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Chapter 9 Solution Managerial Accounting

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Chapter 9 Solution Managerial Accounting

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HARIS AHMED
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Chapter 9 9.17 xX Y Z Contribution per unit £41 £54 £50 Kg used (Limiting factor) 2 (£10/5) 1 3 Contribution per kg £20.5 £54. £16.67 Ranking 2 1 3 Answer =B 9.18 The material is in regular use and if used will have to be replaced at a cost of £1950 (600 x £3.25). The cash flow consequences are £1950. Answer =D 9.19 The shadow price is the opportunity cost or contribution per unit of a scarce resource. Quone Qutwo Contribution per unit £8 £8.50 Kg per unit 3 (£6/£2) 2.50 (£5/£2) Contribution per kg £2.67 £3.40 Scarce materials will be used to make Qutwos and will yield a contribution of £3.40 per kg. Therefore the opportunity cost is £3.40 per kg : Answer = D ming that fixed costs will remain unchanged whether or 9.20 Se pore makes or buys the components the relevant ne manufacture will be the variable cost. Under these t of oe vamstances the company should only purchase components Scanned with CamScanner 1208 ANSWERS TO REVIEW PROBLEMS irate purchase price is less i } vane coat Thetetve 9.27 (Diet wages peeiage over e | | | thomas enya componet 7 Variable) £3600 (Fed) Aazwes =o Direct labour costs (E80 000)" = 200% of direct wages 2 Incremental cost of new employees = £40 000 x4 = ay ee co Wate overheat ate al costs of retraining “£64.00 Variable _ RO000 Direct labour costs {000 + £100 000 replacement cost = £115 000 80% of direct = rect wages Retraining isthe cheaper altemative and therefore tie relevant cont ofthe contacts £115 00, Problem 1: Answer = B . ° Per 2000 init units Ee 9.22 Answer B (Allo the smaining items are not relevant ost) Rasamaal arses a 1en 30000 ditional edsts 9.23 The material is readably available andthe use ofthe materials ere 800 will necessitate their placement. The relevant cost is Tae hoa ‘3.00 therefore the replacement costo £4050 (1250 kg at £3.24). Valable cvethend Answer = B (owxes) + 320 2030400 9.24 Specific (avoidable) fined overheads per division = £262.5 x eee eo aan? (60% = £157,5/3 = £52.5 order shou! eI nse porta eo kate tee in 19.600 sCatrbutions per bottleneck minute sre: “¥ 000 units x £2.60 eontibution) 730 J =£13.25 15900120) 2 (9000 units x £3.20 contribution) °° 28800 K = £13,00 (£1300/100) ‘X (S501 hours x £1.80 contribution) 6600 L 2£17.14 (2120070) 1.5 hours eo M-=£12.27 (£1350/110) ‘Total contribution 62800 “The rankings are L, J, K and M. Less fixed costs. “809 Answer=D ‘Maximum profit, soo Scanned with CamScanner bore, “3k Product X should be pe MMH rein eas tess 3806 unite ane Therefore the A constraint are less than gaa’ S88 of Brodit W should emt pa Pasha been sseentatec eae re (7s Direct abo san) Net cost of machinery 7000 Relevant cost L130 Contract price 1800 Contribution An.000 Notes: Bon (1) There isa saving in materia eo ee ial costs of £1750 aera 2) The actual cost of material B represents the incremental cost. s (3) The hiring of the labour on the other contract represents the additional cash flows of undertaking this contra (4) The net cost of purchasing the machinery represents the the contrat, tinue even if additional cash flows associated (5) Supervision and overheads wil stil the contract is not accepted and are therefore irrelevant. (b) The report should indicate that the costs given inthe question do not represent ineremental cashflows arising from undertaking the contract As the company is oerting at an activity level in excess of break-even point any revenue in exces of £18 000 incremental cons vf i ribation which will et provide an addtional conten vik Wh Increase in profits. Assuming thatthe company Yo Capacity, and that competitors reD 0 ‘order at £30 000, then a tender ice