Question

1. The Dorilane Company specializes in producing a set of wood patio furniture consisting of a table and four chairs. The set enjoys great popularity, and the company has ample orders to keep production going at its full capacity of 2,000 sets per year. Annual cost data at full capacity follow:

... Direct labor ........ Advertising ...... Factory supervision ................. Property taxes, factory building ....... Sales commissions ....... Insurance, factory ...... Depreciation, administrative office equipment Lease cost, factory equipment ....... Indirect materials, factory ...... Depreciation, factory building .......... Administrative office supplies (billing)...... Administrative office salaries ............ Direct materials used (wood, bolts, etc.) ... Utilities, factory ........ $118,000 $50,000 $40,000 $3,500 $80,000 $2,500 $4,000 $12,000 $6,000 $10,000 $3,000 $60,000 $94,000 $20,000

Prepare an answer sheet with the column headings shown below. Enter each cost item on your answer sheet, placing the dollar amount under the appropriate headings. As examples, this has been done already for the first two items in the list above. 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 direct or indirect as shown.)

Total the dollar amounts in each of the columns in (1) above. Compute the average product cost of one patio set.

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? Explain. No computations are necessary.

Refer to the original data. The president’s brother-in-law has considered making himself a patio set and has priced the necessary materials at a building supply store. The brother-in-law has asked the president if he could purchase a patio set from the Dorilane Company “at cost,” and the president agreed to let him do so.

Would you expect any disagreement between the two men over the price the brother-in-law should pay? Explain. What price does the president probably have in mind? The brother-in-law?

Answer 1

Cost Item	Cost Behavior		Period (Selling or Administrative Cost)	Product Cost
	Variable	Fixed		Direct	Indirect
Direct labor	118000			118000
Advertising		50000	50000
Factory supervision		40000			40000
Property taxes, factory building		3500			3500
Sales commissions	80000		80000
Insurance, factory		2500			2500
Depreciation, administrative office equipment		4000	4000
Lease cost, factory equipment		12000			12000
Indirect materials, factory	6000				6000
Depreciation, factory building		10000			10000
Administrative office supplies (billing)	3000		3000
Administrative office salaries		60000	60000
Direct materials used (wood, bolts, etc)	94000			94000
Utilities, factory	20000				20000
Total costs	321000	182000	197000	212000	94000

Average product cost of one patio set: $153

	Product Cost
Direct	212000
Indirect	94000
Total $	306000
Number of sets produced	2000
Average cost per set $ ($306000/2000)	153.00

Increase

With a drop in production from 2000 sets to 1000 sets, the variable cost per set will remain unchanged however, the fixed cost per set will increase as the total fixed cost which remains constant is spread over a lesser number of sets. Hence, the average product cost per set will increase due to the increase in the fixed costs per set.

Yes.

Disagreement over the price between the president and brother-in-law is expected.

The price that the president has in mind is probably $153 while the price that the brother-in-law has in mind is the direct product cost of $212000/2000 = $106.