Question

During their senior year at Clarkson College, two business students, Gerry Keating and Louis Lamont, began a part-time business making personal computers. They bought the various components from a local supplier and assembled the machines in the basement of a friend's house. Their only cost was $363 for parts; they sold each computer for $625. They were able to make three machines per week and to sell them to fellow students. The activity was appropriately called Keating & Lamont Computers (KLC). The product quality was good, and as graduation approached, orders were coming in much faster than KLC could fill them. A national CPA firm made Ms. Lamont an attractive offer of employment, and a large electronics company was ready to hire Mr. Keating. Students and faculty at Clarkson College, however, encouraged the two to make KLC a full-time venture. The college administration had decided to require all students in the schools of business and engineering to buy their own computers beginning in the coming fall term. It was believed that the quality and price of the KLC machines would attract the college bookstore to sign a contract to buy a minimum of 1,000 units the first year for $509 each. The bookstore sales were likely to reach 2,000 units per year, but the manager would not make an initial commitment beyond 1,000 The prospect of $509,000 in annual sales for KLC caused the two young entrepreneurs to wonder about the wisdom of accepting their job offers. Before making a decision, they decided to investigate the implications of making KLC a full-time operation. Their study provided the following information relating to the production of their computers: Components from wholesaler Assembly labor Manufacturing space rent Utilities $230 per computer 14.80 per hour 2,180 per month 380 per month 280 per month 2,750 per year 2 hours per computer Janitorial services Depreciation of equipment Labor The two owners expected to devote their time to the sales and administrative aspects of the business. Required a. Classify each cost item into the categories of direct materials, direct labor, and manufacturing overhead. b. Classify each cost item as either variable or fixed c. What is the cost per computer if KLC produces 1,000 units per year? What is the cost per unit if KLC produces 2,000 units per year? d. If the job offers for Mr. Keating and Ms. Lamont totaled $91,000, would you recommend that they accept the offers or proceed with plans to make KLC a full-time venture?

Answer 1

a & b	Cost category
	Components from wholesaler	Direct material	Variable
	Assembly labor	Direct labor	Variable
	Manufacturing space rent	Overheads	Fixed
	Utilities	Overheads	Fixed
	Janitorial services	Overheads	Fixed
	Depreciation of equipment	Overheads	Fixed
c	calculation of cost per unit
	Fixed cost per year	Amount in $	Amount in $
	Manufacturing space rent	26160	2180*12
	Utilities	4560	380*12
	Janitorial services	3360	280*12
	Depreciation of equipment	2750
	Total fixed cost for a year	36830
	variable cost per computer
	Components from wholesaler	230
	Assembly labor	14.8
	Total variable cost	244800	230+14.8*1000
	Total cost for the year	281630
	Unit cost of computer	281.63	281630/1000
	Total profit	227370	(509-281.63)*1000
	Fixed cost per year	Amount in $	Amount in $
	Manufacturing space rent	26160	2180*12
	Utilities	4560	380*12
	Janitorial services	3360	280*12
	Depreciation of equipment	2750
	Total fixed cost for a year	36830
	variable cost per computer
	Components from wholesaler	230
	Assembly labor	14.8
	Total variable cost	489600	(230+14.8)*2000
	Total cost for the year	526430
	Unit cost of computer	263.215	526430/2000
	Total profit	491570	(509-263.215)*2000
d	Job offer totaled $96000 is less than the total profit computed above. So it is recommend to
	to proceed with plans to make KLC a full time venture