Question

Q.1

Ecoclock manufactures four environmentally friendly consumer products, and the firm is organized as four operating centers, each responsible for a single product. The main mechanism of each product is the same and requires an identical initial processing step, although subsequent processing for each product is very different. Ecoclock’s management has decided to centralize the initial processing function and purchase new equipment that has a 40,000 unit annual practical capacity. For budgeting and costing purposes, the initial processing function will be assigned to a new center, Center E. Shown below is the budgeted production for the product centers.

	Annual Production
Center A	5,000
Center B	7,500
Center C	4,000
Center D	6,000

A large part of the managers’ compensation is derived from bonuses that they receive for meeting or exceeding cost targets. The mangers of centers A through D each agree that they should be charged with the variable costs per unit that are delivered by Center E. However, they disagree about the allocation of the fixed costs of Center E, primarily because they believe that the new equipment has

a much larger capacity than is necessary and they do not want to be charged with the cost of the unused capacity. The fixed costs for Center E total $150,000, while the variable cost per unit is $6.

REQUIRED:

1.   Assume fixed costs are allocated based on the proportion of units produced by each center. What

is Center D’s per unit cost?

2.   What would be Center A’s per unit cost if Center E’s fixed costs are allocated based on practical

capacity?

3.   Although allocating Center E’s fixed costs on a per-unit produced basis seems equitable, the manager of Center C is worried about Center B reducing the number of units produced.

a. Calculate Center C’s per unit cost with no change in production.

b.   If Center B reduces the number of units produced to 5,000, will Center C’s cost increase or

decrease and by how much?

4.   The center managers are concerned that being charged for unused capacity will impact their bonus.

a. Explain how company management could alleviate the concerns.

b.   Identify three additional measures that could be used to evaluate manager performance.

Answer 1

Answer:

Answer-1:
	Center A	Center B	Center C	Center D	Total
Annual production (units)	5,000	7,500	4,000	6,000	22,500
Allocation of Center E's fixed cost	$             33,333	$          50,000	$        26,667	$            40,000	$    150,000
Fixed cost per unit	$                  6.67	$              6.67	$            6.67	$                 6.67
Variable cost per unit	$                  6.00	$              6.00	$            6.00	$                 6.00
Total per unit cost	$               12.67	$            12.67	$          12.67	$              12.67
Answer-2:
	Center A	Center B	Center C	Center D	Total
Annual production (units)	5,000	7,500	4,000	6,000
Allocation of Center E's fixed cost (150,000/40,000 × production unit)	$             18,750	$          28,125	$        15,000	$            22,500	$      84,375
Fixed cost per unit	$                  3.75	$              3.75	$            3.75	$                 3.75
Variable cost per unit	$                  6.00	$              6.00	$            6.00	$                 6.00
Total per unit cost	$                  9.75	$              9.75	$            9.75	$                 9.75
Answer-3(a):
	Center A	Center B	Center C	Center D	Total
Annual production (units)	5,000	7,500	4,000	6,000
Allocation of Center E's fixed cost (150,000/40,000 × production unit)	$             18,750	$          28,125	$        15,000	$            22,500	$      84,375
Fixed cost per unit	$                  3.75	$              3.75	$            3.75	$                 3.75
Variable cost per unit	$                  6.00	$              6.00	$            6.00	$                 6.00
Total per unit cost	$                  9.75	$              9.75	$            9.75	$                 9.75
Answer-3(b):
	Center A	Center B	Center C	Center D	Total
Annual production (units)	5,000	5,000	4,000	6,000
Allocation of Center E's fixed cost (150,000/40,000 × production unit)	$             18,750	$          18,750	$        15,000	$            22,500	$      75,000
Fixed cost per unit	$                  3.75	$              3.75	$            3.75	$                 3.75
Variable cost per unit	$                  6.00	$              6.00	$            6.00	$                 6.00
Total per unit cost	$                  9.75	$              9.75	$            9.75	$                 9.75
If Center B reduces the number of units produced to 5,000, it'll have no impact on Center C’s cost.