Practical capacity, cost driver rates, and the death spiral. Youngsborough produ

Question

Practical capacity, cost driver rates, and the death spiral. Youngsborough products, a supplier to the automotive industry, had seen its operating margin sinkbelow 20% as its customers put continued pressure on pricing. Youngsborough produced four products in its plant and decided to eliminate products that no longer contributed positive gross margins. The total plant overhead cost is $122,000 per year. Details on the four products are as followed: Production Volume Units: A. 10,000, B. 8,000, C. 6,000, D. 4,000. Selling price: A. 15.00, B. 18.00, C. 20.00, D. 22.00. Materials per unit: A. 4.00, B. 5.00, C. 6.00, D. 7.00. Direct labor hours per unit: A. 0.24, B. 0.18, C. 0.12, D. 0.08. Total direct labor hours: A. 2,400, B. 1,440, C. 720, D. 320. Youngsborough calculates a plantwide overhead rate by dividing total direct labor hours into total overhead costs. Assume that plant overhead is a fixed cost during the year, but that direct labor is a variable cost. The direct labor rate is $30 dollars per hour.

Requirements: A. Calculate the plantwide driver rate and use this rate to assign overhead costs to products. Calculate the gross margin for each product and calculate the total gross margin. B. If any product is unprofitable in part A, drop this product from the mix. Recalculate the cost driver rate based on the new total direct labor hours remaining in the plan and use this rate to assign overhead costs to the remaining three products. Calculate the gross margin for each product and calculate the total gross margin. C. Drop any product wthat is unprofitable with the revised cost assignments. Repeat the process, eliminating any unprofitable products at each stage. D. In 500 word or more explain what is happening at Youngsborough and why? How could this situation be avoided? Please cite or list references, perferably 3.

Explanation / Answer

1.The problem is asked on the concept of absortion of overheads over the products. Any positive contribution will help to reduce to reduce the fixed cost ( overhead cost ). the company is following wrong method of absorption of overheads based on the direct labour hours worked. the overheads may not arise equally among the products, so the company have to look at how much over head resulted from each product, if doesnot have the information , then the best method is to compute the combined contribution and there from total overheads can be reduced if there is no information about the overheads arised from each product.

2.If we follow the mothod specified in the problem given then we have to close A first, then B, then C, and finally D..., as the overheads are absorbed on the basis of labour hours, here in the problem the products C and D are having high contribution , so overheads can be absorbed more from these prosucts. the material costs of these products are also more so we can absorb more overheads based on material cost or some other reasonable basis.

3.In the above problem we are having profit of 89600 from all the products taken as a whole, if we close A, the burden of Overheads of 60000 and loss of contribution 38000, will happen, the burden of this will fall on the remaining 3 products, so on it results in close of enire plants. Instead of putting burden on low contribution products, overheads can be absorbed more from C and D, then A and B also have gross positive margins.

the decision of Youngsborough products, to close plants is wrong as all the plants are having positive contribution

(Sales - Variable cost). the problem lies with the cost driver taken for absorption of overheads.

1.the following above method overheads being absorbed more by C and D, and the remaining by A and B.

so. 2..material cost per unit can be one cost driver. 3..overheads can be absorbed on the basis of sales or sale price.

particulars A B C D total selling price (A) 15 18 20 22 less Variable cost matetial p. u 4 5 6 7 labour p. u 7.2 5.4 3.6 2.4 Total vc    (B) 11.2 10.4 9.6 9.4 contribution ( C) A- B 3.8 7.6 10.4 12.6 prodution units D 10000 8000 6000 4000 total contribution E ( C*D) 38000 60800 62400 50400 211600 over head     (F) 60000 36000 18000 8000 122000 (2400*25) (1440*25) (720*25) (320*25) Total E- F ( profit /loss) -22000 24800 44400 42400 89600 working notes variable cost materials p.u (A) 4 5 6 7 production   ( B) 10000 8000 6000 4000 material cost (A*B) 40000 40000 36000 28000 labour hr p.u 0.24 0.18 0.12 0.08 labour hrs ( A) 2400 1440 720 320 labour rate per hr ( B) 30 30 30 30 labour cost ( A*B) C 72000 43200 21600 9600 production       D 10000 8000 6000 4000 labour cost p.u C/D 7.2 5.4 3.6 2.4 plant wise overhead rate = Total overhead cost/ Total direct labour hours 122000/4880 over head absorption rate per hour 25

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