TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers t

ID: 2601840 • Letter: T

Question

TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the company’s products is a heavy-duty corrosion-resistant metal drum, called the WVD drum, used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,000 hours of welding time is available annually on the machine. Because each drum requires 0.8 hours of welding machine time, annual production is limited to 2,500 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided the following financial data concerning the WVD drums:

Management believes 3,000 WVD drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Harcor Industries, Inc., a supplier of quality products, would be able to provide up to 1,800 WVD-type drums per year at a price of $140 per drum, which TufStuff would resell to its customers at its normal selling price after appropriate relabeling.

Megan Flores, TufStuff’s production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.2 hours of welding machine time per frame and yet sell for far more than the drums. Megan believes that TufStuff could sell up to 3,500 bike frames per year to bike manufacturers at a price of $71 each. The accounting department has provided the following data concerning the proposed new product:

The bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at $1.11 per WVD drum and $1.20 per bike frame. The variable manufacturing overhead cost would not be incurred on drums acquired from the outside supplier.

Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $0.91 per WVD drum whether made or purchased and would be $1.00 per bike frame.

All of the company’s employees—direct and indirect—are paid for full 40-hour workweeks and the company has a policy of laying off workers only in major recessions.

Would you be comfortable relying on the financial data provided by the accounting department for making decisions related to the WVD drums and bike frames?

Compute the contribution margin per unit for [assume direct labor is a fixed cost]: (Do not round intermediate calculations. Round your answers to 2 decimal places.)

As soon as your analysis was shown to the top management team at TufStuff, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable cost in textbooks and in practice and has always been considered a variable cost at TufStuff. After all, “direct” means you can directly trace the cost to products. “If direct labor is not a variable cost, what is?” Another manager argued just as strenuously that direct labor should be considered a fixed cost at TufStuff. No one had been laid off in over a decade, and for all practical purposes, everyone at the plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted Lean Production techniques. Whether the welding machine is used to make drums or frames, the total payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the bike frames would require.

Compute the contribution margin per welding hour for [assume direct labor is a fixed cost]: (Round your final answers to 2 decimal places.)

Determine the number of WVD drums (if any) that should be purchased and the number of WVD drums and/or bike frames (if any) that should be manufactured. [Assume direct labor is a fixed cost]

What is the increase in net operating income that would result from this plan over current operations? (Do not round intermediate calculations.)

Redo requirements (2) and (3) making the opposite assumption about direct labor from the one you originally made. In other words, if you treated direct labor as a variable cost, redo the analysis treating it as a fixed cost. If you treated direct labor as a fixed cost, redo the analysis treating it as a variable cost.

Compute the contribution margin per unit for [assume direct labor is a variable cost]: (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Compute the contribution margin per welding hour for [assume direct labor is a variable cost]: (Round your final answers to 2 decimal places.)

Determine the number of WVD drums (if any) that should be purchased and the number of WVD drums and/or bike frames (if any) that should be manufactured. [Assume direct labor is a variable cost]

What is the increase in net operating income that would result from this plan over current operations? (Do not round intermediate calculations.)

Explanation / Answer

1) No. Reason: The information given does not specify the variable and fixed cost elements. 2) a) PURCHASED WVD DRUMS Salling price per drum 165.00 Variable expenses: Purchase cost 140.00 Manufacturing overhead 0.00 Selling and administrative expense 0.91 Total variable expenses 140.91 Contribution margin per unit 24.09 Answer b) MANUFACTURED WVD DRUMS Salling price per drum 165.00 Variable expenses: Direct materials 45.10 Manufacturing overhead 1.11 Selling and administrative expense 0.91 Total variable expenses 47.12 Contribution margin per unit 117.88 Answer MANUFACTURED BIKE FRAMES Salling price per drum 71.00 Variable expenses: Direct materials 18.10 Manufacturing overhead 1.20 Selling and administrative expense 1.00 Total variable expenses 20.30 Contribution margin per unit 50.70 Answer Contribution Margin a. Purchased WVD drums 24.09 per unit b. Manufactured WVD drums 117.88 per unit c. Manufactured bike frames 50.70 per unit 3) a) Contribution Margin Manufactured WVD Drums (117.88/0.8) 147.35 per hour Manufactured Bike frames (50.70/0.2) 253.50 per hour b) As the manufactured bike frame has the higher CM per machine hour it should be produced to the maximum. Hence, 3500 bike frames would be produced using 3500*0.2 = 700 machine hours Balance machine hours of 1300 (2000-700) would be used to produce 1300/0.8 = 1625 WDV frames. 3000-1625=1375 WDV drums can be purchased and sold. Hence, the allocation would be: Purchased Manufactured WVD drums 1375 1625 Bike frames 3500 c) Total contribution from current operations: 2500 WVD drums manufactured & sold = 2500*117.88 = 294700 Total contribution from revised plan: 1625 WVD drums manufactued and sold = 1625*117.88 = 191555 1375 WDV drums purchased and sold = 1375*24.09 = 33124 3500 Bike frames manufactured and sold = 3500*50.70 = 177450 Total contribution under revised plan 402129 INCREASE IN NET OPERATING INCOME 107429 Answer 4) WORKINGS FOR CONTRIBUTION MARGIN PER UNIT: PURCHASED WVD DRUMS Salling price per drum 165.00 Variable expenses: Purchase cost 140.00 Manufacturing overhead 0.00 Selling and administrative expense 0.91 Total variable expenses 140.91 Contribution margin per unit 24.09 MANUFACTURED WVD DRUMS Salling price per drum 165.00 Variable expenses: Direct materials 45.10 Direct labor 4.50 Manufacturing overhead 1.11 Selling and administrative expense 0.91 Total variable expenses 51.62 Contribution margin per unit 113.38 MANUFACTURED BIKE FRAMES Salling price per drum 71.00 Variable expenses: Direct materials 18.10 Direct labor 22.50 Manufacturing overhead 1.20 Selling and administrative expense 1.00 Total variable expenses 42.80 Contribution margin per unit 28.20 a) Contribution Margin Purchased WVD drums 24.09 per unit Manufactured WVD drums 113.38 per unit Manufactured bike frames 28.20 per unit b) Contribution Margin Manufactured WVD drums (113.38/.8) 141.73 per hour Manufactured bike frames (28.20/0.2) 141.00 per hour c) As the manufactured WVD has higher Contribution Margin per hour it should be produced to the maximum. Hence, 2500 WVD drums should be produced using 2500*0.8 = 2000 machine hours The machine hours available would thus be fully utilized for WVD drums. Hence, there would be no production of Bike frames. As 3000 WVD drums can be sold, balance 500 would be purchased and sold. Hence, the allocation would be: Purchased Manufactured WVD drums 500 2500 Bike frames 0 d) Total contribution from current operations: 2500 WVD drums manufactured & sold = 2500*113.38 = 283450 Total contribution from revised plan: 1625 WVD drums manufactued and sold = 2500*113.38 = 283450 1375 WDV drums purchased and sold = 500*24.09 = 12045 Total contribution under revised plan 295495 INCREASE IN NET OPERATING INCOME 12045 Answer

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