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Jones Inc. produces two types of water pumps, the WP2 and the WX4. The budget for the coming year shows the following data:
|
WP2 |
WX4 |
Yearly production (units) |
10,000 |
30,000 |
Selling price (€) |
240 |
210 |
Direct labor hours per unit |
3 |
4 |
Raw materials per unit (€) |
70 |
50 |
The total indirect costs of Jones are € 2.6 million per year and represent general managerial activities, equipment and machinery costs, and warehousing costs. They are fixed costs. Since both products use the same machines and equipment. Direct labor hours have a cost of € 20 per hour; these costs are variable costs. Currently, Jones calculates cost prices using a single cost pool, with direct costs as the allocation basis.
Calculate the unit cost of the WP2 and the WX4 using the current costing method of Jones.
The unit cost of WP2 is
The unit cost of WX4 is
Jim Jones, the owner of Jones Inc. is not happy with the way unit costs are calculated at the moment. He believes that the current unit costs do not accurately reflect the activities that are required for each type of pump. Therefore, he decides to implement a refined costing system. As a basis for this system, he identifies three main activities in the organization: general administrative tasks, production, and logistics. He collects the following data regarding the activity costs:
Activity cost pool |
Costs |
General |
600,000 |
Production |
1,300,000 |
Logistics |
700,000 |
Total |
2,600,000 |
As cost drivers for the cost pools, Jones chooses the following drivers:
WP2, and also 2,000 for the WX4.
Explain what a cost driver is, and use this explanation to state whether Jones has chosen the right cost drivers for the production and logistics department.
Cost driver: a variable or characteristic that causally affects costs. If the variable increases, costs will also increase
The costs drivers seem logical: more parts will require more production activities, and logistics will increase with each order. The general activities cost driver seems a decent approach
Calculate the unit cost of both types of pumps using the refined system.
The unit cost of WP2 is
The unit cost of WX4 is
Based on the results of the analysis, Jim Jones decides to focus the attention of the firm on the pump with the highest profit margin percentage according to the new unit costs (calculated under question 3). The budgeted production of the pump with the highest margin will be increased by 5,000, and the budgeted production of the other type will be decreased by 5,000 (so the total production will remain 40,000 units).
What will be the impact of this shift in production on budgeted profit? Explain the result.
The operating profit will (fill increase or decrease here).
While planning for the coming year, Jones learns that the supply of labor for the production department will become difficult. The highly skilled employees that are used in this department are in demand, and as a result Jones will not be able to recruit all employees that he needs to produce the number of pumps that the customers want to buy.
What type of pump should be given priority in production in order to maximize short-term profit?
should be given priority.
HB Ltd produces perfume for which it uses three different types of liquid inputs. The following data is available regarding the inputs for the production of 80 litres of the perfume.
Input |
Litres |
Cost per litre |
Total |
A |
40 |
€ 6.00 |
€ 240.00 |
B |
30 |
€ 3.50 |
€ 105.00 |
C |
30 |
€ 2.50 |
€ 75.00 |
Totals |
100 |
|
€ 420 |
Note that the required input for 80 litres of perfume is 100 litres in materials. For the past month, the following production data is available:
Input |
Litres |
Total costs |
A |
45,000 |
€ 247,500 |
B |
35,000 |
€ 147,000 |
C |
20,000 |
€ 55,000 |
Total |
100,000 |
€ 449,500 |
This input has resulted in 75,000 litres of perfume.
Calculate the direct materials price and efficiency variance for A, B and C, as well as at the process level
Price Variance for A, B and C are respectively
Efficiency Variance for A, B and C are respectively
Calculate the yield and mix variances for A, B and C.
The yield variance for A, B and C are , and respectively
The mix variance for A, B and C are , , and respectively
Explain how the results of question a and question b are related to each other. How should we interpret the yield and mix variance for input A, so how can we use it in managing the production process?
The yield and mix variance explain where the efficiency variance of – €48,750 comes from: is this from less effecient use of the inputs, or is it also due to using the inputs in a different mix than expected?
The sales department of HB is expected to sell the 75,000 litres of perfume at a cost per litre of € 20. At the end of the month, actual sales revenues are € 1,080,000, and the sales volume is 60,000 litres. While the sales department acknowledges that the volume fell short of the target, it claims that it actually did a decent job: it points to market research saying that the total market volume for the month was 340,000 litres instead of the budgeted 400,000 litres: ‘Actually, we did quite ok in a declining market’.
Calculate the sales price variance (flexible budget variance) and the sales volume variance.
The sales price variance is and the sales volume variance is
Calculate the market share variance and the market size variance
The market share variance is and the market size variance is .
Comment on the sales department’s remark. Did they do a good job? Why?
Answer:
We got a lower price, this leads to an unfavorable variance.
We sold a lower volume, this also leads to an unfavorable variance.
In a declining market, we still lost market share.
So although the market development was not favorable, the sales department did even worse than the market.
Sungsam Electronics is a South Korean multinational conglomerate headquartered in Seoul, South Korea. It comprises numerous affiliated businesses, most of which operate under the Sungsam brand. Amongst others, its divisions manufacture memory chips, television screens and other consumer electronics; other divisions are active in construction and financial services.
The Memory Chips Division is manufacturing memory chips for mobile phones. The memory chips are sold internally to the Mobile Phone Division, as well as externally to other firms that manufacture phones (e.g. Apple, LG Electronics, Sony, etc). Total number of memory chips sold is 70,000; 40,000 are sold internally (to the Mobile Phone Division of Sungsam), the rest (30,000) is sold to outside parties. Total available capacity at the Chips Division is 100,000 units. The market price for the memory chips is €25; variable manufacturing costs are €7 per unit, and total fixed costs for the Chips Division are € 945,000. Fixed costs are allocated to products based upon the budgeted production of 70,000 units.
The Mobile Phone Division sells 40,000 phones; available capacity is 50,000 units. The sales price for the phone is €280; variable costs (in addition to the transferred in costs from the Chips Division) are
€65 and fixed costs are €6.5 mln for the Mobile Phone Division.
What is the profit for the Chips Division when the transfer price is set at market price?
Profit for the Chip Department will be
The manager of the Mobile Phone Division is arguing that the transfer price should be set at full cost plus 10%, the average profit margin for the Mobile Phone Division.
What is the profit for the Chips Division when the transfer price is set at full cost plus 10%?
The profit for the Chip division is
Will the choice for a market price or a full cost plus 10% price impact the choices of each division? Why or why not?
Since both units are operating below capacity, the choice of the transfer price does not matter: in both cases neither division will be better off if they refuse to engage in internal transfers
The Chips Division receives an offer from an outside party, which is willing to pay €18.50 for 20.000 memory chips. This outside party is unlikely to become a client of Sungsam for a longer period of time; in addition, it is not a competitor of the Mobile Phone Division nor for other divisions of Sungsam. The manager of the Chips Division refuses the offer, arguing that the price is below market price and below the full production costs of the Chips Division.
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