Question

Question 2

Hydropure Ltd commenced operations at the beginning of the current year. One of the company’s products, an alkaline antioxidant water filter, sells for $299 per unit. Information related to the current year’s activities are as follows:

$

Variable costs per unit:

Direct materials 40

Direct labour   74

Manufacturing overhead 96

Annual fixed costs:

Manufacturing overhead 700,000   

Selling and administrative 880,000

Production and sales activity:

Production (units) 25,000
Sales (units) 20,000

Hydropure Ltd carries its finished goods inventory at the average unit cost of production. There was no work in process at the yearend.

Required:

(a) Determine the cost of the yearend finished goods inventory.

(b) Calculate Hydropure Ltd’s net profit for the current year. Ignore taxation.

(c) If the next year’s production decreases to 24,000 units and the general cost behaviour and patterns do not change, what is the likely effect on:

(i) Direct labour cost of $74 per unit? Explain why.

(ii) Fixed manufacturing overhead cost of $700,000? Explain why.

(iii) Fixed selling and administrative cost of $880,000? Explain why.

(iv) Average unit cost of production? Explain why.

Answer 1

Solution (a)
Production in units	25,000
Sale in units	(20,000)
Closing inventory in units	5,000
Valuation
Direct Material	$            40.00	$       200,000.00
Direct labor	$            74.00	$       370,000.00
Manufacturing overhead
Variable	$            96.00	$       480,000.00
Fixed	700000/25000	$       140,000.00
Cost of year-end finished goods		$    1,190,000.00
Solution (b)
Calculation of net profit
		25000 units	20000 units
Sale revenue	$          299.00		$   5,980,000.00
Direct Material	$            40.00	$    1,000,000.00
Direct labor	$            74.00	$    1,850,000.00
Manufacturing overhead
Variable	$            96.00	$    2,400,000.00
Fixed	700000/25000	$       700,000.00
Cost of goods produced during the year		$    5,950,000.00
Less Closing inventory		$   (1,190,000.00)
Cost of goods sold		$    4,760,000.00	$ (4,760,000.00)
Operating income			$   1,220,000.00
Selling and administrative expense			$     (880,000.00)
Net profit			$      340,000.00
Solution (C-i)
Direct labor cost	No change
Since direct labor cost is variable cost and hence any decrease in production level will also decrease the expense being incurred on each unit being produced and hence total direct labor cost will go down but
per unit labor cost will remain the same.
Solution (C-ii)
Fixed manufacturing overhead	No change
Since fixed manufacturing overhead cost is fixed cost and hence the total fixed cost will remain the same irrespective of the level of production.
Solution (C-iii)
Fixed selling and administrative overhead	No change
Since fixed selling and administrative cost is fixed cost and hence the total fixed cost will remain the same irrespective of the level of production.
Solution (C-iv)
The average unit cost of production	change
Since the average unit cost of production also includes the fixed manufacturing overhead. Fixed manufacturing overhead will remain same but production will go down,
Hence reduced production level will increase the average unit cost as shown below
Calculation of average unit cost of production
		25000 units	24000 units
Direct Material	$            40.00	$    1,000,000.00	$       960,000.00
Direct labor	$            74.00	$    1,850,000.00	$   1,776,000.00
Manufacturing overhead
Variable	$            96.00	$    2,400,000.00	$   2,304,000.00
Fixed	700000/25000	$       700,000.00	$       700,000.00
Cost of goods produced during the year		$    5,950,000.00	$   5,740,000.00
Average unit cost	5950000/25000	$               238.00
Average unit cost	5740000/24000		$              239.17