Question

The Dorilane Company produces a set of wood patio furniture consisting of a table and four chairs. The company has enough customer demand to justify producing its full capacity of 2,000 sets per year. Annual cost data at full capacity follow: Py ry busing Decode Locat in t actory Deco ctiory building Advog 31000 Dermed wood.b U factory ) SO $ 20.000 Required: 1. Enter the dollar amount of each cost item under the appropriate headings. Note that each cost item is classified in two ways: first, as variable or fixed with respect to the number of units produced and sold; and second, as a selling and administrative cost or a product cost. (If the item is a product cost, it should also be classified as either director indirect.) 2. Compute the average product cost of one patio set. 3. Assume that production drops to only 1,000 sets annually. Would you expect the average product cost per set to increase, decrease, or remain unchanged?

Answer 1

Solution:

Dorilane Company

1. Classification of costs as variable and fixed –

Cost classification as variable or fixed:
Cost Item	Amount	Variable/Fixed
Direct Labor	$118,000	Variable
Advertising	$50,000	Fixed
Factory Supervision	$40,000	Fixed
Property Taxes, factory building	$3,500	Fixed
Sales Commission	$80,000	Variable
Insurance, factory	$2,500	Fixed
Depreciation, administrative office equipment	$4,000	Fixed
Lease cost factory equipment	$12,000	Fixed
Indirect materials, factory	$6,000	Variable
Depreciation factory building	$10,000	Fixed
Administrative office supplies (billing)	$3,000	Variable
Administrative office salaries	$60,000	Fixed
Direct materials used (wood, bolts etc)	$94,000	Variable
Utilities factory	$20,000	Variable

Cost classification as product cost or selling and administrative cost:

Cost Item	Amount	Product Cost/selling and administrative cost
Direct Labor	$118,000	Product Cost (Direct)
Advertising	$50,000	Selling and administrative cost (Fixed)
Factory Supervision	$40,000	Product cost (Indirect)
Property Taxes, factory building	$3,500	Product cost (Indirect)
Sales Commission	$80,000	Selling and administrative cost (Variable)
Insurance, factory	$2,500	Product cost (Indirect)
Depreciation, administrative office equipment	$4,000	Selling and administrative cost (Fixed)
Lease cost factory equipment	$12,000	Product cost (Indirect)
Indirect materials, factory	$6,000	Product Cost (Indirect)
Depreciation factory building	$10,000	Product cost (Indirect)
Administrative office supplies (billing)	$3,000	Selling and administrative cost (Variable)
Administrative office salaries	$60,000	Selling and administrative cost (Fixed)
Direct materials used (wood, bolts etc)	$94,000	Product Cost (Direct)
Utilities factory	$20,000	Product Cost (Indirect)

2. Average product cost of one patio:

Product Cost –

Product Cost
Direct labor	$118,000
Factory supervision	$40,000
Property taxes, factory building	$3,500
Insurance, factory building	$2,500
Lease cost factory building	$12,000
Indirect materials	$6,000
Depreciation factory building	$10,000
Direct materials	$94,000
Utilities factory building	$20,000
Total product cost	$306,000
number of patio sets	2,000
average cost per set	$306,000/2,000 = $153

3. When demand falls to 1,000 sets annually,

The average product cost increases.

Explanation:

When demand falls, variable costs also decrease proportionately. However, fixed production costs remain the same as these costs are not affected by changes in sales volume. Since, the fixed costs remain the same, the average cost per unit increases with fall in sales.

This is because when the number of sales units are decreased that the entire fixed production cost is absorbed by a fewer units, thereby increasing the average cost per unit.