ate £30 000 would be spr ie fllowing nomsnontty (c) Before accepting the be factors Should be Cons are capacity to undertake the i) Isthery, (i) Isthen . soms(ity Is the overseas custo (iii) Has the workforce the m the project? (iy) Is the contract the customer? ewe re aver (@) Ifthe company ‘order would Pro ete eee to fe to accept the onder and i ontibutons 10 cO¥ET not survive. credit worthy”? tecessary skills to umdertake repeat business likely ost the break-even point ASWNIREG ley) ay) 1209 ANSWERS TO HEVIEW FHOML EMS Material un hak wa Matcviat ¥ fo shink i) avon woydets ot tsi § i 2 Matera X wot yet ont oun Matevil 7 wot yetanler (9 Labo ish nou 110000 Sie managewnent v4 s ation aa ave fo ste manage (vi) omy 344K "ant ental ever 4) cae onalyelaune 9) 24h) ive 264.400 Content oie 2a M 33200 Net enti soy 87000 (HVC) mateia Nis wot asc on the Neuth Hast contaet the nat benefice we fs uve Hn 8 ba material thas avid 9x 20 8.1 of uteri the eo £1Y440 on the other Gi) Material ¥ sn comunon pos of Using the materials on the South jenast entat wil mie hat ey will have to be replaced at agus of C49 G0 (E24 ROO 2) “Therefore the future ease How impact oF taking on the contact £49 600, i) teis assured tat with ty ones for materia itis thaw, Therefore the ative is selected, tute materi iP Hone, based wt posse fo cancel the pu ‘cost will oceur whatever {utute il The materials will be used as Ws they afe not used on the contact and jonthe same reasoning as note (i) above, th cot isthe purse pice ofthe subtiite materal (091000 (iv), The material hay not heen need andthe cost will only be incurred ithe contract is undertaken, fore adlitional cash Cows of £60 000 will be ncurred if the company takes on the North East ‘contact, me principles apply here as were explained in ‘ote (iv) and adlitional cash flows of £71 200 will be * neurted only ifthe company takes on the South coast ‘conte (vi) Wisassumed that labours an therefore relevant, (vid) The ste manager ne that the total company ost tn espe of ite management ent 7 rean uhanged inthe shot tent whatence contac ae taken on. Site management hereon ielevant, nem eestsate (si Te costs would be undertaken only ifthe conte eundertaken, Thereore they ue televantenen (6) ih Nw Eat contact sander he company Will be able to ire ott surplus pan FecO cet Mt SH plant and obsin a Scanned with CamScanner 1210 ANSWERS TO REVIEW PROBLEMS ose South oat contacto utente cOMPaNY Oi waa fo the North East onto area pat cot of £28 060 Mune sets wll cntinie whichever dnd hey nen relevant oss ib ove ash terest However ifthe inerestosts associated with the contract iffer then they would be relevant and stould be eluded in the cost and irelevant for os ad) Fe uct , op oe © © @® Seling price boo Less vanable cost: ‘Materials o ®. ® Latour ® @ as Vurableovetad() = G30) Coatibuion 30 4 Note (1) Fixed overheads are apportioned to products on the basis of sales volume and the remaining overhéads are variable with output Gi Product Boe © © Selling price 2 950 Less variable cost Materials ® @ Labour @ (180) Variable overhead =) (1.50) Contibation 4 jm ow : Frat ee ee Faken 3008 OID WOW 13500 Les ede Laie (2000 Frc anion ‘oom Prt 10000. w Pratt 8 nc) Tadoartaiee 0000 S760 156000 Lessee linet «soc Fed lisesi rt ‘sou on, Neste man steann wm ‘orem So reciente) (¢) Product A should not be elimi ated exen thous is a ri et ten will be borne by the ‘remaining products. Product A Soormsereagain hc Soci eee additional contribution from Product C of £176 000 (£576 000 ~ £400 000). This will result in anet loss in ontribution of £174 000. However, fixed cost savings of £110 000 (£50 000 administration apportioned to Product ‘A plus £100 000 labour for A less an extra £40 000 labour for Product C) can be obtained if Product Ai abandoned, ‘Therefore there will be a net loss in contribution of £64 000 (£174 000 - £110 000) and profits will decline from £110 000 to £64 000. 