Question

Strategic Initiatives and CSR

Get Hitched Inc. is a production company that is in the process of testing a strategic initiative aimed at increasing gross profit. The company’s current sales revenue is $1,800,000. Currently, the company’s gross profit is 35% of sales, but the company’s target gross profit percentage is 40%. The company’s current monthly cost of production is $1,170,000. Of this cost, 50% is for labor, 30% is for materials, and 20% is for overhead.

The strategic initiative being tested at Get Hitched is a redesign of its production process that splits the process into two sequential procedures. The make up of the costs of production for Procedure 1 is currently 50% direct labor, 45% direct materials, and 5% overhead. The makeup of the costs of production for Procedure 2 is currently 55% direct labor, 25% direct materials, and 20% overhead. Company management estimates that Procedure 1 costs twice as much as Procedure 2.

1. Determine what the cost of labor, materials, and overhead for both Procedures 1 and 2 would need to be for the company to meet its target gross profit at the current level of sales.

Cost makeup of Procedure 1:

Direct Labor $ _________

Direct Materials __________

Overhead ___________

Total $ _________

Cost makeup of Procedure 2:

Direct Labor $ _________

Direct Materials ________

Overhead ___________

Total $ ________

2. The company’s actual direct materials cost is $334,800 for Procedure 1. Determine the actual cost of direct labor, direct materials, and overhead for each procedure, and the total cost of production for each procedure.

Cost makeup of Procedure 1:

Direct Labor $ __________

Direct Materials __________

Overhead ___________

Total $ _________

Cost makeup of Procedure 2:

Direct Labor $ _______

Direct Materials _________

Overhead ________

Total $ _________

3. The company is planning a CSR initiative to reuse some of the indirect materials used in production during Procedure 2. These indirect materials normally make up 60% of the overhead cost for Procedure 2, but the CSR initiative would reduce the usage of indirect materials. Determine what the maximum new cost of these indirect materials could be for Procedure 2 if this CSR initiative is expected to enable the company to meet its target gross profit percentage (holding all other costs constant).

Maximum new cost of P2 overhead materials: _________

Answer 1

Get Hitched Inc.
Answer 1 :
Particulars	Amount
Total sales	$    1,800,000
Target Gross Profit %	40%
Target Production Cost %	60%
Total Cost of Production	$    1,080,000
Total Cost of Production	=$ 1,080,000
$ 1,080,000	=Cost of Procedure 1 (P1) + cost of procedure 2 (P2)
$ 1,080,000	=2(P2) + (P2)
$ 1,080,000	=3(P2)
P2	= $ 1,080,000/3
P2	= $ 360,000
P1	= 2(P2)
P1	= 2(360,000)
P1	= $ 720,000
Cost make of Production Cost	Procedure 1	Procedure 2
Direct Labour	50%	$             360,000	55%	$        198,000
Direct Materials	45%	$             324,000	25%	$          90,000
Overhead	5%	$               36,000	20%	$          72,000
Total	100%	$             720,000	100%	$        360,000
Answer 2:
Total Cost of Production for P1	= Direct Material + Direct Labour + Overhead
P1	= 0.45(P1) + 0.50(P1) + 0.05(P1)
P1	= 334,800 + 0.50(P1) + 0.05(P1)
P1	= 334,800 + 0.55(P1)
P1 - 0.55 (P1)	= 334,800
0.45 (P1)	= 334,800
P1	= 334,800/0.45
P1	= 744,000
P1	= 2(P2)
P2	= 744,000/2
P2	= 372,000
Cost make of Production Cost	Procedure 1	Procedure 2
Direct Labour	50%	$             372,000	55%	$        204,600
Direct Materials	45%	$             334,800	25%	$          93,000
Overhead	5%	$               37,200	20%	$          74,400
Total	100%	$             744,000	100%	$        372,000
Answer 3:
Current Cost of Production	=$ 1,170,000
Cost of Production (P1)	=$ 1,170,000*2/3
Cost of Production (P1)	=$ 780,000
Cost of Production (P2)	=$ 1,170,000*1/3
Cost of Production (P2)	=$ 390,000
Cost make of Production Cost	Procedure 1	Procedure 2
Direct Labour	50%	$             390,000	55%	$        214,500
Direct Materials	45%	$             351,000	25%	$          97,500
Overhead	5%	$               39,000	20%	$          78,000
Total	100%	$             780,000	100%	$        390,000
Target Gross Profit		= 40% of sales
		= 40% * $ 1,800,000
		= $ 720,000
Current Gross Profit		= 35% of sales
		= 35% * $ 1,800,000
		= $ 630,000
Additional GP required		= $ 720,000 - $ 630,000
		= $ 90,000
Current Cost of Indirect Material (P2)	=60% * overhead cost
		=60% * $ 78,000
		= 46,800
Additional Gross profit required is more than the current cost of indirect material
for P2. So the new GP will not be get by reducing total cost of indirect material,