Question

Portsmouth Company makes upholstered furniture. Its only variable cost is direct materials. The demand for the company's products far exceeds its manufacturing capacity. The bottleneck (or constriant) in the production process is upholstery labor-hours. Information concerning three of Portsmouth's upholstered chairs appears below: Recliner Sofa Love Seat Selling price per unit $ 1,346 $ 1,850 $ 1,275 Variable cost per unit $ 850 $ 1,300 $ 850 Upholstery labor-hours per unit 8 hours 11 hours 5 hours Required: 1. Portsmouth is considering paying its upholstery laborers additional compensation to work overtime. Assuming that this extra time would be used to produce sofas, up to how much of an overtime premium per hour should the company be willing to pay to keep the upholstery shop open after normal working hours? 2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a price of $44 per hour. The management of Portsmouth is confident that this upholstering company’s work is high quality and their craftsmen can work as quickly as Portsmouth’s own craftsmen on the simpler upholstering jobs such as the Love Seat. How much additional contribution margin per hour can Portsmouth earn if it provides the raw materials to the nearby company and then hires it to upholster the Love Seats? 3. Should Portsmouth hire the nearby upholstering company?

Answer 1

Hello!

In the case of Portsmouth Company the only variable cost is direct materials, even labor hour has been assumed to be fixed. Since the demand far exceeds the production capacity our goal would be to maximize production. However, we have a constraint which is upholstery labor hours.

The contribution per upholstery labor hours is calculated below (Values in $'s):

                                                                                       Recliner                         Sofa                  Love seat

Selling price/unit                                                                1346                          1850                          1275

Less: Variable costs                                                           (850)                       (1300)                         (850)

Contribution                                                                        496                           550                             425

Labor hours per unit                                                              8                             11                                  5

Contribution/labor hr (contribution/labor hrs required)         62                            50                                 85

1) Contribution per hour is $50 for Sofas. If the overtime hours is spend in producing sofas then each hour can be paid a compensation up to a maximum of $50. At this rate the overtime would generate $0 contribution. An overtime premium of less than that would generate an increase in overall contribution.

2) The nearby upholster company charges $44 per labor hour. Note that this labor expense is in addition to the fixed labor expense the company incurs as fixed expense. Therefore this should be considered as a variable expense. The additional contribution margin per hour Portsmouth earns if it hires upholster is calculated below:

Love seat (Values in $'s):

Selling price/unit                                             1275

-Direct material Variable cost                           (850)

- Labor as a variable cost ($44 x 5 hrs)           (220)

Contribution                                                      205

Labor hours required                                             5

Contribution per labor hour                                  41

3) Yes. As per the above calculation Portsmouth can earn a contribution of $41 per hour. Portsmouth should therefore hire the upholstering company for as many hours as possible as long as the production does not exceed the demand.

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