Chapter 14, Problem 62C

Bo Vonderweidt, the production manager for Sportway Corporation, had requested to have lunch with the company president. Vonderweidt wanted to put forward his suggestion to add a new product line. As they finished lunch, Meg Thomas, the company president, said, “I’ll give your proposal some serious thought, Bo. I think you’re right about the increasing demand for skateboards. What I’m not sure about is whether the skateboard line will be better for us than our tackle boxes. Those have been our bread and butter the past few years.”

Vonderweidt responded with, “Let me get together with one of the controller’s people. We’ll run a few numbers on this skateboard idea that I think will demonstrate the line’s potential.”

Sport way is a wholesale distributor supplying a wide range of moderately priced sports equipment to large chain stores. About 60 percent of Sport way’s products are purchased from other companies while the remainder of the products are manufactured by Sport way. The company has a Plastics Department that is currently manufacturing molded fishing tackle boxes. Sport way is able to manufacture and sell 8,000 tackle boxes annually, making full use of its direct-labor capacity at available work stations. The selling price and costs associated with Sport way’s tackle boxes are as follows:

Because Sport way’s sales manager believes the firm could sell 12,000 tackle boxes if it had sufficient manufacturing capacity, the company has looked into the possibility of purchasing the tackle boxes for distribution. Maple Products, a steady supplier of quality products, would be able to provide up to 9,000 tackle boxes per year at a price of $68.00 per box delivered to Sport way’s facility.

Bo Vonderweidt, Sport way’s production manager, has come to the conclusion that the company could make better use of its Plastics Department by manufacturing skateboards. Vonderweidt has a market study that indicates an expanding market for skateboards and a need for additional suppliers. Vonderweidt believes that Sport way could expect to sell 17,500 skateboards annually at a price of $45.00 per skateboard.

After his lunch with the company president, Vonderweidt worked out the following estimates with the assistant controller.

In the Plastics Department, Sport way uses direct-labor hours as the application base for manufacturing overhead. Included in the manufacturing overhead for the current year is $50,000 of factory wide, fixed manufacturing overhead that has been allocated to the Plastics Department. For each unit of product that Sport way sells, regardless of whether the product has been purchased or is manufactured by Sport way, there is an allocated $6.00 fixed overhead cost per unit for distribution that is included in the selling and administrative cost for all products. Total selling and administrative costs for the purchased tackle boxes would be $10.00 per unit.

Required: In order to maximize the company’s profitability, prepare an analysis that will show which product or products Sport way’s Corporation should manufacture or purchase.

1. 1. First determine which of Sport way’s options makes the best use of its scarce resources. How many skateboards and tackle boxes should be manufactured? How many tackle boxes should be purchased?
2. 2. Calculate the improvement in Sport way’s total contribution margin if it adopts the optimal strategy rather than continuing with the status quo.

To determine

Identify the option that makes the best use of Corporation S’s scarce resources.

Explanation of Solution

Contribution Margin: The process or theory which is used to judge the benefit given by each unit of the goods produced is called as contribution margin.

• Corporation S must purchase 9,000 tackle boxes from Company M, manufacture 17,500 skateboards, and manufacture 1,000 tackle boxes, In order to maximize the company’s profitability.
• This mixture of purchased and manufactured goods increases the contribution per direct-labor hour available.

The analysis supporting this conclusion is prepared as follows:

	Purchased	Manufactured
Particulars	Tackle Boxes	Tackle Boxes	Skate- boards
Selling price	$86	$86	$45
Less:
Material	($68)	($17)	($12.50)
Direct labor	$0	($18.75)	($7.50)
Manufacturing overhead	$0	(7)($6.25)	(9)($2.50)
Selling and administrative cost	(4.00)	($11)	(3.00)
Contribution margin	$14	$33	$19.50
Direct-labor hours per unit	$0	(1)$1.25	(8)$.5
Contribution per hour	$0	$26.40	$39

Table (1)

Working notes:

Trackle boxes:

(1)Calculate direct-labor hours:

