Question

Industrial Solutions, Inc. Activity

Industrial Solutions, Inc., manufactures three types of containers – a drum, a bin, and a box – that are used in the chemical industry. The company uses a just-in-time production system for these containers. As a result, it holds no inventory.

Industrial Solutions, Inc.’s accountants have provided detailed cost information for three containers (also in the accompanying spreadsheet).

	Drums	Bins	Boxes
Units produced and sold annually	5,000	4,500	3,000
Sales	$745,000	$495,000	$297,000
Variable costs:
Direct materials	255,500	85,500	72,000
Direct labor	18,000	40,500	36,000
Variable manufacturing overhead	6,750	9,000	18,750
Variable selling and administrative	3,750	13,500	11,250
Contribution margin	$461,000	$346,500	$159,000
Fixed costs:
Advertising, traceable	145,250	54,000	29,250
Depreciation on special equipment	40,000	33,750	39,000
Salaries of product-line managers	79,750	67,500	49,500
Allocated common fixed expenses*	45,000	90,000	62,250
Net operating income (loss)	$151,000	$101,250	$(21,000)
*Allocated based on sales dollars

Case 1 – Add or Drop a Product Line

Management is concerned about the continued losses shown by the box containers and wants a recommendation as to whether the line should be discontinued. The special equipment used to produce the boxes can be sold immediately for its book value.

Required:

1. Indicate whether each item listed below is relevant or irrelevant in this situation.

	relevant	irrelevant
a. Sales revenue
b. Direct materials
c. Direct labor
d. Variable manufacturing overhead
e. Depreciation – special equipment
f. Book value – special equipment
g. Disposable value – special equipment
h.Variable selling and administrative expense
i. Advertising expense
j. Salaries of product-line managers
k. Common fixed expenses

2. Should production and sale of the box containers be discontinued? Explain. Show computations to support your answer.

3. Recast the above data in a format that would be more usable to management in assessing the long-run profitability of the various product lines. (segment margin format – Ch. 5.)

Case 2 – Make or Buy

Harcor Industries has offered to sell drums to Industrial Solutions, Inc. for $75.00 per unit. Cost per unit to ship the drums from Harcor to Industrial Solutions would be $3.00. Assume that there will be no layoffs for any product-line managers unless a major recession. The special equipment used to produce the drums has a no resale value of and does not wear out.

Required:

1. Indicate whether each item listed below is relevant or irrelevant in this situation.

	relevant	irrelevant
a. Sales revenue
b. Direct materials
c. Direct labor
d. Variable manufacturing overhead
e. Depreciation – special equipment
f. Book value – special equipment
g. Disposable value – special equipment
h. Variable selling and administrative expense
i. Advertising expense
j. Salaries of product-line managers
k. Common fixed expenses
l. Purchase price from supplier
m. Additional shipping costs

2. Should Industrial Solutions, Inc. outsource the drums? By what amount would its operating income change if the drums were outsourced?

3. What is the most that Industrial Solutions, Inc. should be willing to pay to outsource the drums? By how much would Harcor need to reduce their selling price to make outsourcing attractive to Industrial Solutions, Inc.?

4. Suppose that if the drums are purchased, Industrial Solutions, Inc., could use the freed capacity to manufacture the new container. The segment margin of the new container would be $125,500. Should Industrial Solutions accept this offer?

5. What are some qualitative concerns of accepting Harcor’s offer?

Answer 1

Case 1 all parts have been answered.

Items	Relevant / Irrelevant
Sales revenue	Relevant as it effects the revenue
Direct materials	Relevant as it move directly with production
Direct labour	Relevant as it move directly with production
Variable manufacturing overhead	Relevant as it move directly with production
Depreciation Special equipment		Irrelevant as depreciation is a fixed expense
Book value special equipment		Irrelevant as it does not affect the financial performance
Disposable value equipment		Irrelevant as it does not affect the financial performance
Variable selling and administrative expenses		Relevant as it is directly dependent on the number of units sold
Advertising expenses		Irrelevant as it is generally a fixed cost
salaries of product line manager		Relevant as it is directly dependent on the number of units sold
Common fixed expenses		Irrelevant as it is a fixed expense

Part 2:

No, the company should not discontinue the production and sales of boxes as the contribution from sale of boxes is $159000. It is despite the fact that the sale of boxes is eventually incurring a loss of $21000. This is due to the fact that the fixed expenses will continue as it is thus, the contribution is the main aspect which is to be considered while assessing the desirability of a production line.

Contribution	159000
Less: Product line manager salary	49500
Yardstick to determine the desirability of boxes production and sales	109500

It is only the relevant costs which have been deducted from the amount of contribution as the irrelevant costs are not to be considered in deciding whether to continue or discontinue a production line.   

Part 3:                                                                                  

	Drums	Bins	Boxes
(A): Sales	745000	495000	297000
Variable costs
Direct materials	255500	85500	72000
Direct labour	18000	40500	36000
Variable manufacturing overhead	6750	9000	18750
Variable selling and administrative	3750	13500	11250
(B): Total variable cost	284000	148500	138000
Contribution (A-B)	461000	346500	159000
Less: Relevant fixed costs
Salaries of product line managers	79750	67500	49500
Profit before irrelevant costs	381250	279000	109500