Develop full product costs per unit for the voltage

Question

Case Analysis 1:

Digital Solutions, Inc., manufactures two component parts for the television industry:

- Voltage Regulator: Annual production and sales of 50,000 units at a selling price of
$48.72 per unit.
- Mother Board: Annual production and sales of 25,000 units at a selling price of $72 per unit.

Digital Solutions includes all R&D and design costs in engineering costs. Assume that Digital Solutions has no marketing, distribution, or customer-service costs.

The direct and overhead costs incurred by Digital Solutions on the Voltage Regulator and Mother Board are described as follows:

	Voltage Regulator	Mother Board		Total
Direct materials costs (variable)	$1,020,000	$720,000		$1,740,000
Direct manufacturing labor costs (variable)	360,000	240,000		600,000
Direct machining costs (fixed)	180,000	120,000		300,000
Manufacturing overhead costs:
Machining setup costs			112,500
Testing costs			600,000
Engineering costs			480,000
Manufacturing overhead costs				$1,192,500
Total costs				$3,832,500

Digital Solution's management identifies the following activity cost pools, cost drivers for each activity, and the costs per unit of cost driver for each overhead cost pool:

Activity	Description	Cost Driver	Cost per Unit of Cost Driver
Setup	Preparing the machine to manufacture a new batch of products	Setup hours	$30 per setup-hour
Testing	Testing components and final product (each unit is tested individually)	Testing hours	$2.40 per testing hour
Engineering	Designing products and processes and ensuring their smooth functioning	Complexity of product and process	Costs assigned to products by special study

Over a long-run time horizon, Digital Solution's management views direct materials costs and direct manufacturing labor costs as variable with respect to the units of Voltage Regulator's and Mother Board's produced. Direct machining costs for each product do not vary over this time horizon and are fixed long-run costs. Overhead costs vary with respect to their chosen cost drivers. For example, setup costs vary with the number of setup-hours. Additional information is as follows:

	Voltage Regulator	Mother Board
Production batch size	500 units	200 units
Setup time per batch	15 hours	18 hours
Testing and inspection time per unit of product produced	2.5 hours	5 hours
Engineering costs incurred on each product	$200,000	$280,000

Digital Solutions is facing competitive pressure to reduce the price of the Voltage Regulator and has set a target price of $48, well below its current price of $52.50. The challenge for Digital Solutions is to reduce the cost of the Voltage Regulator. Digital Solution's engineers have proposed a new product design and process improvements for the "New Voltage Regulator" to replace the Voltage Regulator. The new design would improve product quality, and reduce scrap and waste. The reduction in prices will not enable Digital Solutions to increase its current sales. (However, if Digital Solutions does not reduce prices, it will lose sales.)

The expected effects of the new design relative to the Voltage Regulator are as follows:

- Direct materials costs for the New Voltage Regulator are expected to decrease by $2.50 per unit.
- Direct manufacturing labour costs for the New Voltage Regulator are expected to decrease by $0.70 per unit.
- Time required for testing each unit of the New Voltage Regulator is expected to be reduced by 0.5 hours.
- Machining time required to make the New Voltage Regulator is expected to decrease by 20 minutes. It currently takes one hour to manufacture one unit of Voltage Regulator. The machines are dedicated to the production of the New Voltage Regulator.
- The New Voltage Regulator will take 7 setup-hours for each setup.
- Engineering costs are unchanged.
Assume that the batch sizes are the same for the New Voltage Regulator as for the Voltage Regulator. If Digital Solutions requires additional resources to implement the new design, it can acquire these additional resources in the quantities needed. Further assume the costs per unit of cost driver for the New Voltage Regulator are the same as those described for Voltage Regulator.

Required

1) Develop full product costs per unit for the Voltage Regulator and Mother Board, using an activity-based product costing approach.

2) What is the markup on the full product cost per unit for the Voltage Regulator?

