Question 1. Powell Dentistry Services is part of an HMO that operates in a large city. Currently, Powell has its own dental laboratory to produce gold crowns. It normally uses 1,250 gold crowns per year although the laboratory can produce up to 2,500 gold crowns a year. There are no taxes. The accountant reports that the cost of gold crowns per-unit at the current annual volume is:
Raw materials$ 149
Direct labor 44
Variable overhead 10
Fixed overhead: direct 44
Fixed overhead: indirect 6
Total cost per crown$253
Note: Fixed overhead: direct (i.e., traceable to the dental lab) for the year was estimated in total to be:
Salary (supervisor) $24,000
Depreciation (equipment)5,000
Depreciation (lab building) 26,000
Total$55,000
Fixed overhead (indirect) consists of allocations of the HMO’s corporate overhead to the dental lab.
An outside dental laboratory has offered to supply Powell the 1,250 gold crowns it needs annually. Its price is $232 per crown. If the offer is accepted,
- the equipment used by Powell would be junked for $0 (it is old and has no market)
- the lab building could be rented out, but for only $15,000 annually
- the supervisor would be laid off
REQUIRED: Should Powell continue to make its own crowns or should they be purchased from the external supplier? None of the indirect fixed overhead is avoidable by abandoning production of crowns
Question 2. Leland Manufacturing uses 10 units of part KJ37 each month in the production of radar equipment. The accountant says that Leland’s cost for manufacturing each unit of KJ37 is as presented below.
Direct materials $1,000
Direct labor 8,000
Materials handling (20% of direct material cost) 200
Testing equipment 3,000
Other manufacturing overhead 12,000
Total manufacturing cost $24,200
Scott Supply, one of Leland's reliable vendors, has offered to supply part KJ37 at a unit price of $15,000.
If Leland were to purchase part KJ37, materials handling costs would not be incurred.
The testing equipment is a special one for part KJ37 and is under a longterm, noncancelable lease.
Leland's other manufacturing overhead is onethird variable (with units produced) and two thirds fixed.
Required:
- If Leland purchases the KJ37 units from Scott, the capacity Leland was using to manufacture these parts would be idle. Should Leland purchase the parts from Scott?
- Assume Leland Manufacturing is able to rent all idle capacity for $25,000 per month. Should Leland purchase from Scott Supply?
- Assume that besides the rental possibility, Leland could use idle capacity to manufacture another product that would contribute $52,000 per month. Should Leland manufacture KJ37?
Question 3. Omega Co. makes and sells a single product at a volume of 5,000 units per month and a selling price of $90 per unit. The accountant reports the following as the product’s per unit manufacturing and selling costs.
Manufacturing costs Selling and administrative costs
Direct material$35Variable15
Direct labor12Fixed 8
Variable overhead8
Fixed overhead 5
The company has received a proposal from an outside supplier to make and ship the product directly to the company’s customers as sales orders are forwarded. If the supplier’s proposal is accepted, the above variable selling and administrative costs would not be eliminated, rather they would fall by 40%. The company would however be able to use its manufacturing facilities to produce a new product.
The new product would be sold through manufacturer’s agents at a 10% commission based on a selling price of $40 per unit. The accountant projects the unit cost of this product, based on its predicted monthly volume, will be as follows:
Manufacturing costs Selling and administrative costs
Direct material$6Variable (commission)10% of selling price
Direct labor12Fixed 9.6
Variable overhead8
Fixed overhead 6
Assume also the following:
Total monthly fixed factory overhead and total monthly fixed selling expenses will not change if the new product line is added.
Selling price of the old product will remain unchanged.
Required: What is the maximum price per unit that the company should pay the supplier for subcontracting production of the old product?