Inez Company recently began production of a new product, a digital clock, which required the investment of $1,600,000 in assets. The costs of producing and selling 80,000 units of the digital clock are estimated as follows: Variable costs: Direct materials $10.00 per unit Direct labor 6.00 Factory

Question

Inez Company recently began production of a new product, a digital clock, which required the investment of $1,600,000 in assets. The costs of producing and selling 80,000 units of the digital clock are estimated as follows:

Variable costs:

Direct materials $10.00 per unit

Direct labor 6.00

Factory overhead 4.00

Selling and administrative expenses 5.00

Total [latex]\underline{\underline{\$ \ 25.00}}[/latex] per unit

Fixed costs:

Factory overhead $800,000

Selling and administrative expenses 400,000

Inez Company is currently considering establishing a selling price for the digital clock. The president of Inez Company has decided to use the cost-plus approach to product pricing and has indicated that the digital clock must earn a 10% rate of return on invested assets.

Instructions

1. Determine the amount of desired profit from the production and sale of the digital clock.

2. Assuming that the product cost concept is used, determine (a) the cost amount per unit, (b) the markup percentage, and (c) the selling price of the digital clock.

3. Under what conditions should Inez Company consider using activity-based costing rather than a single factory overhead allocation rate in allocating factory overhead to the digital clock?

4. Assume the market price for similar digital clocks was estimated at $38. Compute the reduction in manufacturing cost per unit needed to maintain the desired profit and existing selling and administrative expenses under target costing.

5. Assume that for the current year, the selling price of the digital clock was $42 per unit. To date, 60,000 units have been produced and sold, and analysis of the domestic market indicates that 15,000 additional units are expected to be sold during the remainder of the year. On August 7, 2014, Inez Company received an offer from Wong Inc. for 4,000 units of the digital clock at $28 each. Wong Inc. will market the units in Korea under its own brand name, and no selling and administrative expenses associated with the sale will be incurred by Inez Company. The additional business is not expected to affect the domestic sales of the digital clock, and the additional units could be produced during the current year, using existing capacity. Prepare a differential analysis dated August 7, 2014, to determine whether to reject (Alternative 1) or accept (Alternative 2) the special order from Wong.

Accepted Answer

1. $160,000 ($1,600,000 × 10%)

2. a. Total manufacturing costs:

Variable ($20 × 80,000 units) $1,600,000
Fixed factory overhead 800,000
Total [latex]\underline{\underline{\$ \ 2,400,000}}[/latex]

Cost amount per unit: $2,400,000/80,000 units = $30.00

b. Markup Percentage = [latex]\frac{Desired Profit + Total Selling and Administrative Expenses}{Total Product Cost}[/latex]

Markup Percentage = [latex]\frac{\$ 160,000 + \$ 400,000 + (\$ 5 imes 80,000 units)}{\$ 2,400,000}[/latex]

Markup Percentage = [latex]\frac{\$ 160,000 + \$ 400,000 + \$ 400,000}{\$ 2,400,000}[/latex]

Markup Percentage = [latex]\frac{\$ 960,000}{\$ 2,400,000}[/latex] = 40%

c. Cost amount per unit $30.00

Markup ($30 × 40%) 12.00

Selling price [latex]\underline{\underline{\$ \ 42.00}}[/latex]

3. Inez should consider using activity-based costing for factory overhead allocation when the product and manufacturing operations are complex. For example, if the digital clock was introduced as one among many different consumer digital products, then it is likely these products will consume factory activities in different ways. If this is combined with complex manufacturing and manufacturing support processes, then it is likely a single overhead allocation rate will lead to distorted factory overhead allocation. Specifically, the digital clock is a new product. Thus, it is likely that it will consume more factory overhead than existing stable and mature products. In this case, a single rate would result in the digital clock being undercosted compared to results using activity-based rates for factory overhead allocation.

4.

Current selling price $42

Expected selling price –38

Required reduction in manufacturing cost to maintain same profit [latex]\underline{\underline{\$ \ 4}}[/latex]

Revised revenue and cost figures:

	Current	Desired
Selling price	$42	$38
Costs:
Variable selling and administrative expenses per unit	$ 5	$ 5
Fixed selling and administrative expenses per unit ($400,000/80,000 units)	5	5
Existing manufacturing cost per unit [part (2)]	30
Target manufacturing cost per unit ($30 – $4)		26
Total costs	$40	$36
Profit	[latex]\underline{\underline{\$ \ 2}}[/latex]	[latex]\underline{\underline{\$ \ 2}}[/latex]

5.

Differential Analysis—Wong Inc. Special Order Reject Order (Alternative 1) or Accept Order (Alternative 2) August 7, 2014
	Reject Order (Alternative 1)	Accept Order (Alternative 2)	Differential Effect on Income (Alternative 2)
Revenues	$0	$112,000*	$112,000
Costs:
Variable manufacturing costs	$0	–80,000**	–80,000
Income (loss)	[latex]\underline{\underline {\$ \ 0}}[/latex]	[latex]\underline{\underline {\$ \ 32,000}}[/latex]	[latex]\underline{\underline {\$ \ 32,000}}[/latex]

*4,000 units × $28 per unit
**4,000 units × $20 per unit

The proposal should be accepted

Question 24.IP.1: Inez Company recently began production of a new product, a d...

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