3) What is Digital Solution's target cost per unit for the New Voltage Regulator if it is to maintain the same markup percentage on the full product cost per unit as it had for the Voltage Regulator?

4) Will the New Voltage Regulator design achieve the cost reduction targets that Digital Solutions has set?

5) What price would Digital Solutions charge for the New Voltage Regulator if it used the same markup percentage on the full product cost per unit for the New Voltage Regulator as it did for the Voltage Regulator?

6) What price should Digital Solutions charge for the New Voltage Regulator, and what next steps should Digital Solutions take regarding the New Voltage Regulator?

7) Provide a recommendation given the case facts and your analysis.

8) Pay attention to detail within your answers in terms of spelling, grammar, and formatting.

Case Analysis 2:

Titanium Business Operations (Production)

Titanium clothing sells uniforms for superheroes. Titanium's strategy is to offer a wide selection of clothing options, excellent customer service, and a premium price. Titanium presents the following data for 2015 and 2016. For simplicity, assume that each customer (superhero) purchases one piece of clothing.

	2015	2016
Pieces of clothing purchased and sold	40,000	40,000
Average selling price	$60	$59
Average cost per piece of clothing	$40	$41
Selling and customer-service capacity	51,000 customers	43,000 customers
Selling and customer-service costs	$357,000	$296,700
Selling and customer-service capacity cost per customer (line 5 / line 4)	$7	$6.90
Purchase and administrative capacity	980 designs	850 designs
Purchase and administrative costs	$245,000	$204,000
Purchasing and administrative capacity cost per distinct design (line 8 / line 7)	$250 per design	$240 per design

Total selling and customer-service costs depend on the number of customers that Titanium has created capacity to support, not the actual number of customers that Titanium serves. Total purchasing and administrative costs depend on purchasing and administrative capacity that Titanium has created (defined in terms of the number of distinct clothing designs that Titanium can purchase and administer). Purchasing and administrative costs do not depend on the actual number of distinct clothing designs purchased. Titanium purchased 930 distinct designs in 2015 and 820 distinct designs in 2016.

At the start of 2016, Titanium planned to increase operating income by 10% over operating income in 2015.

Titanium Supporting Function (Cafeteria)

Titanium currently subsidizes cafeteria services for its 250 employees. Titanium is in the process of reviewing the cafeteria services as cost-cutting measures are needed throughout the organization to keep the prices of its products competitive. Two alternatives are being evaluated: downsize the cafeteria staff and offer a reduced menu or contract with an outside vendor.

The current cafeteria operation has five employees with a combined annual salary of $155,000 plus additional employee benefits at 25% of salary. The cafeteria operates 260 days each year, and the costs for utilities and equipment maintenance average $52,000 annually. The daily sales include 100 entre´es at $7.20 each, 90 sandwiches or salads at an average price of $4.50 each, and an additional $300 for beverages and desserts. The cost of all cafeteria supplies is 62% of revenues.

The plan for downsizing the current operation envisions retaining two of the current employees whose combined base annual salaries total $94,000. An entre´e would no longer be offered, and prices of the remaining items would be increased slightly. Under this arrangement, Titanium expects daily sales of 160 sandwiches or salads at a higher average price of $5.10. The revenue for beverages and desserts is expected to increase to $340 each day. Because of the elimination of the entre´e, the cost of all cafeteria supplies is expected to drop to 52% of revenues. All other conditions of operation would remain the same. Titanium is willing to continue to subsidize this reduced operation but will not spend more than 20% of the current subsidy.

A proposal has been received from Delicious Foods, an outside vendor that is willing to supply cafeteria services. Delicious Foods has proposed to pay Titanium $1,300 per month for use of the cafeteria and utilities. Titanium would be expected to cover equipment repair costs. In addition, Delicious Foods would pay Titanium 8% of all revenues received above the breakeven point; this payment would be made at the end of the year. All other costs incurred by Delicious Foods to supply the cafeteria services are variable and equal 75% of revenues. Delicious Foods plans to charge $7.80 for an entre´e, and the average price for the sandwich or salad would be $5.50. All other daily sales are expected to average $370. Delicious Foods expects daily sales of 70 entre´es and 98 sandwiches or salads.

