Question

Cost Data for Financial Reporting and Special Order Decisions

Friendly Greeting Card Company produces a full range of greetings cards sold through pharmacies and department stores. Each card is designed by independent artists. A production master is then prepared for each design. The production master has an indefinite life. Product designs for popular cards are deemed to be valuable assets. If a card sells well, many batches of the design will be manufactured over a period of years. Hence, Friendly Greeting maintains an inventory of production masters so that card may be periodically reissued. Cards are produced in batches that may vary by increments of 1,000 units. An average batch consists of 10,000 cards. Producing a batch requires placing the production master on the printing press, setting the press for the appropriate paper size, and making other adjustments for colors and so forth. Following are facility-, product-, and unit-level cost information:

Product design and production master per new card…………… $ 2,000.00

Batch setup (typically per 10,000 cards)…………………………. 200.00

Materials per 1,000 cards………………………………………….. 100.00

Conversion per 1,000 cards……………………………………….. 80.00

Shipping Per batch…………………………………………………………... 25.00

Per card……………………………………………………………. 0.02

Selling and administrative

Companywide…………………………………………………….. 200,000.00

Per product design marketed…………………………………… 500.00

Information from previous year...

Products designs and masters prepared for new cards……….. 90

Product designs marketed………………………………………… 120

Batches manufactured…………………………………………….. 500

Cards manufactured and solid……………………………………. 5,000,000

QUESTIONS:

a. Describe how you would determine the cost of goods sold and the value of any ending inventory for financial reporting purposes. (No computations are required.)

b. You have just received an inquiry from Walgreens stores to develop and manufacture 20 special designs for sale exclusively in Walgreens stores. The cards would be sold for $1.50 each, and Walgreens would pay Friendly Greeting $0.35 per card. The initial order is for 20,000 cards of each design. If the cards sell well, Walgreens plans to place additional orders for these and other designs. Because of the preestablished sales relationship, no marketing costs would be associated with the cards sold to Walgreens. How would you evaluate the desirability of the the Walgreens proposal?

c. Explain any differences between the costs considered in your answer to requirements (a) and the costs considered in your answers to requirements (b).

Answer 1

1. Describe how you would determine the cost of goods sold and the value of any ending inventory for financial reporting purposes. (No computations are required.)

The cost of goods sold will include the variable costs incurred for manufacturing the cards. It will include direct material, direct labor and variable overheads. The fixed costs and other recurring costs (period costs) will be deducted separately from the contribution margin.

The value of ending inventory will be the variable cost incurred for manufacturing. It should not include any part of fixed costs, unless absorption costing method is used.

2. You have just received an inquiry from Walgreens stores to develop and manufacture 20 special designs for sale exclusively in Walgreens stores. The cards would be sold for $1.50 each, and Walgreens would pay Friendly Greeting $0.35 per card. The initial order is for 20,000 cards of each design. If the cards sell well, Walgreens plans to place additional orders for these and other designs. Because of the preestablished sales relationship, no marketing costs would be associated with the cards sold to Walgreens. How would you evaluate the desirability of the Walgreens proposal?

The offer to purchase the cards at $0.35 per card, will give a total sale revenue of $7,000 for 20,000 cards per design. Hence the variable cost of manufacturing 20,000 cards and the initial designing cost should be less than $7,000 for cards of each design.

Manufacturing variable cost - $0.02 per card             $400

Batch set up $200 per batch set up of 10,000 cards   $400

Material $100 per 1,000 cards                                    $2000

Conversion cost $80 per 1,000 cards                          $1,600

Shipping cost $25 per batch of 10,000 cards              $50

Product design – per design                                        $2,000

            Total cost of 20,000 cards                              $6,450

                                                                                    =====

Since the sales revenue of 20,000 cards is $7,000 and total cost is $6,450, there is a contribution margin of $550 per design cards.

Hence the proposal of Walgreen should be accepted.

3. Explain any differences between the costs considered in your answer to requirements (a) and the costs considered in your answers to requirements (b).

The cost ascertained in part (a) is total costs which needs analysed in variable costs and fixed costs. Accordingly, the cost of goods sold and ending inventory is computed.

The costs computed in part (b) is the relevant costs, incurred to manufacture the special product. These costs are relevant to take a decision to accept/reject the special order.