9.32 The following information represents a comparison of alternatives 1 and 2 with the sale of material XY. fonvercsimmeditessle (6) i) sh TS revenve (90 units t 0 pret 30000 Les Relevant cons 2. Maral XY oppertnity cost 21000 SMa A (600 unit £0) 540m 4 Marri B (1000 nits £45) 500 Diet abou ‘ashes 3000s at £6) 0000 Semisiled si Highly shied S000 rs at £17) 5009 115000 (6. Varisbl overhead 15 00 sat £1) 15000 7 Seling nd deliver expenses 70 “Advising 18000 8 Fed overeads Excess of leven revenues Alleratve2: Adaptation versus immediate sale 9 Sovng on purchase of mb sce: ermal pending (1200 units £900) 1080000 Revised pending (900 units £950) 850m 225000 Lssreevantcoas, «2 Material XY apport ost 2100 10, Material C (1000 units a £55) 55000 Diet tour ‘Unskiled 4000 rst 6) 24.000 Semiiled ‘il Skilled 4000Rrsat 16) om 8800 (6 Variable overheads (90081) 900) {LFitedovebeads ‘al. 173000 Netrlevan savings “200 Notes 1. Ther willbe ational sles revenue of £340 C00 aleve lis chosen 2 Accepance ofthe altematve 1 or2 wil meat ls of revenue of £21 000 fom the sal of te obsolete material XY. Thisis an opportunity ect, which mus be cored whichever aeraiveischosen. The rg purchase cot of| £7500 fr mera XY isa sunk cost and sieeve. 3. Acceptance of aemaive | will mean that material A mast be replaced at an sonal cost of 56000, 4. Ascepanceofderaive Iwill mean that materia B willbe diverted fom the production of roi Z. The eres of levant evens over reevant cost for profuct2is£180 and each ust product use for units of material. The est. ‘orb (etcutng he cost of terial B whichis incre for both terns) wil therefore be [45 for eac fntrlB that sedi ‘omeriag the aw mails ito a specie product. 5 Unkle labor cn be matched excl tothe company's product euiremens. The acceptance of eter alternative I or? wlleause compa oe chains ro ioceteoelter dite there wouldbe sficie excess upp fot emative ano exis cot seems i tem tc Sop ere ae ie cm Setar atcnai amelie epee etre i ena ciel tn ier ucts sea soe i 1 ani dt ast eee te herbal Scanned with CamScanner f sah cg pee hee costs are lynn ese Ml sone toc eet emt * Some felted nates ete ae, een haem tee vo Toeeompany wilincr aig) eee heey 2S 0m ‘mamerial C that is ma nktona vibe cone eae ‘When considering a problem s : it 99 WHEN oman EHS ay tay eh at ae pel Th -—- hwo stated alternatives with thea oe relevant information ene O00: The above ‘three possibilities alternative Lis to be neem taf the stobepeane, Anallerative presentation of hi te may prefer, is as follows: information, which you tft Feet evens seep _ ere Aeratie2 Tesrievaccons 2100 — son Diese = £5000 Difereoce=E13 000 (66050-27309 ‘We show here the sale ofthe obsolete dematve, and sth opporniy comet maicia 20 tmcumting 952100 (re em in ane i included in either alternative 1.02, since itis brought into the analysis under the heading “Sale of obsolete materials for scrap’ in the above alternative presentation. Consequently, both altematives I and 2 the relevant revenues es eerat costs figure is increased by £21 000. Te differences between Sttemative | and 2 andthe sae ofthe obsolete materi re still, however, £65 000 and £52 000 respectively, which gives tan identical result 0 that obtained inthe above solution. 9.33 (a) Preliminary calculations Variable costs are quoted per acre, but ein pices 2 quoted per tonne. Therefore, its necessa calculate the Aswers ro review enowtems 1212 (li) Profit statement for recommended ik reese ip eee a (Rag am ome OMettaengiemn | ectcie A? Py (¢) Recoenmended ena (acres) 4 0 raieeman'Ge) cian 6h sas 502 oe ieee Bis “nme cine een facet re ses ore ee ne) Tem Seg ert Sree a a er patetenbsstarenk OM Sm ely a ‘oe roducton sald be concent ona WH ——— cece highest comibution per 2€ E960) eo «iy Conrbation from 100 acres of <= (100 « £960) Fined overhead Profit fom catots 96.000 54.000, 42000 nd cons (£54 O00) Gi) grat enpitin aes ect” a r= OD aseasaces for cats ‘Contibution in sales value on 125 (5625 acres at £1620 sales FEVEME PE sere). 