A pottery has to quote for a special order of clay pipe fittings to be made in its two departments, Blunging and Extruding. Details are as follows:
Blunging Extruding
Standard direct wage rate per hour £5 £3
Standard variable overhead per hour £2.50 £2
Standard fixed overhead per hour £6 £4
Direct labour hours per unit for the first
1000 clay fittings 12 6
Direct labour hours available per period 40,000 30,000
Expected rate of learning curve, applied
per block of 1000 units 80% 70%
Cost of clays used in Blunging are as follows:
Level of output Cost per clay fitting
(fittings) £
1000 36.00
2000 32.40
8000 27.00
No overtime premium has been included in the calculation of overhead, but overtime is paid at time and a half.
The special order involves special tooling to be used in Extruding at a total cost of £6,000, chargeable to the customer.
In arriving at selling prices, the company adds profit mark-ups of 20%.
If the order is for 2000 clay fittings or fewer, it will need to be done during period 5 which already has a workload of:
Blunging 25,600 direct labour hours
Extruding 14,000 direct labour hours.
Required:
a) Recommend the price to be charged for clay fittings made entirely within the company for an order of:
(i) 1000 clay pipe fittings
(ii) 2000 clay pipe fittings.
b) Assume that an order for 2000 clay pipe fittings has been placed as in a) (ii) above, recommend the lowest price the company could charge for an additional order of 600 clay pipe fittings in the following conditions:
(i) The company wished to treat this as an incremental order but did not wish to make a loss on it;
(ii) the additional work would be done when there were no capacity constraints for either department; and
(iii) the materials suppliers would charge the price at the 8000 level.
Solution
Blunging Extruding
Direct labour hours for order of 1,000 units 12,000 6,000
Current workload 25,600 14,000
Total hours with order of 1,000 units 37,600 20,000
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Direct labour hours for order of 2,000 units
2,000 x 12 x 0.8 19,200 (2,000 x 6 x 0.7) 8,400
Current workload 25,600 14,000
Total hours with order of 200 units 44,800 22,400
===== =====
Overtime hours required 4,800
Overtime premium (x £2.50) £12,000
= £6 per unit
a) Assuming that the order is to be costed as part of the normal business of the company and will therefore be required to absorb the full amount of fixed overhead.
(i) Order of (ii) Order of
1,000 units 2,000 units
Blunging £/unit £/unit £/unit £/unit
Direct wages 12 x £5 60.00 x 0.80 48.00
Variable overhead 12 x £2.50 30.00 x 0.80 24.00
Fixed overhead 12 x £6 72.00 x 0.80 57.60
Overtime premium 0 6.00
162.00 135.60
Extruding
Direct wages 6 x £3 18.00 x 0.70 12.60
Variable overhead 6 x £2 12.00 x 0.70 8.40
Fixed overhead 6 x £4 24.00 x 0.70 16.80
54.00 37.80
Direct materials (clays) 36.00 32.40
Special tooling £6,000 ÷ 1,000 6.00 £6,000 ÷ 2,000 3.00
258.00 208.80
Profit Margin (20%)
51.60 41.76
Recommended price per unit 309.60 250.56
b) If the company wishes to treat the order as incremental only those costs which are incurred as a direct result of the order would be included in the estimate. assuming that fixed overheads will not increase, they are excluded from the calculations.
Since the company wishes to charge the lowest price possible without making a loss, no profit margin will be added.
A further order of 600 units in addition to an initial order for 200 would bring cumulative volume to 800 units. this means that the original volume of 200 fittings would be doubled twice.
2,000 fittings 8,000 fittings
£/unit £/unit
(from a(ii))
Direct wages and variable
overhead
Blunging 72.00 x 0.8 x 0.8 46.08
Extruding 21.00 x 0.7 x 0.7 10.29
Direct materials 32.40 27.00
125.40 83.37
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£
Incremental cost of 8,000 units 8,000 x £83.37 666,960
Less incremental cost of 200 units 200 x £125.40 250,800
Incremental cost of 6,000 units 416,160
======
= £69.36 per unit
The lowest unit price that the company could charge for an additional order of 600 units is £69.36.
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