Required:

Titanium Operations

1) Is Titanium's strategy one of product differentiation or cost leadership? Explain.

2) Calculate the change in Titanium's operating income in 2015 and 2016.

3) Calculate the growth, price-recovery, and productivity components of changes in operating income between 2015 and 2016.

4) Does the strategic analysis of operating income indicate Titanium was successful in implementing its strategy in 2016? Explain.

Titanium Support Function

5) Determine whether the plan for downsizing the current cafeteria operation would be acceptable to Titanium Corporation. Show all calculations.

6) Is the Delicious Foods proposal more advantageous to Titanium Corporation than the downsizing plan? Show all calculations.
7) Provide a recommendation given the case facts and your analysis.

8) Pay attention to detail within your answers in terms of spelling, grammar, and formatting.

Case Analysis 3:

In southern Ontario, The Wild Orchard Corporation grows, processes, packages, and sells three joint apple products: (a) sliced apples that are used in frozen pies, (b) applesauce, and (c) apple juice. The skin of the apple, processed as animal feed, is treated as a by-product. Wild Orchard uses the estimated NRV method to allocate costs of the joint process to its joint products. The by-product is inventoried at its selling price when produced; the net realizable value of the by- product is used to reduce the joint production costs before the splitoff point. Details of Wild Orchard's production process are presented here:

- The apples are washed and the skin is removed in the Cutting Department. The apples are then cored and trimmed for slicing. The three joint products and the by-product are recognizable after processing in the Cutting Department. Each product is then transferred to a separate department for final processing.
- The trimmed apples are forwarded to the Slicing Department, where they are sliced and frozen. Any juice generated during the slicing operation is frozen with the slices.
- The pieces of apple trimmed from the fruit are processed into applesauce in the Crushing Department. The juice generated during this operation is used in the applesauce.
- The core and any surplus apple pieces generated from the Cutting Department are pulverized into a liquid in the Juicing Department. There is a loss equal to 8% of the weight of the good output produced in this department.
- The outside skin is chopped into animal feed and packaged in the Feed Department. It can be kept in cold storage until needed.

A total of 270,000 kilograms of apples entered the Cutting Department during October. The following schedule shows the costs incurred in each department, the proportion by weight transferred to the four final processing departments, and the selling price of each end product.

Departments	Costs Incurred	Proportion Transferred to Department	Selling Price per Kg of Final Product
Cutting	$72,000
Slicing	13,536	33%	$0.96
Crushing	10,260	30%	0.66
Juicing	3,600	27%	0.48
Feed	840	10%	0.12
Total	$100,236	100%	$2.22

The Wild Orchard Corporation classifies animal feed as a by-product. The by-product is inventoried at its selling price when produced; the net realizable value of the product is used to reduce the joint production costs before the splitoff point. Before 2017, Wild Orchard classified both apple juice and animal feed as by-products. These by-products were not recognized in the

accounting system until sold. Revenues from their sale were treated as a revenue item at the time of sale.

The Wild Orchard Corporation uses a "management by objectives" basis to compensate its
managers. Every six months, managers are given "stretch" operating-income-to-revenue ratio targets. They receive no bonus if the target is not met and a fixed amount if the target is met or exceeded.

Required:

1) The Wild Orchard Corporation uses the estimated NRV method to determine inventory cost of its joint products; by-products are reported on the statement of financial position at their selling price when produced. For the month of October 2017, calculate the following:
a. The output for apple slices, applesauce, apple juice, and animal feed, in kilograms.
b. The estimated NRV at the splitoff point for each of the three joint products.
c. The amount of the cost of the Cutting Department assigned to each of the three joint products and the amount assigned to the by-product in accordance with corporate policy.
d. The gross margins in dollars for each of the three joint products.

