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 $ 1,354 $ 1,950 $ 1,200 Variable cost per unit $ 850 $ 1,300 $ 850 Upholstery labor-hours per unit 9 hours 13 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 $46 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

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?

Ans

To answer this first calculate the contribution margin for the constrained resource labor hours for sofas

Formula to calculate contribution margin is given below

Contribution margin = selling price – variable cost

The per unit contribution margin for sofa is

Per unit Contribution margin for sofa = per unit selling price of sofa – per unit variable cost of sofa

= $1950 - $1300

=$650

The per unit total labor hours is 13

Per hour labor contribution = per unit contribution / total labor hours per unit

= $650 / 13 hours

=$50

The maximum overtime payable per hour is $50

2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a price of $46 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?

Ans

First calculate contribution margin of constrained resource labor hours for all three products

• Recliner
• Sofa
• Love seat

Calculated as below as per formula given in answer 1

contribution margin per unit of constrained resource for all three products
particulars		Recliner	Sofa	Love Seat
		$	$	$
selling price per unit	a	1354	1950	1200
variable cost	b	850	1300	850
contribution per unit	C=a-b	504	650	350
Upholstery labor-hours per unit	D	9	13	5
contribution margin per unit of constrained resource labor hours	E=C/D	56	50	70

If the company Portsmouth can get a quote of $46 per labor hour from outside

Then the additional contribution margin earned for love seat is given below

Additional contribution per labor hour for love seat = contribution margin per hour of l0ve seat - cost of per hour labor cost paid to outsider to produce love seat

= $70-$46

=$24

The additional contribution per hour for love seat will be $24 or the savings

3. Should Portsmouth hire the nearby upholstering company?

Ans

The company should hire the nearby upholstering because of following reasons

• The constrained resource is labor hour and cost of outsourcing per labor hour is $46 and the contribution margin per labor hour for all three products are more than $50 or the cost of labor is more than $50 per hour therefore there will be savings in all three products if outsourced for labor

It will depend upon company to outsource love seat labor and produce other two products as the savings is more if love seat is outsourced