9.34 @) era tours = 36750 (120 000028) +48 000% 8 15) Fined overhead ate perbour = £40 21 "470 000736 750 hows) product (6) Penduct B18) Direct materials 2 0 , arable production verbend 28 4 ‘ Weaernmoenes _ 100025x840) 20! ‘Taaleost ry 0 Selling prise a n Profit m a Assuming that he company focuses. on profs Per UNE 5x40) Fane ses even pre Te cues ‘el be inifefent between the 2 products iling pice and onbtion ear 81 wart = £3 300000 (120000 £20) + (45000 £20) Totals Torips Panis Coats 5 oaiemamen wd) a Product Product i eee cop ens cist Cyseting ETON |) iow cxmd HD A ‘Cenarion per it socesy a6c0-4 {eps revere pera ‘ym 5109S Botenek bows (a Vantec ee oro fos 55- oH Bomempertoceseckhoor (£1900 £1732 een ‘Based om the consbution per botleneck hour Me current eat Mximum demand of product B should be produced, (Profit statement for ean saan maxim gcnd of product B requires 810 hours peo {$4 0000.01) leaving 265 hours (3075-810) 10 ome Baws allocated tof {VA. This will result in the production of CO eerebon eC Ee ene 413 250 uit (2265 hours/0.02) of A. The maximum profit we reaemnbaicaxt) £125 tas iscalulated as follows: / £ ‘Contribution from product A (113 250%£30) 3397500 s tenor) LN “4801 500 4s Fixed overhead cost ‘470000 Neete 3331500 iy Scanned with CamScanner 1212 ANSWERS TO REVIEW PROBLEMS {o) (_ Retum perbotteneck hot = (Selling price ~ material eesn/CTime on bottleneck resource) Praguct A = £2900 (E60 £2.00 hours) Promner = £2000 (£70 = £40)00015 hours) Prout A should be sold up 0 its maxim capacity Profane 2880 bosteneck hours (144 009 nt ‘io? hours). This wil Ieave 195 hours for product B thoa enabling 13 000 unit (19510.015) 10 be produced. “The maximum profit is calculated as follows: f From product A (144 000 x £58) Throughput reum product B (13 000 x £30) Contribution from Less: variable overheads? fixed overhead cost Net profit Note Ms assumed thatthe variable overheads (68. diet labour) rises nthe short-term, They ae derived from Par (@) = {1120 000 x £28) + (45 000 «£401 (©) Gi) Total overhead cost (£3 540. 000+ £14 £5,010 000 Gerhead cost per botleneck hour = £1629.27 (£5010 00/3075 hours) ‘Treoughput return pe boteneck hour = £2000 (scee() Throughput accounting ratio= 1.2275 (€2000/81 629.27) (©) (ii) With throughput account : ‘ihe throughput rtm per bottleneck hours B=" than the production cost (excluding direct materials) per throughput hour. In other words, ‘Ne throughput Per vanting ratio should exceed 1,00. Increasing § vets throughput ratio can increase profits. THe Throughput ratio can be increased BY: 1. Increasing the selling price or reducing, material sete cnote that product B has 2 very high material cost). 2. Reducing the time resource. 4, Cheating more capacity ofthe bottleneck res Oice craut posable increase the capacity so thatthe bottleneck can be removed (subject 10 any vaitional nancial outlay being justified). [Note that product B should be sold because itt throughput ratio exceeds 1 but ranking because it has a higher throushPU rae (6) Go) If material costs inerease by 20% fot product B the ered retur per bottleneck hour will be £1467 {£70 ~£48/0.015] giving a throughput Fa of 0.9 {£14677£1629.27.Atough thi is es han | *'B can be justified in the short-em™ jal circumstances that apply. Product A to its maximum demand and the 70.000) = 1g product should be sold required on the bottleneck ition of talance of capacity applied to product B has 00 is thus fixed in the short-term. tn flow of £22 incremental cost and. ‘Therefore product B will contribute a cas (£70 ~ £48) per unit. Scanned with CamScanner ts and ing relevant'cos Measuring rele' king revenues for decision-ma! Solutions to Chapter 9 questions “Question 9.35 a) aoe Purchase price of component from sup Additional cos of manufacturing (variable cost only) Saving