Question

You are an eager and ambitious young graduate of the Reginal F. Lewis College of Business at Virginia State University with a new Accounting degree and a great life ahead of you. One of your closest friends is an inventor and an entrepreneur who wants to start a business selling a break-through new drywall screw that he has invented and that he believes works much better than the drywall screws currently on the market. He wants to start the business by opening a factory to produce the screws which can then be sold to either wholesalers or retailers who will then sell them to the general public. After searching all over creation for the right sized building in the perfect location to properly meet the needs of his target customers, he found that the ideal building in which to put up his factory was right here in Petersburg all along. To begin, he was able to purchase the building he needed outright for $525,000. Useful life of the building is 40 years and it is depreciated on a straight-line basis. Estimated salvage value is $25,000. Property taxes on the building each year are $3,500. There is a new machine that another fellow VSU grad has invented that takes the metal for the screws and molds them into their proper size and shape, and takes the plastic for the anchors and molds them into their proper size and shape; an assembly line is attached to the machine where workers put the screws and anchors into boxes. The finished product is a box of 32 drywall screws and their plastic anchors that work unlike any that have come before them. He purchased this machine outright for $175,000. The machine has a useful life of 25 years with no residual value and is depreciated on a straight-line basis. The machine can produce 23,000 boxes of screws and anchors per year. He is sure that he can sell every unit produced. It is determined that to produce the 32 screws in each box will require 112 ounces of metal which is the only material used to make the screws and to produce the 32 anchors in each box will take 48 ounces of plastic which is the only material used to make the anchors. The metal you need is produced by multiple suppliers and you've found one so far that will allow you to buy it at $1.50 per pound. The plastic used is also produced by multiple suppliers and you've found one so far that will allow you to buy it at $.15 per pound. It takes 15 minutes for the workers on the assembly line to box the screws and anchors because they are put in there in a way that prevents them from becoming disorderly. This is part of the quality aspect of the product. Assembly line workers are paid at a rate of $17.00 per hour. Your friend hired a Vice President (VP) who has a degree in Marketing from VSU. She did some market research and determined that in order to be competitive with your new product you are going to charge $20.75 per box of screws and anchors. The Vice President is paid $58,000 per year. He also hired a Chief Operating Officer who will be paid $58,000 per year. Your friend has also asked you to serve as a consultant to his company to make sure that the business gets off to a good start. Your fee has not yet been determined and is not part of this problem Please answer only these questions,

Prepare a variable costing format income statement assuming that the company makes and sells the maximum possible number of units. If the income is negative, what is the reason? What is the new break-even point after implementing your solution? What is the maximum income the company can make after implementing your solution? Is this enough profit to justify going into business?

Prepare both an absorption costing income statement and a variable costing income statement to reflect your solution. State your assumptions about the number of units produced and the number sold.

Answer 1

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Calculation of Variable cost per box:		Note
Metal (ounces) required for 32 screws	112.00	A
1 pound to ounces	16.00	B
Metal (pounds) required for 32 screws	7.00	C=A/B
Cost per pound	1.50	D
Cost of metal per box	10.50	E=C*D
Plastic (ounces) required for 32 anchors	48.00	F
1 pound to ounces	16.00	G
Plastic (pounds) required for 32 anchors	3.00	H=F/G
Cost per pound	0.15	I
Cost of plastic per box	0.45	J=H*I
Labor time required for one box (mins)	15.00	K
Labor hour required for one box	0.25	L=K/60
Labor hour rate	17.00	M
Cost of labor per box	4.25	N=L*M
Total Variable cost per box	15.20	O=E+J+N
Sell Price per box	20.75	P
Contribution per box	5.55	Q=P-O
Calculation of Fixed cost:
Building depreciation	12,500.00
(525000-25000)/40
Property Taxes	3,500.00
Machine depreciation	7,000.00
(175000/25)
Salary to VP	58,000.00
Salary to COO	58,000.00
Total Fixed cost:	139,000.00	R
Income Statement
Number of boxes sold	23,000.00	S
Sell Price per box	20.75	P
Variable cost per box	15.20	O
Contribution per box	5.55	Q
Contribution amount	127,650.00	T=S*Q
Total Fixed cost:	139,000.00	R
Net Income/(Loss)	(11,350.00)	U=T-R
New solution
The machine can produce only 23,000 units, so only option is to increase the price.
Current Net Loss	11,350.00	U
Number of boxes	23,000.00	S
Minimum increase in price per box	0.49	V=U/S
Revised Sell Price	21.24	W=P+V
Revised Contribution per box	6.04	X=W-O
Break Even units	23,000.00	Y=R/X
So at sell price of $ 21.94 the company will be in Breakeven and there will be no profit or loss.
Any increase in price from $ 21.94 will give the company a profit by the same amount.
Absorption vs Variable costing
As it is mentioned that the company can sell its entire production so income under variable and absorption costing approach will be same as there will be no closing or opening inventory.