In: Accounting
It is December 15 and Jane Jones, the plant manager at Acme Electric Fan Co., faces a difficult decision. The operation has been running steadily over the last 11 months. During that time, Jane worked with the production engineers to tweak the production machinery just enough to allow for a small increase in available capacity. The plant produced 18,000 fans between January and the end of November and is scheduled to produce 2,000 fans in the month of December. The sales manager indicates that all 20,000 fans will be sold by the end of the year. Jane realizes the extra investment in engineering costs will allow the plant to produce an extra 500 fans in December. Cost and pricing information are provided below:
Sale per unit= $12
Raw Mateiral per unit= $3
Direct Labour per unit= $2
Variable Production Costs= $1
Variable Selling Exps= $1
Fixed Manaudacturing Costs= $61,500
Begining Inventory= 0
Inventory holding costs are negligible, and customers have been known to place unexpected special orders that are typically difficult to fill. Jane figures a small safety stock of 500 fans would provide a cushion against future special orders. Even so, Jane is torn about the decision to produce the 500 additional fans. Her performance is evaluated mainly by the profit generated by the plant. In addition, her year-end bonus is based on profitability of the plant. Jane is worried that incurring the extra costs will have a negative effect on plant profitability.
Required:
Take on the role of the plant accountant and provide Jane with the analysis she needs to make an informed decision. Assuming the company utilizes absorption costing, analyze the effect of producing the additional 500 fans on plant profitability and on Jane’s bonus, and recommend a course of action.
Prepare a presentation to Jane on your findings. Be sure to include any detailed notes for each of the points on your slides in the notes pages for the slides. You should also provide any handouts with your detailed quantitative analysis.
You will be given 10-15 minutes to present your findings and this will be followed by a 10-minute Q&A period. The senior management team does not want you just answer the guide questions so organize your presentation by stating the issues in the case, preparing a quantitative and qualitative analysis, and providing value added recommendations that will improve the company’s profitability in the future.
Please submit your PowerPoint slides with the detailed notes, handouts, and any other visual aids to the dropbox a week before the presentation.
In this case we need to find the impact of the additional 500 units produced at the plant and its impact on the profit and loss statement for that period. Producing 500 units is a strategic and its financial impact can lead to over production hencec we will make a comparative income statement to understand the impact under absorption costing method. Under absorption costing , cost per unit produced is calculated as the sum of both the variable manufacturing costs incurred and the fixed manufacturing costs allocated to those units. Below is the working
Current state | Remark | with 500 additional units | remark | |||
A | Sales | 24000 | 2000 x 12 | 24000 | 2000 x 12 | |
B | Cost of Goods sold | 18150 | 2000 x [(3+2+1)+61500/20000] | 18000 | 2000 x [(3+2+1)+61500/20500] | |
C | Contribution | 5850 | A-B | 6000 | A-B | |
D | Selling expenseses | 2000 | 2000 x 1 | 2000 | 2000 x 1 | |
E | Operaing profit | 3850 | C-D | 4000 | C-D |
so if we analyse the above statement we see the cost per unit goes down as we produced more and thus we generate more profit as Sales is unchanged the cost per unit has gone down as the fixed cost is allocated to more production units which has increased the inventory valuation but reduced the cost per unit. So infact this decission would have a positive impact on plant profitability