if component manufactured Isle 3S fr i tions are ‘The component shouldbe manufactured provided the following a8S0P (i) Direct labour represents the additional labour cost of producing the rent. pa ; (@ Trefompany will not incur any addition! fixed overheads ifthe component ii) Saati aee ce resources. Therefore the manufacture of the component will not restrict the production of ‘other more profitable products. Gi) Additional fixed costs of £56 000 will be incurred, but there will be a saving in™ °o purchasing costs of £16 per unit produced: The break-even point is 3500 units {fixed costs of £56 000616 per unit saving). If the quantity of components manufuctured per year is less than 3500 units then it will be cheaper to pur- chase frora the outside supplier. a The contribution per unit sold from the, existing product is £40 and each unit produced uses 8 scarce labour hours. The contribution per labour hour is £5, Therefore if the component is manufactured, 4 scarce labour hours will be used, resulting in a lost contribution of £20. Hence the relevant cost of manufacturing the coniponents is £54, consisting of £34 incremental cost plus a lost contribution of £20. The component should be purchased from the supplier. (©) The book value of the equipment is a sunk cost and is not relevant to the decision whether the company should purchase or continue to manufacture the components. If we cease production now, the written-down value will be written off in a lump sum, whereas if we continue production, the written- down value will be written off over a period of years. Future cash outflows on the equipment will not be affected by the decision to purchase ot continue to manufacture the components. For an. illustration of the irrelevance of the written down value of assets for decision-making purposes see ‘Replacement of equipment in Chapter 9. @ Question 9.36 (a) Calculation of minimum selling price: © Direct materials: Steel* 5 35.00 Brass Fittings’ 20.00 Direct Labour: Skilled 300.00 Semi-skilled! ~ bey Teen ‘MEASURING FELEVANT COSTS AND REVENUES FOR DECSONMAKNG Scanned with CamScanner Overhead: 750 Estimating time = Administration’ Relevant cost of the order Notes: “Using the materials for the order will result in them having to be replaced. » Therefore future cash outflows will increase by £55. ture cash outflows of £20 will be incurred. ‘te : equired labour hours can be obtained by reducing production of another xoduct involving a lost contribution before deducting the labour cost of £21 13 + £8) per hour (note that the labour cost will be incurred for all alternatives and therefore is not ar. incremental czsh flow). Alteratiely, the company can Pay additional wages involving overtime of £300 (25 hours x £12). Therefore the latter course of action is the most economical and the incremental cash flows from undertaking the order will be £300. {No incremental cost is involved since the alternative is paid idle time. ‘ The only incremental cost is power consisting of 10 hours at £0.75 per hour. Estimating time is a sunk cost. . # Administration does not involve any incremental cash ‘lows. Factors to be considered include: @ time Pefiod for repeat orders, the number of repeat orders and the likely lemand; the cash flows generated from the alternative use of the capacity; (ii) competition to obtain future orders from Exe ple; (iv) estimated price quotations from competitors. ‘Limiciag factor presentation: . ¥ Y : ProductX Product Y Product contribution , £10 £20 Kg of material used pet product 1 4 ve Contribution per kg, £10 s Thus scarce materials should be allocated to Product X since it yields a contribu- tion of £5 per kg in excess of the contribution derived from Product Y. Opportunity cost approach: Product X Product ¥ Prodiict contribution at acquisition cost £10 £20 Lost cdntribution from alternative use: 1 kg allocated to Y at £5 per kg, (5) 4kg allocated