TENNESSEE CORPORATION ….. has the following unit costs of manufacturing and mark
ID: 2527739 • Letter: T
Question
TENNESSEE CORPORATION
….. has the following unit costs of manufacturing and marketing a chair at an expected output level of 20,000 chairs per month (240,000 chairs per year):
CONSIDER EACH PART INDEPENDENTLY
REQUIRED:
1. For an inventory of 10,000 chairs, what amount would be presented on the balance sheet as per GAAP?
2. If they used variable costing for internal purposes, an inventory of 10,000 chairs would be valued at how much?
3. For the upcoming year, the company is thinking of reducing its selling price by $ .20 per unit, which will increase unit sales 10%. Is this a good idea? Why or why not?
4. In a particular month, the company is thinking of accepting a contract with an old friend for 5,000 chairs. This deal calls for the reimbursement of all manufacturing costs plus a fixed fee of $1,000. Since this is a friend of the company, there will be no variable marketing expenses on this order. You are asked to compare the following two alternatives:
Which alternative should the company do: Alternative A or Alternative B, and by HOW MUCH?
5. Assume the same data with respect to the contract as in requirement 2) above, except that the two alternatives to be compared are as follows:
Now which alternative should the company do: Alternative A or Alternative B? WHY?
6. In a particular month, the company wants to enter an international market in which price competition is keen. The company seeks a special order for 10,000 units at the minimum acceptable price. It expects that shipping costs for this order will amount to only $.75 per unit, and the fixed costs of obtaining the contract will be $4,000. The company will incur no variable marketing costs in connection with this order other than the shipping. Regular business is unaffected by this special order. What is the minimum price that the company must charge?
7. The company has an inventory of 1,000 chairs that must be sold immediately at reduced prices, otherwise the inventory will become worthless and thrown away. What is the minimum price that the company must charge for these chairs?
8. A proposal is received from an outside supplier who will make and ship the chairs directly to the company’s customers. Fixed marketing costs will be unaffected, but its variable marketing costs will be slashed by 20%. The company’s plant will be idle, but its fixed manufacturing overhead will continue at 50% of the present levels. What is the maximum price that the company would be willing to pay the outside supplier without decreasing operating income?
Manufacturin Direct materials Direct labor Variable overhead Fixed manufacturing overhead $1.00 1.20 0.80 0.50 Marketing Variable (shipping) Fixed 1.50 0.90 Normal selling price $6.00Explanation / Answer
Solution 1: $35,000
As per GAAP, Inventory should be recorded at lesser of Cost or Market Value. To compute the cost, let’s use Absorption costing technique. Under this technique, all the manufacturing overheads are taken in costing of closing inventory.
Let’s compute the cost of production for a single chair:
Cost Items
Amount
Direct Material
1
Direct Labor
1.2
Variable Overhead
0.8
Fixed Manufacturing overhead
0.5
Total Product Cost
3.5
Since Closing Inventory is 10,000 chairs, the value of cost for Closing stock would be 10,000 * 3.5= $35,000. Market value under GAAP is defined as the current replacement cost as limited by net realizable value. Since there is no information on Market value, Inventory can be valued at $35,000.
Please note Selling Price doesn’t form the part of valuation amount.
Solution 2: $30,000
Under Variable costing approach, no fixed overhead is considered at the time of valuation. All the fixed overheads are treated as period expenses and are directly charged to P&L A/c and no amount is added in valuation of inventory.
Under this approach, closing stock will be valued at variable cost and no variable selling overheads will be taken into consideration since this overhead is incurred at the point of selling.
Let’s compute Variable cost per unit:
Cost Items
Amount
Direct Material
1
Direct Labor
1.2
Variable Overhead
0.8
Total Variable Cost
3
Since Closing Inventory is 10,000 chairs, the value of cost for Closing stock would be 10,000 * 3= $30,000. Please note Selling Price doesn’t form the part of valuation amount.
Solution 3:
Since the company’s fixed cost will remain same throughout the year, let’s compare the Net Income under both the cases. If there is an overall increase in income for the year, company may implement the drop in price and increase the sale quantity.
Cost Items
Normal
Reduced Selling Price
Selling Price
6
5.8
Variable Cost:
Direct Material
1
1
Direct Labor
1.2
1.2
Variable Overhead
0.8
0.8
Variable Cost of Production
3
3
Gross Contribution
3
2.8
Less: Variable Selling Overheads
1.5
1.5
Net Contribution
1.5
1.3
No. of Units to be sold
240000
264000
Total Contribution
360000
343200
Less: Fixed Cost
Fixed Manufacturing Overhead
120000
120000
Fixed Selling Overhead
216000
216000
Total Fixed Costs
336000
336000
Net Income
24000
7200
Since Net Income is lower if the price is dropped, we can conclude here that dropping price is not a good idea since it reduces the overall income.
Solution 4: Alternative B
It should be noted that the fixed cost will remain same at the level of 15,000 units as well as 20,000 units and will not change in total.
Alternative A: If the company sells 15,000 units to customer only, Net Income would be -$5,500
Cost Items
Normal
Selling Price
6
Variable Cost:
Direct Material
1
Direct Labor
1.2
Variable Overhead
0.8
Variable Cost of Production
3
Gross Contribution
3
Less: Variable Selling Overheads
1.5
Net Contribution
1.5
No. of Units to be sold
15000
Total Contribution
22500
Less: Fixed Cost
Fixed Manufacturing Overhead
10000
Fixed Selling Overhead
18000
Total Fixed Costs
28000
Net Income
-5500
Alternative B: In addition to alternative A, there is a special order of a friend who commits to reimburse all the manufacturing costs plus a fixed fees of $1000. It should be noted that on this special order we will get reimbursed for all the variable costs except variable selling overheads and fixed manufacturing overheads can also be claimed.
Since this is a cost plus contract, this order can be accepted. An additional fees of $1000 and claim of fixed manufactruing overhead will reduce the loss incurred above of $5,500.
Cost Items
Amount
Direct Material
1
Direct Labor
1.2
Variable Overhead
0.8
Fixed Manufacturing overhead
0.5
Total Product Cost
3.5
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