Industrial Solutions, Inc. Activity Industrial Solutions, Inc., manufactures thr
ID: 2540037 • Letter: I
Question
Industrial Solutions, Inc. Activity
Industrial Solutions, Inc., manufactures three types of containers – a drum, a bin, and a box – that are used in the chemical industry. The company uses a just-in-time production system for these containers. As a result, it holds no inventory.
Industrial Solutions, Inc.’s accountants have provided detailed cost information for three containers (also in the accompanying spreadsheet).
Drums
Bins
Boxes
Units produced and sold annually
5,000
4,500
3,000
Sales
$745,000
$495,000
$297,000
Variable costs:
Direct materials
255,500
85,500
72,000
Direct labor
18,000
40,500
36,000
Variable manufacturing overhead
6,750
9,000
18,750
Variable selling and administrative
3,750
13,500
11,250
Contribution margin
$461,000
$346,500
$159,000
Fixed costs:
Advertising, traceable
145,250
54,000
29,250
Depreciation on special equipment
40,000
33,750
39,000
Salaries of product-line managers
79,750
67,500
49,500
Allocated common fixed expenses*
45,000
90,000
62,250
Net operating income (loss)
$151,000
$101,250
$(21,000)
*Allocated based on sales dollars
Case 1 – Add or Drop a Product Line
Management is concerned about the continued losses shown by the box containers and wants a recommendation as to whether the line should be discontinued. The special equipment used to produce the boxes can be sold immediately for its book value.
Required:
1. Indicate whether each item listed below is relevant or irrelevant in this situation.
a. Sales revenue
b. Direct materials
c. Direct labor
d. Variable manufacturing overhead
e. Depreciation – special equipment
f. Book value – special equipment
g. Disposable value – special equipment
h.Variable selling and administrative expense
i. Advertising expense
j. Salaries of product-line managers
k. Common fixed expenses
2. Should production and sale of the box containers be discontinued? Explain. Show computations to support your answer.
3. Recast the above data in a format that would be more usable to management in assessing the long-run profitability of the various product lines. (segment margin format – Ch. 5.)
Case 2 – Make or Buy
Harcor Industries has offered to sell drums to Industrial Solutions, Inc. for $75.00 per unit. Cost per unit to ship the drums from Harcor to Industrial Solutions would be $3.00. Assume that there will be no layoffs for any product-line managers unless a major recession. The special equipment used to produce the drums has a no resale value of and does not wear out.
Required:
1. Indicate whether each item listed below is relevant or irrelevant in this situation.
a. Sales revenue
b. Direct materials
c. Direct labor
d. Variable manufacturing overhead
e. Depreciation – special equipment
f. Book value – special equipment
g. Disposable value – special equipment
h. Variable selling and administrative expense
i. Advertising expense
j. Salaries of product-line managers
k. Common fixed expenses
l. Purchase price from supplier
m. Additional shipping costs
2. Should Industrial Solutions, Inc. outsource the drums? By what amount would its operating income change if the drums were outsourced?
3. What is the most that Industrial Solutions, Inc. should be willing to pay to outsource the drums? By how much would Harcor need to reduce their selling price to make outsourcing attractive to Industrial Solutions, Inc.?
4. Suppose that if the drums are purchased, Industrial Solutions, Inc., could use the freed capacity to manufacture the new container. The segment margin of the new container would be $125,500. Should Industrial Solutions accept this offer?
5. What are some qualitative concerns of accepting Harcor’s offer?
Drums
Bins
Boxes
Units produced and sold annually
5,000
4,500
3,000
Sales
$745,000
$495,000
$297,000
Variable costs:
Direct materials
255,500
85,500
72,000
Direct labor
18,000
40,500
36,000
Variable manufacturing overhead
6,750
9,000
18,750
Variable selling and administrative
3,750
13,500
11,250
Contribution margin
$461,000
$346,500
$159,000
Fixed costs:
Advertising, traceable
145,250
54,000
29,250
Depreciation on special equipment
40,000
33,750
39,000
Salaries of product-line managers
79,750
67,500
49,500
Allocated common fixed expenses*
45,000
90,000
62,250
Net operating income (loss)
$151,000
$101,250
$(21,000)
*Allocated based on sales dollars
Explanation / Answer
Case 1 all parts have been answered.
Items
Relevant / Irrelevant
Sales revenue
Relevant as it effects the revenue
Direct materials
Relevant as it move directly with production
Direct labour
Relevant as it move directly with production
Variable manufacturing overhead
Relevant as it move directly with production
Depreciation Special equipment
Irrelevant as depreciation is a fixed expense
Book value special equipment
Irrelevant as it does not affect the financial performance
Disposable value equipment
Irrelevant as it does not affect the financial performance
Variable selling and administrative expenses
Relevant as it is directly dependent on the number of units sold
Advertising expenses
Irrelevant as it is generally a fixed cost
salaries of product line manager
Relevant as it is directly dependent on the number of units sold
Common fixed expenses
Irrelevant as it is a fixed expense
Part 2:
No, the company should not discontinue the production and sales of boxes as the contribution from sale of boxes is $159000. It is despite the fact that the sale of boxes is eventually incurring a loss of $21000. This is due to the fact that the fixed expenses will continue as it is thus, the contribution is the main aspect which is to be considered while assessing the desirability of a production line.
Contribution
159000
Less: Product line manager salary
49500
Yardstick to determine the desirability of boxes production and sales
109500
It is only the relevant costs which have been deducted from the amount of contribution as the irrelevant costs are not to be considered in deciding whether to continue or discontinue a production line.
Part 3:
Drums
Bins
Boxes
(A): Sales
745000
495000
297000
Variable costs
Direct materials
255500
85500
72000
Direct labour
18000
40500
36000
Variable manufacturing overhead
6750
9000
18750
Variable selling and administrative
3750
13500
11250
(B): Total variable cost
284000
148500
138000
Contribution (A-B)
461000
346500
159000
Less: Relevant fixed costs
Salaries of product line managers
79750
67500
49500
Profit before irrelevant costs
381250
279000
109500
Items
Relevant / Irrelevant
Sales revenue
Relevant as it effects the revenue
Direct materials
Relevant as it move directly with production
Direct labour
Relevant as it move directly with production
Variable manufacturing overhead
Relevant as it move directly with production
Depreciation Special equipment
Irrelevant as depreciation is a fixed expense
Book value special equipment
Irrelevant as it does not affect the financial performance
Disposable value equipment
Irrelevant as it does not affect the financial performance
Variable selling and administrative expenses
Relevant as it is directly dependent on the number of units sold
Advertising expenses
Irrelevant as it is generally a fixed cost
salaries of product line manager
Relevant as it is directly dependent on the number of units sold
Common fixed expenses
Irrelevant as it is a fixed expense