Question

Prepare your solutions to requirements in Excel using formulas. Think of this as an exercise to prepare a managerial report – good form is important to be able to get your message across!

Phone Company

The Phone Company has the following costs of producing and selling a cell phone assuming it produces and sells the normal volume of 100,000 of these cell phones per month:

Per unit manufacturing cost

            Direct materials                                              $50.00

            Direct labor                                                     10.00

            Variable manufacturing overhead cost             40.00

            Fixed manufacturing overhead cost                 30.00

Per unit selling cost

            Variable                                                          15.00

            Fixed                                                               10.00

Note that 100,000 (normal volume of production and sales) is the denominator used to calculate and allocate fixed costs per unit (regardless of the number of units actually produced). Any under- or over-allocated overhead will be adjusted at the end of the year to COGS. The selling price of a cell phone is $250, unless otherwise stated in the questions below. Variable selling costs are incurred only if (and when) the phones are sold.

Each situation below is independent of the other situations. That is, when you answer one question, assume that the situations described in other questions have not occurred. When you are considering opportunities for increased sales, assume that Phone Company has enough manufacturing and sales capacity to make these sales without incurring additional fixed costs. Ignore tax issues: just think in terms of operating income.

Show calculations on Excel using formulas whenever possible.

Required:

1. What is the unit cost (inventory value) of a cell phone on the Phone Company’s balance sheet for external reporting?

2. The Phone Company currently produces and sells 100,000 cell phones each month. The company’s marketing research department estimates that the sales volume of cell phones would increase by 20% if the price per phone is reduced to $200. If the price is reduced to $200, then will this increase or decrease the company’s operating income, and by how much?

3. The Phone Company is considering entering into a contract to provide Service Provider Company with 10,000 cell phones per month, in addition to its existing business. The contract would require Service Provider to reimburse Phone Company for its full manufacturing costs per unit plus an additional fee of $100 per phone. Assume that the above-mentioned allocation rates for overhead costs will not change during the year as a result of taking this contract. That is, the allocation rates will remain the same regardless of any under- or over-allocated overhead caused by accepting the order. The customer will not be charged or credited with any under- or over-allocation that happened during the year. Any over- or underallocated overhead will be charged or credited to Phone Company’s COGS at the end of the year. The Phone Company would incur no variable selling costs related to this contract. How much would Phone Company’s monthly operating income increase or decrease as a result of taking this contract?

4. The Phone Company has the opportunity to provide an organization with a one-time special order of 20,000 cell phones, in addition to its existing business. The only variable selling cost associated with this order would be shipping costs of $10.00 per cell phone, and fixed selling costs for this order (in addition to Phone Company’s existing fixed costs) would be a lump sum of $200,000. What selling price per unit would be required to generate $600,000 in incremental operating income from this order?

5. The Phone Company plans to introduce a new cell phone in the immediate future and thus it must immediately sell its finished-goods inventory of already produced cell phones (incurring variable selling costs). If this inventory is not sold before the company introduces the new cell phone, then this inventory will have $0 value. What is the minimum price at which Phone Company would sell these phones? That is, if the price is lower than this, the company would be better off disposing of the phones by throwing them out or giving them away (assume that disposal would be costless).

6. The Phone Company has received an offer from a contract supplier to manufacture and ship the Phone Company’s cell phone directly to Phone Company’s customers. If the Phone

Company accepts this offer, then it will continue to do product design and marketing but will no longer manufacture the phones itself and its variable manufacturing costs would be $0 and its fixed manufacturing cost would be reduced by 50% of its current level. (Phone Company can dispose of some of its fixed capacity immediately, but will keep some.) In addition, its variable selling cost would decrease by one-third and its fixed selling cost would not change. How much per cell phone could the Phone Company pay the contract supplier if it wants to maintain its present level of operating income?

Answer 1

Answer-1:

For external reporting purposes, company must use finished goods inventory figure computed on the basis of absorption costing system. Hence, fixed manufacturing overhead is also reported as a product cost.

Unit cost (inventory value) of a cell phone on the Phone Company’s balance sheet for external reporting is $130

Answer-2:

150 Selling price Total variable manufacturing cost Contribution margin per unit Sales unit Total contribution margin Less: Variable selling cost @ $15 p.u. When SP = $250 When SP = $200 250 $ 200 100 100 100 100,000 120,000 15,000,000 12,000,000 1,500,000 1,800,000 13,500,000 10,200,000 Less: Fixed cost: Manufacturing OH Selling cost Net income 3,000,000 1,000,000 9,500,000 3,000,000 1,000,000 6,200,000 S $

If the price is reduced to $200, then this will decrease the company’s operating income by $3,300,000