In: Accounting
Drugs-R-Us, Inc., produces equipment for manufacturing drugs. The costs of manufacturing and marketing this equipment at the company's normal volume of 3,000 units per month are shown in Exhibit 1.
EXHIBIT 1 - Costs per Unit for Equipment
Unit manufacturing costs:
Variable materials $200
Variable labor 300
Variable overhead 150
Fixed overhead 240
Total unit manufacturing costs $ 890
Unit marketing costs:
Variable $100
Fixed 280
Total unit marketing costs $ 380
Total unit costs $1,270
The following questions refer only to the data given above. Unless otherwise stated, assume there is no connection between the situations described in the questions; each is to be treated independently. Unless otherwise stated, a regular selling price of $1,580 per unit should be assumed. Ignore income taxes and other costs that are not mentioned in Exhibit 1 or in the question.
1. Market research estimates that monthly equipment production could be increased to 3,500 units which is well within production capacity limitations, if the price were cut from $1,580 to $1,400 per unit. Assuming the cost behavior patterns implied by the data in Exhibit 1 are correct, would you recommend that this action be taken? What would be the impact on monthly sales, costs, and income?
2. Drugs-R-Us has an opportunity to enter a foreign market in which price competition is keen. An attraction of the foreign market is that demand there is greatest when demand in the domestic market is quite low; thus, idle production facilities could be used without affecting domestic business. Unlike many foreign markets there are no government restrictions. An order for 1,000 units is being sought at a below-normal price in order to enter this market. Additional shipping and handling costs for this order will amount to $150 per unit, while the cost of obtaining the contract (marketing costs) will be $8,000 in addition to the normal variable marketing costs. Domestic business would be unaffected by this order. What is the minimum (e.g. breakeven) unit price Drugs-R-Us should consider for this order of 1,000 units?
Per Unit | Total | Relevant??? | ||
Variable Costs | Materials | $ 200 | $ 200,000 | |
Labor | $ 300 | $ 300,000 | ||
Overhead | $ 150 | $ 150,000 | ||
Marketing | $ 100 | $ 100,000 | ||
Shipping | $ 150 | $ 150,000 | ||
Fixed Costs | Mfg OH | $ 240 | $ 240,000 | |
Marketing | $ 280 | $ 280,000 | ||
Contract | $ 8000 | $ 8,000 |
How can I fill out the Relevant???
How can I distinguish between relevant cost and irrelevant cost?
3. An inventory of 230 units of equipment remains in the stockroom. These must be sold through regular channels at reduced prices or the inventory will soon be valueless. What is the minimum price that would be acceptable for selling these units?
Any price > variable cost of selling/marketing the units
1.
If price cut down to $1400 per unit, production volume increased to 3500 units
If selling price $1500 then
Profit= selling price - total unit cost
Profit= 1500- 1270 = $ 230
Total profit of 3000 units = $230 × 3000= $ 690000
If selling price $1400 then
Profit = $1400 - 1270 = $ 130
Total profit of 3500 units= $130 × 3500 = $ 455000
Difference = $235000
If price cut down then profit will decrease by $235000.
2. Break even unit selling price= fixed cost + variable cost per unit
Variable material | 200 | Relevant |
Variable labor | 300 | Relevant |
Variable OH | 150 | relevant |
Variable marketing cost | 100 | relevant |
Shipping cost | 150 | relevant |
Fixed manuf. OH | 240 | relevant |
Cost of contract 8000÷1000 | 8 | relevant |
Total cost | 1148 |
Fixed marketing cost which is irrelevant here to consider because it is remained whether contract of 1000 units received or not.
Difference between Relevant and Irrelevant cost
It is the classification of cost important in managerial decision. Relevant cost which is affected by managerial decision and irrelevant cost which is not affected by managerial decision.
Irrelevant cost which is not dependent on decisions, it is same in different alternatives and on the other hand relevant cost is different in various alternatives.
3. Minimum price of inventory remains in stockroom
= Releasable value or variable cost less disposal value.