Question

Cane Company manufactures two products called Alpha and Beta that sell for $225 and $175, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity to annually produce 130,000 units of each product. Its average cost per unit for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	42			$	24
Direct labor			42				32
Variable manufacturing overhead			26				24
Traceable fixed manufacturing overhead			34				37
Variable selling expenses			31				27
Common fixed expenses			34				29
Total cost per unit		$	209			$	173

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars.

1. What is the total amount of traceable fixed manufacturing overhead for each of the two products, Alpha and Beta? and What is the company’s total amount of common fixed expenses?

2. Assume that Cane expects to produce and sell 99,000 Alphas during the current year. One of Cane's sales representatives has found a new customer who is willing to buy 29,000 additional Alphas for a price of $156 per unit. What is the financial advantage (disadvantage) of accepting the new customer's order?

3. Assume that Cane expects to produce and sell 109,000 Betas during the current year. One of Cane’s sales representatives has found a new customer who is willing to buy 5,000 additional Betas for a price of $82 per unit. What is the financial advantage (disadvantage) of accepting the new customer's order?

4. Assume that Cane expects to produce and sell 114,000 Alphas during the current year. One of Cane's sales representatives has found a new customer who is willing to buy 29,000 additional Alphas for a price of $156 per unit; however pursuing this opportunity will decrease Alpha sales to regular customers by 13,000 units. What is the financial advantage (disadvantage) of accepting the new customer’s order?

Answer 1

1.   The total traceable fixed manufacturing overhead for Alpha and Beta is computed as follows:

Alpha            Beta

Traceable fixed overhead per unit (a) ........          $34            $37 Level of activity in units (b).......................               130,000      130,000

Total traceable fixed overhead (a) × (b) .... $4,420,000 $4,810,000

The total common fixed expenses is computed as follows:

Alpha Beta Common fixed expenses per unit (a) .........        $34        $29 Level of activity in units (b)....................... 130,000 130,000 Total common fixed expenses (a) × (b) ..... $4,420,000 $3,770,000

The company’s total common fixed expenses would be $8,190,000.

2.   The profit impact is computed as follows:

Per             Total

Unit        29,000 units

Incremental revenue ............................       $156       $4,524,000 Incremental costs:

Variable costs:

Direct materials...............................	42	1,218,000
Direct labor.....................................	42	1,218,000
Variable manufacturing overhead .....	26	754,000
Variable selling expenses .................	31	899,000
Total variable cost .............................	$141	4,089,000
Incremental net operating income .........		$435,000

3.   The profit impact is computed as follows:

Per             Total

Unit        5,000 units

Incremental revenue ............................       $82        $410,000 Incremental costs:

Variable costs:

Direct materials...............................         24           120,000

Direct labor.....................................         32           160,000

Variable manufacturing overhead .....        24           120,000 Variable selling expenses .................                    27         135,000

Total variable cost .............................        $107        535,000

Incremental net operating income .........                     $ (125,000)

4.   The profit impact is computed as follows:

Incremental revenue

(29,000 units × $156) (a) .........................                  $4,524,000

Incremental variable costs:

Direct materials (16,000 units × $42)...... $672,000 Direct labor (16,000 units × $42)............                 672,000

Variable manufacturing overhead

(16,000 units × $26) ............................. 416,000

Variable selling expenses

(16,000 units × $31) ...........................   496,000

Total incremental variable cost (b)...........                     2,256,000 Foregone sales to regular customers

(13,000 units × $225) (c) .........................                   2,925,000

Incremental net operating income

(a) − (b) – (c) ........................................                 $(657,000)