$\begin{array}{c}\text{Direct}\text{labor}\text{hours}\text{=}\frac{\text{Direct}\text{labor}}{\text{Direct}\text{labor}\text{per}\text{hour}}\\ \text{=}\frac{\text{\$18}\text{.75}}{\text{\$15}}\\ \text{=}\text{1}\text{.25}\text{hours}\end{array}$

(2)Calculate the overhead per direct-labor hour:

$\begin{array}{c}\text{Overhead}\text{per}\text{direct-labor}\text{hour}\text{=}\frac{\text{Manufacturing}\text{overhead}}{\text{Direct}\text{labor}\text{hours}}\\ \text{=}\frac{\text{\$12}\text{.50}}{\text{1}\text{.25}\text{hours}\text{(1)}}\\ \text{=}\$\text{10}\end{array}$

(3)Calculate the capacity:

$\begin{array}{c}\text{Capacity}\text{=}\text{Number}\text{of}\text{boxes}\text{×}\text{Direct}\text{labor}\text{hours}\\ \text{=}\text{8,000}\text{boxes}\text{×}\text{1}\text{.25}\text{per}\text{hour}\text{(2)}\\ \text{=}\text{10,000}\text{hours}\end{array}$

(4)Calculate the total overhead:

$\begin{array}{c}\text{Total}\text{overhead}\text{=}\text{Number}\text{of}\text{hours}\text{×}\text{Overhead}\text{per}\text{direct-labor}\text{hour}\\ \text{=}\text{10,000}\text{hours}\text{(3)}\text{×}\text{\$10}\text{per}\text{hour}\text{(2)}\\ \text{=}\text{\$100,000}\end{array}$

(5)Calculate the total variable overhead:

$\begin{array}{c}\text{Total}\text{variable}\text{overhead}\text{=}\text{Total}\text{overhead}-\text{Manufacturing}\text{overhead}\text{current}\text{year}\\ \text{=}\text{\$100,000}\text{(4)}-\text{\$50,000}\\ \text{=\$50,000}\end{array}$

(6)Calculate variable overhead per hour:

$\begin{array}{c}\text{Variable}\text{overhead}\text{per}\text{hour}\text{=}\frac{\text{Total}\text{variable}\text{overhead}}{\text{Number}\text{of}\text{hours}\left(\text{capacity}\right)}\\ \text{=}\frac{\text{\$50,000}\text{(5)}}{\text{10,000}\text{(3)}}\\ \text{=\$5}\end{array}$

(7)Calculate the variable overhead per box:

$\begin{array}{c}\text{Variable}\text{overhead}\text{per}\text{box}\text{=}\text{Variable}\text{overhead}\text{per}\text{hour}\text{×}\text{Overhead}\text{per}\text{direct}\text{labor}\text{hour}\\ \text{=}\text{\$5}(6)\text{×}\text{1}\text{.25}\text{per}\text{hour}\text{(1)}\\ \text{=}\text{\$6}\text{.25}\end{array}$

Skateboards:

(8)Calculate direct-labor hours:

$\begin{array}{c}\text{Direct}\text{labor}\text{hours}\text{=}\frac{\text{Direct}\text{labor}}{\text{Direct}\text{labor}\text{per}\text{hour}}\\ \text{=}\frac{\text{\$7}\text{.50}}{\text{\$15}}\\ \text{=}0.5\text{hours}\end{array}$

(9)Calculate variable overhead:

$\begin{array}{c}\text{Variable}\text{overhead}\text{=Manufacturing}\text{overhead}\text{×}\text{Direct-labor}\text{hours}\\ \text{=}\text{\$5}\text{×}\text{.5}\text{hours}\text{(8)}\\ \text{=}\text{\$2}\text{.50}\end{array}$

Note: In computing the contribution margin, $6.00 of fixed overhead cost per unit for distribution should be subtracted from the selling and administrative cost.

To determine

Compute the improvement in Corporation S’s contribution margin if it adopts the optimal strategy rather than continuing with the status

Explanation of Solution

The following table displays the improvement in the total contribution margin of the company if it manufactures 17,500 skateboards and 1,000 tackle boxes, instead of manufacturing 8,000 tackle boxes:

The optimal use of Corporation S’s available direct-labor hours (DLH):

Figure (1)