Question

The Sweater Company produces sweaters. The company buys raw wool on the market and processes it into wool yarn from which the sweaters are woven. One spindle of wool yarn is required to produce one sweater. The costs and revenues associated with the sweaters are given below:

                                                                                         Per Sweater

Selling price                                                                           P30.00

Cost to manufacture:

Raw materials:

Buttons, threads, lining                                       P 2.00

Wool yarn                                                             16.00

Total raw materials                                               18.00

Direct labor                                                                 5.80

Manufacturing overhead                                             8.70     32,50

Manufacturing profit (loss)                                                    P(2,50)

Originally, all of the wool yard was used to produce sweaters, but in recent years a market has developed for the wool yarn itself. The yarn is purchased by other companies for use in production of wool blankets and other wool products. Since the development of the market for the wool yarn, a continuing dispute has existed in the Sweater Company as to whether the yarn should be sold simply as yarn or processed into sweaters. Current cost and revenue data on the yarn are given below:

                                                                                          Per Spindle

Selling price                                                                           P20.00

Cost to manufacture:

Raw materials (raw wool)                                        P7.00

Direct labor                                                               3.60

Manufacturing overhead                                           5.40     16.00

Manufacturing profit                                                                P4.00

The market for sweaters is temporarily depressed, due to unusually warm weather. This has made it necessary for the company to discount the selling price of the sweaters to P30 from the normal P40 price. Since the market for wool yarn has remained strong, the dispute has again surfaced over whether the yarn should be sold outright rather than processed into sweaters. The sales manager thinks that the production of sweaters should be discontinued; she is upset about having to sell sweaters at a P2,50 loss when the yarn could be sold for a P4.00 profit. However, the production superintendent is equally upset at the suggestion that he close down a large portion of the factory, He argues that the company is in the sweater business, not the yarn business, and that the company should focus on its core strength.

Due to the nature of the production process, virtually all of the manufacturing overhead costs are fixed and would not be affected even if sweaters were discontinued. Manufacturing overhead is assigned to products on the basis of 150% of direct labor cost.

Would you recommend that the wool yearn be sold outright or processed into sweaters?

a. Sold outright because profit would decrease by P2.50 per sweater

b. Processed into sweaters because profit would increase by P6.20 per sweater

c. Processed further because profit would increase by P0.80 per sweater

d. Processed into sweaters because profit would increase by P2.20 per sweater

How much fixed overhead per unit is relevant to the production of sweaters?

a. P5.40

b. P8.70

c. P14.10

d. P0

Answer 1

Would you recommend that the wool yearn be sold outright or processed into sweaters?

a. Sold outright because profit would decrease by P2.50 per sweater

The above option is recommended since Manufacturing Profit per Spindle of Yarn is P4.0. Whereas,

Per Sweater Manufacturing profit (loss)  P(2.50), which is not a positive sign. Hence measures to improve the Sweater business is recommended, meanwhile Sale of Wool Yearn would add some profits.

The sales manager thinks that the production of sweaters should be discontinued; she is upset about having to sell sweaters at a P2,50 loss when the yarn could be sold for a P4.00 profit.

Selling price                                                                           P30.00

Cost to manufacture:

Raw materials:

Buttons, threads, lining                                       P 2.00

Wool yarn                                                             16.00

Total raw materials                                               18.00

Direct labor                                                                 5.80

Manufacturing overhead                                             8.70     32,50

Manufacturing profit (loss)                                                    P(2,50)

How much fixed overhead per unit is relevant to the production of sweaters?

ANSWER:

The manufacturing overhead costs are fixed and would not be affected even if sweaters were discontinued. Manufacturing overhead is assigned to products on the basis of 150% of direct labor cost.

Direct Labor per unit = 5.80

Fixed Overheads = 150% of Direct labor cost = 150% of 5.80 = 8.70 per sweater.

Fixed Overheads are fixed for the production capacity and do not vary per unit.

a. P5.40

b. P8.70

c. P14.10

d. P0