Phone Company has the following costs of producing and selling a cell phone when
ID: 2562864 • Letter: P
Question
Phone Company has the following costs of producing and selling a cell phone when it produces and sells 100,000 phones per month:
Manufacturing cost
Direct materials $60.00 per unit
Direct labor $10.00 per unit
Variable manufacturing overhead cost $35.00 per unit
Fixed manufacturing overhead cost $20.00 per unit
Selling cost
Variable $20.00 per unit
Fixed $10.00 per unit
The selling price of a cell phone is $250 unless otherwise stated in the questions below. NOTE: You should assume that the situation described in each requirement below is independent of the situations in the other requirements. That is, when you answer one question, you should assume that the situations described in other questions have not occurred. You should also assume that Phone Company has manufacturing capacity that is sufficient to accommodate any opportunities for increased sales that might arise without the need to incur additional fixed costs.
REQUIRED
1. What is the unit cost of a cell phone on Phone Company’s balance sheet (i.e., what is the value of inventory per unit for external reporting purposes)?
2. Phone Company currently produces and sells 100,000 cell phones each month. The company’s marketing department estimates that sales volume would increase by 20% if the selling price of a phone is reduced to $210. If the selling price is reduced to $210 per unit, then what would be the company’s total monthly operating income? (4 points)
3. Phone Company is deciding whether or not to accept a contract to provide Service Company with 8,000 cell phones per month in addition to Phone Co.’s existing business. The contract would require Service Co. to pay Phone Co. for all manufacturing costs plus a fixed fee of $750,000 per month. Phone Co. would incur no variable selling costs related to this contract. By what amount would Phone Co.’s monthly operating income increase or decrease as a result of accepting this contract? Assume that if Phone Co. accepts this contract, then it does not change the overhead allocation rate that it set at the beginning of the year. (5 points)
4. Phone Company has the opportunity to provide an organization with a one-time special order of 20,000 cell phones in addition to its existing business. The only variable selling cost associated with this order would be shipping costs of $10.00 per cell phone. Fixed selling costs for this order (in addition to Phone Company’s existing fixed costs) would be $200,000. What selling price per unit would be required in order to earn $600,000 in incremental operating income from this order? (4 points)
Explanation / Answer
Phone Company
The value of inventory per unit for external reporting purposes would be based on absorption costing, wherein the production cost per unit would include the allocated portion of fixed cost.
Production cost per unit –
Direct materials $60
Direct labor $10
Variable manufacturing overhead $35
Fixed manufacturing overhead $20
Total production cost per unit $125
Hence, the value of inventory per unit for external reporting purposes is $125.
Contribution margin income statement
Per unit
Total
Sales Revenue
$210
$25,200,000
Variable costs:
Direct materials
$60
$7,200,000
Direct labor
$10
$1,200,000
Variable manufacturing overhead
$35
$4,200,000
variable selling cost
$20
$2,400,000
Total variable cost
$125
$15,000,000
Contribution margin
$85
$10,200,000
Fixed costs:
Manufacturing overhead
$2,000,000
Selling cost
$1,000,000
Net Income
$7,200,000
Hence, the total monthly operating income of the company is $7,200,000 for an increased sales volume of 120,000 at a decreased sales price of $210 per unit.
Step 1 –
Determination of the price the Service Company would pay for the special order:
Manufacturing costs:
Per Unit
Total
Direct materials
$60
$480,000
Direct labor
$10
$80,000
variable manufacturing overhead
$35
$280,000
Allocated Fixed manufacturing overhead
$20
$160,000
Total manufacturing costs
$125
$1,000,000
Add: Fixed fee
$750,000
Total price the Supplier Company would pay
$1,750,000
cost per cell phone
$1,750,000/8,000
= $218.75
The Supplier Company is willing to pay total manufacturing costs plus fixed fee of $750,000, which totals to $1,750,000 for an order of 8,000 cell phones.
Hence, price per phone = $1,750,000/8,000 = $218.75
The variable cost per cell phone –
Direct material $60
Direct labor $10
Variable overhead $35
Total variable cost per cell phone $105
Contribution margin $113.75
Since, order of 8,000 phones earns a contribution margin of $113.75 the monthly operating income of Phone Company would increase by $950,000.
Note: The Phone Co. would not incur the variable selling cost for the special order, hence the same in not included in the total variable cost per unit calculation.
The fixed selling cost is irrelevant for the decision.
Since the company has excess capacity to accommodate increased sales, the fixed costs including manufacturing overhead and selling costs are irrelevant to the decision. However, since the terms indicate total manufacturing cost, the fixed manufacturing overhead is included to arrive at the estimated offer.
As the terms indicate that Supplier Co would pay to cover the total manufacturing costs, the fixed manufacturing overhead allocated on the original basis of $20 per cell phone ($20 x 8,000 = $160,000) is included to arrive at the total sales value of the order.
Desired selling units = (total fixed cost + target profit)/contribution margin
Contribution margin = sales price – total variable cost
Sales price – need to calculate
Variable cost –
Direct materials $60
Direct labor $10
Variable overhead $35
Variable selling cost $10
Total variable cost $115
Fixed cost - $200,000
Target profit = $600,000
Let the selling price be S
Substituting the values,
20,000 units = ($200,000 + $600,000)/ S - $115
20,000 x (S-115) = $800,000
20,000S -$2,300,000 = $800,000
20,000S = $1,500,000
S = $1,500,000/20,000 = $75
Hence, the desired selling price to earn a target incremental revenue = $75
Note: since the company has excess capacity to accommodate special orders, the fixed cost both manufacturing and selling are irrelevant to arrive at the selling price for incremental revenue.
Contribution margin income statement
Per unit
Total
Sales Revenue
$210
$25,200,000
Variable costs:
Direct materials
$60
$7,200,000
Direct labor
$10
$1,200,000
Variable manufacturing overhead
$35
$4,200,000
variable selling cost
$20
$2,400,000
Total variable cost
$125
$15,000,000
Contribution margin
$85
$10,200,000
Fixed costs:
Manufacturing overhead
$2,000,000
Selling cost
$1,000,000
Net Income
$7,200,000