Question

Jumbo Company makes industrial power drills. The table below contains data for the company for the year ended 2014. It shows costs of the plastic housing separately from the costs of electrical and mechanical components.

	A		B	A+B
	Electrical and Mechanical Components*		Plastic Housing	Industrial Drills
Sales: 100,000 units at RM100				RM 10,000,000
Variable costs
Direct materials		RM 4,400,000	RM     500,000	RM   4,900,000
Direct labor		400,000	300,000	700,000
Variable factory overhead		100,000	200,000	300,000
Other variable costs		100,000	-	100,000
Sales commissions, at 10% of sales		1,000,000	-	1,000,000
Total variable costs		RM 6,000,000	RM 1,000,000	RM 7,000,000
Contribution margin				RM 3,000,000
Total fixed costs		RM 2,220,000	RM    480,000	2,700,000
Operating income				RM     300,000

*Not including the costs of plastic housing (column B)

Required:

1. During the year, a prospective customer in an unrelated market offered RM82,000 for 1,000 drills. The drills would be manufactured in addition to the 100,000 units sold. Jumbo Company would pay the regular sales commission rate on the 1,000 drills. The president rejected the order because “it was below our costs of RM97 per unit.

                            

What would operating income have been if Jumbo Company accepted the order? Show calculation to justify you answer.

1. A supplier offered to manufacture the year’s supply of 100,000 plastic housings for RM12.00 each. Assume that Jumbo Company would avoid RM350,000 of the fixed costs assigned to housings if it purchases the housings.

What would be the effect on operating income if the Jumbo Company purchased rather than made the housings?

Answer 1

A)		A+B	Unrelated Market	Total
	Sales	1,00,00,000	82,000	1,00,82,000
		(Given)	(Given)
	Direct Material	49,00,000	49000	49,49,000
		(Given - i.e 49 per unit)	(49*1000)
	Direct Labour	700000	7000	7,07,000
		(Given - i.e 7 per unit)	(7*1000)
	Variable fact OH	300000	3000	3,03,000
		(Given - i.e 3 per unit)	(3*1000)
	Other variable costs	100000	1000	1,01,000
		(Given - i.e 1 per unit)	(1*1000)
	Sales commission	1000000	8200	10,08,200
		10% of sales
	Total Fixed costs			27,00,000
	Operating income			3,13,800
	* The president rejected the order but actually Order is favourable,
	as fixed costs doesnot increase due to increase in sales.
	President has wrongly included fixed costs and arrived at 97 per unit which is wrong
B)	Sales	1,00,00,000
	Electrical and Mechanical components variable cost	60,00,000
	Supplier Cost @12 per unit	12,00,000
	Contribution	28,00,000
	Fixed costs - Electric and Maintainance	22,20,000
	Fixed costs - Housing (480000 less 350000)	1,30,000
	Operating income	4,50,000
	Operating income will increase by 1,50,000 if it purchases from supplier