Question

ABC’s production manager, John, has been under pressure from the company’s president to reduce the conversion costs. In spite of several attempts to reduce conversion costs, they remained more or less constant. Now John is faced with an upcoming meeting with the company president, at which he has to explain why he has failed to reduce conversion costs. John’s annual bonus is based on achieving cost targets approved by the President. ABC uses a participative budgeting process. This year’s cost target is 1% lower than $5.30 for men’s leather belts. John has not achieved this target for the prior 10 months.

John is under pressure to reduce costs in the production process. There is no way to reduce material cost, so he has got to get the conversion costs down. He wants to show just a little progress in next week’s meeting with the president, then he can buy a little time to try some other cost-cutting measures he has been considering. He wants to raise the estimate of percentage completion of November’s WIP inventory to 90 percent. He believes it will increase the number of equivalent units. Then the unit conversion cost will be a little lower.

Discuss whether John’s suggested manipulation of the percentage completion of end WIP will have the desired effects (all other assumptions remains unchanged) on profits (show workings to support your conclusions).

The work-in-process (WIP) inventory consisted of 40,000 partially completed units on November 1. The belts were 25 % complete as to conversion cost. The costs included in the inventory on November 1 were as follows:

Leather strips	$96,000
Buckles	46,000
Conversion costs	16,000
Total	$158,000

During November 760,000 leather strips were placed into production. A total of 700,000 leather belts were completed. The WIP inventory on November 30 consisted of 70,000 belts, which were 10 percent complete as to conversion.

The costs charged to production during November were as follows:

Leather strips	$1,945,600
Buckles	874,000
Conversion costs	1,141,390
Total	$3,960,990

Answer 1

Assumptions: -

1. Opening WIP: -
   • 25% completion is considered only for Conversion Cost in Opening WIP
   • 100 % completion is considered for remaining Leather strips and Buckles in Opening WIP.
2. Closing WIP: -
   • 10% completion is considered only for Conversion Cost in Opening WIP
   • 100 % completion is considered for remaining Leather strips and Buckles in Opening WIP.

Analysis of John's suggested manipulation of the percentage completion of end WIP will have desired effects on profit: -

- Per Unit Cost for 7000 units in WIP as on 30th November (Using 10% completion of conversion cost): -

Leather strips - 20,41,600 (96,000+19,45,600) / 8,00,000 (7,60,000+40,000) = $2.552

Buckles - 9,20,000 (46,000+8,74,000) / 8,00,000 (7,60,000+40,000) = $1.15

Conversion Cost - 11,57,390 (11,41,390+16,000) / 7,37,000 [7,00,000+(40,000x75%)+(70,000x10%)] = $1.57

Total Cost per completed Unit = $5.272

- Per Unit Cost for 7000 units in WIP as on 30th November (Using 90% completion of conversion cost): -

Leather strips - 20,41,600 (96,000+19,45,600) / 8,00,000 (7,60,000+40,000) = $2.552

Buckles - 9,20,000 (46,000+8,74,000) / 8,00,000 (7,60,000+40,000) = $1.15

Conversion Cost - 11,57,390 (11,41,390+16,000) / 7,93,000 [7,00,000+(40,000x75%)+(70,000x90%)] = $1.46

Total Cost per completed Unit = $5.162

Target Cost per Unit - $5.30 - (1% of 5.30) = $5.247

Conculsion: -

If production manager John manipulates the % of work completion from 10% to 90% then he achieved a target cost reduction for the year which is $5.247 per unit. But this manipulation will have impact the company's profitability for current period and future period also as in future this manipulation will need to be ractified.