-costs
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$ 28
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Annual labour hours
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16,700
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Annual overhead costs:
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Material handling and storage
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$ 180,000
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Other overhead costs
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$ 350,700
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Annual cost of materials used
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$ 900,000
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A mark-up of $6 per hour on time charges are applied to all customised jobs.
Required:
Calculate the price for a customised job that requires 65 labour hours and $19,000 material costs.
[Additional practice] Section 6: Product mix
<< Same scenario as Section 6: Pricing >>
Required:
Suppose Example Ltd does not provide customised services and only offers the two packaged services. Determine how many instances of Bundle A and Bundle B should be provided to maximise profitability.