to X at £10 per kg wm Cash flow impact per product cra . Cash flow impact per kg +65 (65/1 kg) (€20/4 kg) The above analysis shows that X yields 2 contribution of £5 per kg when tak- ing. alternative uses of the materials into consideration. Producing Product Y results in the contribution being reduced by £5 per kg taking into account the alternative use of the materials. This is consistent with the limiting, factor approach which indicates that the company is £5 per kg better off using the materials for X or £5 per kg worse off from using the materials for Y. Scanned with CamScanner Question 9.37) Product! Product aoe Total aon) One 1508 Sales ae 1692 532 3am Conanbuon 170 6) 36) Atibutabe fined costs G7) 29-8) deg, General ned coast OF. (05025) 8. By ‘ 35 5b (63) ag ae Profit eclunit = £140/vnit = (€0.04/unit) oo fixed costs are allocated to products at 21% of total sales Teverue M0. (E1668/E7943) ——— 7 ct Illis discontinued itis assumed that variable costs and attriby be i rere ecilic) fixed costs are avoidable. Itis assumed that general hey able (ie. spe a Costs are ‘common and unavoidable to all products and will remas unchanged if Product Ill is discontinued. However, itis possible that some general fixed costs may be avoidable in the longer term. The revised prot its if Product Ill is discontinued will be: (0005 2 Contribution of Products I and Il (£1170 + £1692) oy Attributable fixed costs (£275 + £337) (62) General fixed costs (1668) Profit * 2 Profits will decline by £236 000 (£818 — £582) if Product II ix discontinued because A Ltd will no longer obtain a contribution of £236 000 (£532 — £26) towards general fixed costs. 5 uv (ii) Extra sales of 15.385 units (E80 000 additional fixed costs£5.20 anit conti- : bution) will be required to cover the additional advertising expenditure. ts assumed that existing fixed costs wll emain unchanged. (iv, The revised unit contribution will » 74,45 (£9.45 — £6). < _ £1692 000 (existing total contribution) Required sles = =~ 5.35 revized unit contribution . = 490435 units (an increase of 30.4% over the budgeted sales of 376000 units), ; (©) The following factors will influence cost behaviour in response to changes it activity: “eh, . @ The magnitude 6f the change in activity (more costs are likely to be affects! Q) c when there is a large change in activity). (i) Type of expense (some expenses are directly variable with volume such direct materials, whereas others are fixed or semi-fixed). (iii) Management policy (some expenses aré varied at the discretion of manage ment, eg. advertising). - (iv) The time period (in the long term, all costs can be changed in response . changes in activity whereas in the short term, some costs, e.g. salaries \ ©) supervisors, will remain unchanged). Scanned with CamScanner Task 1 Question 9.38 (a) and (b) Selling price : £60 £70 £80 £90 Sales volume (units) 25000 - 20000 16000 11000 (E per nity per unity(£ per unit) (£ per unit) Direct material 14.00 14.00 14.00 16.10 (£14 x 115/100) Direct labour 13.00 13.00. 11.70 (90%) 11.70 Variable production overhead 4.00 400. 4.00 4.00 Sales commission (10% of selling price) 6.00 _7.00 00, 9.00 Total variable cost perunit 37.00 380037. oso * Contributionper unit 23.00 «3200 «42:30 49.20 £000 £000 £000 Total contribution 575640 5a12 Fixed costs: ~ ay =a production overhead (25.000 x £8) 200 200 190 190 selling and distribution \ (25.000 x £3) 75 70 70 70 administration (25.000 x £2) 50 50 50 50 Total fixed costs 35 320 30 310 Total annual profit 50 320. 