2) Comment on the significance to management of the gross margin dollar information by joint product for planning and control purposes, as opposed to inventory costing purposes.

3) Assume that Wild Orchard managers aim to maximize their bonuses over time. What by- product method (the pre-2017 method or the 2017 method) would the manager prefer?

4) How might a controller gain insight in to whether the manager of the Apple Products division is "abusing" the accounting system in an effort to maximize his or her bonus?

5) Describe an accounting system for the Wild Orchard Corporation that would reduce "gaming" behaviour by managers with respect to accounting rules for by-products.

6) Provide a recommendation given the case facts and your analysis.

7) Pay attention to detail within your answers in terms of spelling, grammar, and formatting.

Case Analysis 4:

Speed Racer in Victoria makes bicycles for people of all ages. The frames division makes and paints the frames and supplies them to the assembly division where the bicycles are assembled. Speed Racer is a successful and profitable corporation that attributes much of its success to its decentralized operating style. Each division manager is compensated on the basis of division operating income.

The assembly division currently acquires all its frames from the frames division. The assembly division manager could purchase similar frames in the market for $480.

The frames division is currently operating at 80% of its capacity of 4,000 frames (units) and has the following details:

	Voltage Regulator
Direct materials ($150 per unit x 320 units)	$480,000
Direct manufacturing labour ($60 per unit x 3,200 units)	192,000
Variable manufacturing overhead costs ($30 per unit × 3,200 units)	96,000
Fixed manufacturing overhead costs	$624,000

All the frames division's 3,200 units are currently transferred to the assembly division. No frames are sold in the outside market.

The frames division has just received an order for 2,000 units at $450 per frame that would utilize half the capacity of the plant. The order has to be either taken in full or rejected totally. The order is for a slightly different frame than what the frames division currently makes but takes the same amount of manufacturing time. To produce the new frame would require direct materials per unit of $100, direct manufacturing labour per unit of $48, and variable manufacturing overhead costs per unit of $30.

Required:

1. From the viewpoint of Speed Racer in Victoria as a whole, should the frames division accept the order for the 2,000 units?

2. What range of transfer prices result in achieving the actions determined to be optimal in question 1 if division managers act in a decentralized manner?

3. The manager of the assembly division has proposed a transfer price for the frames equal to the full cost of the frames including an allocation of overhead costs. The frames division allocates overhead costs to engines on the basis of the total capacity of the plant used to manufacture the frames.

a. Calculate the transfer price for the frames transferred to the assembly division under this arrangement.

b. Do you think that the transfer price calculated in question 3a will result in achieving the actions determined to be optimal in question 1, if division managers act in a decentralized manner?

c. Comment in general on one advantage and one disadvantage of using full costs of the producing division as the basis for setting transfer prices.

4. Now consider the effect of income taxes.

a. Suppose the assembly division is located in a country that imposes a 10% tax on income earned within its boundaries, while the frames division is located in a country that imposes no tax on income earned within its boundaries. What transfer price would be chosen by Speed Racer to minimize tax payments for the corporation as a whole? Assume that only transfer prices that are greater than or equal to full manufacturing costs and less than or equal to the market price of "substantially similar" frames are acceptable to the taxing authorities.

b. Suppose that Speed Racer announces the transfer price computed in question 4a to price all transfers between the frames and assembly divisions. Each division manager then acts autonomously to maximize division operating income. Will division managers acting in a decentralized manner achieve the actions determined to be optimal in question 1?

5. Consider your responses to questions 1 to 4 and assume the frames division will continue to have opportunities for outside business as described in question 1. What transfer-pricing policy would you recommend Speed Racer use and why? Would you continue to evaluate division performance on the basis of division operating incomes?

6. Provide a recommendation given the case facts and your analysis.

7. Pay attention to detail within your answers in terms of spelling, grammar, and formatting.