Question

Anton Manufacturing produced a single product called the Great Thing. During the past three weeks Madison Day, the new cost accountant, had observed that production efficiency and input prices were constant but that output varied considerably. These three weeks were thought of as typical by the sales staff who said that they could be taken as average. Production costs were accumulated and accounted for under seven different groups listed below:

Week 1: Units of Output=400. Direct Materials=$300. Direct Labor=$500. Indirect Labor=$180. Indirect Materials=$300. Electricity=$115. Factory Insurance=$125. Other Overhead=$310.

Week 2: Units of Output=500. Direct Materials=$375. Direct Labor=$625. Indirect Labor=$200. Indirect Materials=$300. Electricity=$125. Factory Insurance=$125. Other Overhead=$360.

Week 3: Units of Output=600. Direct Materials=$450. Direct Labor=$750. Indirect Labor=$220. Indirect Materials=$300. Electricity=$135. Factory Insurance=$125. Other Overhead=$410.

Madison thought that this would be an ideal time to do some cost analysis on the Great Thing. Based on the data for the three weeks’ production cost she felt it would be possible to identify fixed cost, variable cost, and mixed costs. Furthermore, Madison wanted to develop some equations that might be useful for managerial decision making. From such equations it seemed that break-even volume could be generated. Since production was usually based on orders actually received and since products were shipped immediately upon completion, inventories of work-inprocess and finish goods were practically nonexistent. When talking to the sales staff, Madison discovered that on typical orders the selling price of the Great Thing was $7. During lunch one day, Madison was told by the president that office expenses including certain selling items were fixed at $781 per week.

Madison decided to begin her analysis with income statements for the three weeks:

Week 1: Sales=$2880. Cost of Goods Sold=(1830). Gross Margin=970. Other Expenses=(1061). Net Income=(91).

Week 2: Sales=$3500. Cost of Goods Sold=(2110). Gross Margin=1390. Other Expenses=(1131). Net Income=259.

Week 3: Sales=$4200. Cost of Goods Sold=(2390). Gross Margin=1810. Other Expenses=(1201). Net Income=609.

From these statements Madison realized that selling more added to profit. She also realized that cost of goods sold per unit seems to fall as output rose:

-when sales were 400 then cost of goods sold per unit was $4.57 -when sales were 500 then cost of goods sold per-unit was $4.22 -when sales were 600 then cost of goods sold per unit was $3.98

Madison wasn’t sure why costs of goods sold per unit should fall, because, after all, the efficiency and input prices have remained the same. She reasoned that there was something odd about the data and that it would be good to work with some average. Since the three weeks for which Madison had data were thought to be typical, she decided that some “standardized cost information” based on sales of 500 units per week would be very helpful. She derived the following chart:

Useful Data on the Great Thing: Average variable cost per unit produced $2.80 + Average fixed cost per unit produced 1.42= 4.22 + Average fixed administrative and selling cost per unit 1.56 + Commission per unit sold .70= 6.48 Added amount for rounding errors and some ‘funny’ results in data .12= $6.60

The following should be kept in mind when selling the Great Thing: 1.) It costs us $6.60 to deliver a unit of the Great Thing so we only make $.40 cents per unit at a $7.00 selling price.

2.) Decision rule #1 (for sales staff on the road): Never sell the Great Thing for less than $6.60 plus a profit margin because at $6.60 we just break even.

3.) Decision rule #2 (for direct office sales on which no commission is paid): never sell the Great Thing for less than $5.90 plus a profit margin because at $5.90 we just break even.

Madison was very pleased with her chart, particularly the part about different decision rules. When the chart was finished Madison passed it on to Mr. Anton Moore who was the owner, president, and chief decision maker at Anton Manufacturing. Anton, who was skeptical of “scientific analysis,” studied Madison Day’s chart and underlying data. That night Anton said to his attorney, Caleb Middleton, with whom he was having dinner, “I have finally found the kind of practical fast-track analyst I need. My cost accountant, Madison Day has just developed a set of decision rules which will solve all my pricing and profit problems.”

The next day Anton Moore sent a memo to the sales staff and others who were involved in pricing the Great Thing. Among other things the memo stated, “Everyone should study Ms. Day’s chart, especially the decision rules she has generated through complex cost accounting procedures. From now on, all pricing decisions will follow these rules and under no conditions will be priced at less than 10% above our delivery costs. Therefore, the lowest prices that can be quoted by the sales staff and office staff are $7.26 per unit and $6.49 per unit, respectively. This new policy means the sales staff had better stop taking orders at $7 per unit.”

When she read the memo Madison was both pleased and a bit disturbed. In the first place, she didn’t expect Mr. Moore to take her chart so seriously; in the second place, she knew intuitively that any price higher than $7.00 per unit for the Great Thing was too high. Madison explain her position to Mr. Moore who in turn informed the sales staff that $7.00 would be okay but nothing less would be acceptable.

After this revision in policy Madison felt better, Anton Moore went on vacation, the sales staff was confused, and the members of the office staff, who could take orders by phone, we’re pleased with their new role.

During the next week the following four sales prospects were available to the Anton Manufacturing for the Great Thing.

1.) The sales staff sold 450 units at $7 per unit.

2.) The sales staff turned down a request from an irregular customer for 50 units at $6.50 per unit because of the $7 rule.

3.) One telephone order was excepted for $6.50 per unit for 80 units but another order was rejected for $5.75 because of the $6.49 rule.