368 2312 Task 2 (a) A selling price of £80 maximizes company profits at £366 800 per annum. (@) Factors to be considereid include: () The effect on morale avising from a large reduction in direct labour and we resulting redundancies. (i) If competitors do not increase their prices customers may migrate to competi- tors in the long term and long-term annual profits may be considerably less than the profits predicted in the above schedule. The migration of customers may also enable competitors to reap the benefits of economies of scale thus resulting in their having lower unit costs than Rane Ltd. Task 3 (@ The products should first be ranked according to their contribution per component used. ProductA — PridutB Product | Product D Eperunit =perunit’ £perunit —£ perunit Selling price uu 2 16 7:3 Variable costs ty yn 2 R Contribution 3 T 4 5 Number of components used unit ‘2 (EAE) 1(EE2) «3 (E6/E2) 4 (LBNL) Contribution per component £1.50 £1.00 £1.33 £1.25 Ranking 1 4 2 3 ‘The scarce components should be allocated as follows: Product Units. Components used Balance unused A 4000. 8.000 14.400 ic 3600 10.800 * 3.600 D 900 3.600 = 2400" [MEASURING RELEVANT COSTS AND REVENUES FOR DECSIONMANG SSS 73 Scanned with CamScanner Question 9.39 i (b) Profit to be eared next period: Product Units Gontsburon perunit Tou ( 3 12000 ee “4 13400 el . £284) will be obtained for the second altemative from 2005/06 onwards thas exceeding alternative 1 by £988 500 (£852 000 + £136 500) per annum. Therefore, after . two years alternative 2 would be preferred to the first. alternative. % ‘ hh -e-_——s "MEASURING RELEVANT COSTS AND REVENUES Eni nerves scien Scanned with CamScanner nm The choi " aarhe helee of alternatives therefore depends on futuce demand Yevels. If ivecpHonit ama re at 64 000 units, alternative 2 Is the mont attrac- native is pre res ind is expected tu remain at 65.000 units the third alter~ le. It should be noted that qualitative factors, such a6 the impact of redundancies on the ra ae ndancies on the morale of the workforce, shyuld be incorpo- @ ea cost of producing, the new product isthe variable on! eerie 8 the processing, time to another manut.. (vi ere ‘ore profitable to spend three days per week producing the main products, The calculations of the vanable overhead rates are: Question 9.41 Normal hours (0.9 * 40 hrs % 50 weeks) te ramen Fixed overhead rate per hour (£) ace 0001200) 28 (A) 409/100) Total overhead rate per hour (6) 40° 0 Variable overhead rate per hour (£) D 2 The variable costs per hour are: Department 4: £60 (£40 power cost + £20 variable overhead) Department 5: £72 (£60 power cost + £12 variable overhead) Note that labour costs are fixed. If the new product is not developed, Department 4 should sel! unused processing time at £70 per hour, but it is not profitable for Departs. «1:22 to sell, processing time because hourly variable cost is in excess of the sulin price. Therefore the relevant costs per processing hour are: Department 4: £70 (660 variable cost + £10 lost contribution) Department 5: £72 We can now calculate the relevant cost of producing the new product: © Direct material 10.00 ‘Department 4 variable operating cost (0.75 hrs x £70) 5250 Department 5 variable operating cost (033 hrs * £72) 24.00 650 “The total additional contributions for various selling prices and demand levels are: Q® i ie Selling price Uniteontbution 1350 2350 250% Demand 1067" 1000 500 Total contribution 14404 23500 16750 Note ‘Maximum output in Department 4 is 1067 units {(16 weeks * 50 hrs\t1.75 hrs} ae 2400 units in Department 5. Output is therefore restricted to 1067 units. Optimum output of the new product is 1000 units at a selling price of £110. An output of 10@0 units will require 15 hours per week (20 units per week X 0.75 hrs) in Department 4 and 6.67 hours’ in Department 5. Department 4 should therefore sell I hour per ‘week at £70 per hour, but it is not profitable for Department 5 to cell its spare capacity of 9.33 hours per week. 1 ‘The weekly additional gain from this programme is £470 (20 units x £23.50 contribution). The overall weekly gain is calculated without including the lost : contribution of £10 per hour for Department 4. Variable cost is 274 (£86.50 4 ‘elevant cost ess opportunity cost of 0.75 hrs at €10) ana