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Managerial Accounting: Cost allocation and apparent profitability

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Problem 6-10. Cost allocation and apparent profitability. Diamonds, etc. manufactures jewelry settings and sells them to retail stores. In the past, most settings were made by hand, and the overhead allocation rate in the prior year was $10 per labor hour ($2,000,000 overhead /200,000 labor hours). In the correct year, overhead increased by $400,000 due to acquisition of equipment. Labor, however, decrease by 50,000 hours because the equipment allows rapid creation of the settings. One of the company's many customers is a local jewelry store. Jasmine's fine jewelry. This store is relatively small and to make an order of jewelry pieces is typically less than 8 labor hours. On such jobs (less than 8 labor hours). The new equipment is not used, and thus the jobs are relatively labor intensive.

A. Assume that in the current year, the company continues to allocate overhead based on labor hours. What would be the overhead cost of an 8-labor-hour job requested by jasmine's fine jewelry? How does the compare to the overhead cost charged to such a job in the prior year?

B. Assume that the price charged for small jobs does not change in the current year. Are small jobs less profitable than they were in the past?

Problem 6-16 Activity-based Management. Talbot partners are a consulting firm with clients across the nation. Within the company is a travel group that arranges flights and hotel accommodations for it's over 1,000 consultants. The cost of operating the travel group (exclude the cost s associated with actual travel such as hotel cost and airfare) amounts to approximately $800,000.

Recently Talbot partners have conducted an ABM study that has determined the following:

A. Each consultant takes approximately 20 business trips per year.
B. On Average, 30 percent of trips are rescheduling due to conflicts and poor planning.
C. The travel group employs 14 individuals at $45,000 each to book travel. In addition, there is a travel manager and an assistant travel manager.
D. Benchmarking with Talbot partners' client indicates that the client incurs $30 cost per complete trip to book travel.

A. Evaluate the cost incurred by Talbot partners compared to the benchmark cost.

B. Talbot partners are planning a process improvement initiative aimed at reducing schedule conflicts. What would be the savings if rescheduling could be reduced by 5 percent? Assume that the only variable cost in travel services is the wages paid to employees who book travel.

Problem 7-6. Make-or-buy decision. Curtis Corporation is beginning to manufacture mighty mint, a new mouthwash in a small spray container. The product will be sold to whole sellers and large drugstore chains in packages of 30 containers for $18 per package. Management allocates $200,000 of fixed manufacturing overhead costs to mighty mint. The manufacturing cost per package of 30 containers for expected production of $1000, 000 packages is as follows:

Direct material $6.50
Direct labor 3.50
Overhead (fixed and variable) 3.00
Total $13.00

The company has contracted a number of packaging suppliers to determine whether it is better to buy or manufacture the spray containers. The lowest quote for the containers is $1.75 per 30 units. It is estimated that purchasing the containers from a supplier will save 10 percent of direct materials. 20 percent of direct labor and 15 percent of variable overhead. Curtis's manufacturing space is highly constrained. By purchasing space that is estimate to cost $15,000 per year. If the containers are purchased, one supervisory position can be eliminated. Salary plus benefits for this position are $70,000 per year.

Should Curtis make or buy the containers? What is the incremental cost (benefit) of buying the container as oppose to making them?

Problem 6-10 Drop a product/opportunity cost. Midwest Sod Company produces two products: fescue grass and Bermuda grass.
Fescue Grass Bermuda grass
Selling price per square yard $2.00 $2.85
Less variable cost per square yard
(Water, fertilizer, maintenance) .55 1.15

The company has 120,000 square yards of growing space available. In the past year, the company dedicated 60,000 square yards to fescue and 60,000 square yards to Bermuda grass. Annual fixed cost are $120,000, which the company allocates to products on relatively growing space.

Martha Lopez, the chief financial officer of Midwest Sod, has suggested that in the coming year, all 120,000 square yards should be devoted to Bermuda grass. The president vetoed her suggestion, saying, "I know that right now home construction is booming in our area, and we can sell all the grass we can produce, irrespective of what type. But, you know a lot of developers really like that fescue grass and I'd hate to disappoint them by not offering it."

What is the opportunity cost of the president's decision to stick with both types of grass?

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Solution Summary

The solution explains some questions in managerial accounting relating to product profitability, activity based management and make or buy decision.