4.) Ms. Kaitlynn Wetzel, a 19-year-old file clerk, received a phone call from Mckenzie Desio when no one else was in the office. Mckenzie said that she had seen Madison Day’s data on costs and since Anton Manufacturing could produce more economically than Desio, she wanted to order 100 units at $5.50. Furthermore, she explained that since she was going out of business this would be her only order. Kaitlynn said that $6.50 was the minimum price, but Mckenzie responded that that was just Moore double talk. Ms. Wetzel looked over the data and realized that on a special order like this $5.50 would be a good price considering that otherwise Mckenzie Desio would produce the 100 units herself. She accepted the order and anticipated a promotion when Mr. Moore returned.

At the end of the week Madison Day prepared the following sales-cost report for Mr. Moore:

Source # of Units Price/Unit Cost/Unit Profit/Unit
Orders We Accepted
From sales staff 450 $7.00 $6.60 $ .40
Office manager 80 6.50 5.90 .60
Kaitlynn Wetzel 100 5.50 5.90 (.40)
Orders We Rejected
From sales staff 50 6.50 6.60 (.10)
Office manager 50 5.75 5.90 (.15)

After Mr. Moore returned and looked over the report he did two things:

1.) He called in the sales staff and explained that it would be better for the company to sell 350 units at $8.00/unit than the 450 at $7.00/unit. He went on to say that at $8.00/unit he would pay a commission of 15% instead of 10%. His reasoning was as follows:

Revenue $8.00 $7.00
Cost per unit per Day’s chart (5.90) (5.90)
Contribution 2.10 1.10
Commission (1.20) (.70)
Clear profit per unit .90* .40**

*350 units times $.90 per unit equals $315 profit per week.

**450 units times $.40 per unit equals $180 profit per week.

The sales staff was instructed to sell at $8.00 and guaranteed a commission of 15% on the sales of 350 units.

2.) He fired Kaitlynn Wetzel over the Mckenzie Desio mess. He said, “No one is going to cause me to lose 40 cents per unit.”

Required:

Complete the following table for the cost of the Great Thing:

Cost of 500 Units

Manufacturing Cost Variable Cost/Unit Fixed Cost Total Per Unit

Direct materials ? ? ? ?

Direct labor ? ? ? ?

Indirect labor ? ? ? ?

Indirect material ? ? ? ?

Electricity ? ? ? ?

Factory insurance ? ? ? ?

Other overhead ? ? ? ?

Total ? ? ? ?

Admin & Selling

At $7.00 price ? ? ?

Total before amount for rounding ?

Added amount for rounding, etc. .12

Madison Day's stated total cost per unit ?

hint: use the High-Low method to separate mixed costs into their variable and fixed components.

Answer 1

Variable cost will vary with the production units, however per unit cost would remain the same

Fixed cost will remain the same irrespective of the units produced, however per unit cost would decline with the increase in production units

If the variable and fixed cost are mixed, the change is in not proportionate with both the above methods

Description	Total cost	Production units	Per unit cost	classification	Variable cost from mixed cost	Total variable cost	Fixed cost from mixed cost
Direct material	300	400	0.75	Variable cost
	375	500	0.75	Variable cost
	450	600	0.75	Variable cost
Direct labour	500	400	1.25	Variable cost
	625	500	1.25	Variable cost
	750	600	1.25	Variable cost
Indirect labour	180	400	0.45	Mixed cost since the total cost is varying with units produced	0.2	80	100
	200	500	0.4	Mixed cost since the total cost is varying with units produced	0.2	100	100
	220	600	0.36666667	Mixed cost since the total cost is varying with units produced	0.2	120	100
Indirect materials	300	400	0.75	Fixed cost
	300	500	0.6	Fixed cost
	300	600	0.5	Fixed cost
Electricity	115	400	0.2875	Mixed cost since the total cost is varying with units produced	0.1	40	75
	125	500	0.25	Mixed cost since the total cost is varying with units produced	0.1	50	75
	135	600	0.225	Mixed cost since the total cost is varying with units produced	0.1	60	75
Factory insurance	125	400	0.3125	Fixed cost
	125	500	0.25	Fixed cost
	125	600	0.20833333	Fixed cost
Other overhead	310	400	0.775	Mixed cost since the total cost is varying with units produced	0.5	200	110
	360	500	0.72	Mixed cost since the total cost is varying with units produced	0.5	250	110
	410	600	0.68333333	Mixed cost since the total cost is varying with units produced	0.5	300	110
Other selling expenses		781	Per week
Sales	7	2800
	7	3500
	7	4200
Cost of goods sold		1830
		2110
		2390
Gross profit		970
		1390
		1810
Other expenses	1061	400			0.7	280	781
	1131	500			0.7	350	781
	1201	600			0.7	420	781
Net profit		-91
		259
		609

Variable cost from mixed cost	(y2 - y1)/(x2-x1)
Y2	Total cost at highest level of activity			220
Y1	Total cost atlowest level of activity			180
X2	Total volume at highest level of activity			600
X1	Total volume atlowest level of activity			400

Cost of 500 units
	Variable cost/Per unit	Unit fixed cost
Direct materials	0.75
Direct labour	1.25
Indirect material		0.6
Indirect labour	0.2	0.2
Electricity	0.1	0.15
Factory insurance		0.25
Other overhead	0.5	0.22
Total manufacturing overhead	2.8	1.42
Other expenses	0.7	1.562
Total before rounding off	3.5	2.982
Round off .12		0.12
	3.5	3.102