conteibutic is 21 per MEASUFtG RELEVANT COSTS AND REVENUES FOR DECISION MAKING ———— Scanned with CamScanner Question 9.42 | it. The total week gain is 6530 (20 units at £31 per week plus £10 from th, Sea ens au Without the new product, weekly contribution will be ee (16 brs % £10) Therefore there is an additional gain of £470 from introducing the new product. | Seite (®) The Shadow prices indicate that if an hour is lor from the existing optimum contribution will decline by £76 for Department 4 and £27 for Department 5. Thy relevant hourly cost for a scarce resource is: Variable cost per hour plus lost contribution per hour Therefore the relevant cost of producing the new product is: © Direct material 10 Department 4: 0.75 hrs x (£60 + £76) 102 Department 5: 0.33 hrs x (£72 + £27) 3 15 The new product will not increase total contribution if the selling price is less than £145. (©) The shadow price of a scarce resource rey that will be obtained if.a scarce resource can the shadow price can be expressed as the loss in total contribution that will occu if the availability of a sca-ce resource is reduced by I unit. The opportunity cost of using a resource is the lost benefit that occurs fron) using it in the most profitable manner. Shadow prices represent the contribytion that would be lost if one unit of a resource were removed from the optimal production programme. In other words, it represents the lost benefit from using it in the most profitable manner, ‘Therefore shadow prices are equivalent to opportunity costs. presents the increase in total contribution be increased by 1 unit. Alternatively, (a) Alternative uses of spare electric motor Use with exhaust gas extraction equipment ig in the reduction of the loss in produc- + Productior/sales enhancement resultin; of 30 000 units thus increasing sales tion enhancement from 30% to 10% volume by 2000 units at a contribution of £5 (68-€3) £107 1 Less fitting and dismantling costs | (2.500) Add sales value after one year 2.000 Net cash flow 9500 Use in cooling process 7 Hiring cost avoided £3000 Less modification cost .# (1000) Less disposal cost (250) Net cash flow 1750 Hold in store and sell in one year Net cash flow (sale proceeds in one year) <= £3500 The company should use the motor in conjunction with the exhaust gases for the I during the coming year. Scanned with CamScanner , erefone be AP e years time, Note that the production enhancement wil therefore antes (10 060 units less 10%) for one year only and 10 000 units after the sunning in period. Exaluation of decision to conver? me oF it ome year’s time Convert now — Convertin Net benefit/ one year’s, (cost) of delay time forone year Gy © © Cash inflows: : Production/sales enhancement (at £8)72 00 80.000 8000 Sales of space heating equipment (ducted air) 20000 18000 (2.000) Gas extraction machine sale 40.000 (10.000) Electric motor sale 2000 1500 134000 Ch outflows: P. luction/sales enhancement - (Cat £3) 27000 30000 (3.000) Exhaust gas extraction machine Incremental fixed costs 16000’. (16 000) dismantling cost 5.000 5.500 (500) Space heating (ducted air) . running costs 30000 (10.000) dismantling cost 3000 3500 (600) Alternative exhaust gas extraction : machinery inning cost 12.000 12.000 sing cost 4000 +4000 Eleciric motor conversion cust 2500. 2.500 Net cash flow 80500 ‘ Net cost of uclay for one year (E14 000) (€14 000) (@) Inorder to evaluate the three alternatives, it is necessary to estimate the annual Question 9.43 income receivable from customers if the company undertakes to service the appliances itself. The calculation of income receivable from customers is: © ’ Labour: maintenance contract (100/10 x £30 000) 300000 ‘ Labour: ad hoc work (100/15 x £12,000) - 80000 Materials: maintenance contract (137.5410 x £18 000) ~ 247500 Materials: ad hoc work (137.5*/10 x £6000) 82.500 710000 Note “ :

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