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Chapter 25: 25-2TI (page 1384)

Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs.

1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations.

2. Does your answer change if Thomas Company is operating at capacity? Why or why not?

Short Answer

Expert verified
  1. The offer should be accepted if the Thomas company has excess capacity.
  2. The offer should be rejected if the Thomas company is operating at capacity.

Step by step solution

01

Meaning of Fixed Cost

In accounting, fixed cost refers to the cost that isindependent and is not affected by the level of production or quantity of goods produced by a business. Such a cost remains the same for zero production and other levels.

02

Decision on the order acceptance

Particulars

Amounts ($)

Expected increase in revenue (5,000*$9)

45,000

Less: Expected increase in variable manufacturing cost (5,000*$8.50)

(42,500)

Expected increase in operating income

$2,500

03

The company operating at its capacity

Particulars

Amounts ($)

Revenue at capacity sales price (5,000*$9)

45,000

Less: Revenue at regular sales price (5,000*$12.50)

(62,500)

Expected decrease in sales revenue

($17,500)

In the second scenario, Thomas Company should reject the offer because it will result in decreased sales revenue.

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Most popular questions from this chapter

McCollum Company manufactures two products. Both products have the same sales price, and the volume of sales is equivalent. However, due to the difference in production processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.

MCCOLLUM COMPANY

Income Statement

Month Ended June 30, 2018

Total Product A Product B

Net Sales Revenue \(150,000 \)75,000 \(75,000

Variable Costs 90,000 55,000 35,000

Contribution Margin 60,000 20,000 40,000

Fixed Costs 50,000 5,000 45,000

Operating Income/(Loss) \)10,000 \(15,000 \)(5,000)

  1. If fixed costs cannot be avoided, should McCollum drop Product B? Why or why not?
  2. If 50% of Product B’s fixed costs are avoidable, should McCollum drop Product B? Why or why not?

Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

SEA BLUE

Income Statement

For the Month Ended December 31, 2018

Sales in units 32,000

Net Sales Revenue \(608,000

Variable Costs:

Manufacturing 96,000

Selling and Administrative 108,000

Total Variable Costs 204,000

Contribution Margin 404,000

Fixed Costs:

Manufacturing 124,000

Selling and Administrative 94,000

Total Fixed Costs 218,000

Operating Income \)186,000

Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision.

2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order.

3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.

Snappy Plants operates a commercial plant nursery where it propagates plants for garden centers throughout the region. Snappy Plants has \(5,100,000 in assets. Its yearly fixed costs are \)650,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.90. Snappy Plants’s volume is currently 500,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.25 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.

Requirements

1. Snappy Plants’s owners want to earn a 11% return on investment on the company’s assets. What is Snappy Plants’s target full product cost?

2. Given Snappy Plants’s current costs, will its owners be able to achieve their target profit?

3. Assume Snappy Plants has identified ways to cut its variable costs to \(1.75 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?

4. Snappy Plants started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Snappy Plants does not expect volume to be affected, but it hopes to gain more control over pricing. If Snappy Plants has to spend \)105,000 this year to advertise and its variable costs continue to be $1.75 per unit, what will its cost-plus price be? Do you think Snappy Plants will be able to sell its plants to garden centers at the cost-plus price? Why or why not?

Johnson Builders builds 1,500-square-foot starter tract homes in the fast-growing suburbs of Atlanta. Land and labor are cheap, and competition among developers is fierce. The homes are a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:

Land \(50,000

Construction 123,000

Landscaping 9,000

Variable selling costs 8,000

Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for \)207,000 each. Assume the company has no fixed costs.

Requirements

1. Which approach to pricing should Johnson Builders emphasize? Why?

2. Will Johnson Builders be able to achieve its target profit levels?

3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost \(16,000 per home but would enable Johnson Builders to increase the sales prices by \)28,000 per home.

(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?

What is cost-plus pricing? Who uses it?
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