Question

You are an eager and ambitious young graduate of the Reginal F. Lewis College of Business at Virginia State University with a new Accounting degree and a great life ahead of you. One of your closest friends is an inventor and an entrepreneur who wants to start a business selling a break-through new drywall screw that he has invented and that he believes works much better than the drywall screws currently on the market. He wants to start the business by opening a factory to produce the screws which can then be sold to either wholesalers or retailers who will then sell them to the general public. After searching all over creation for the right sized building in the perfect location to properly meet the needs of his target customers, he found that the ideal building in which to put up his factory was right here in Petersburg all along.                                            

To begin, he was able to purchase the building he needed outright for $525,000. Useful life of the building is 40 years and it is depreciated on a straight-line basis. Estimated salvage value is $25,000. Property taxes on the building each year are $3,500.                                                                                                                                                                                                               

There is a new machine that another fellow VSU grad has invented that takes the metal for the screws and molds them into their proper size and shape, and takes the plastic for the anchors and molds them into their proper size and shape; an assembly line is attached to the machine where workers put the screws and anchors into boxes. The finished product is a box of 32 drywall screws and their plastic anchors that work unlike any that have come before them. He purchased this machine outright for $175,000. The machine has a useful life of 25 years with no residual value and is depreciated on a straight-line basis. The machine can produce 23,000 boxes of screws and anchors per year. He is sure that he can sell every unit produced.                                                                                                                                                                                                                                     

It is determined that to produce the 32 screws in each box will require 112 ounces of metal which is the only material used to make the screws and to produce the 32 anchors in each box will take 48 ounces of plastic which is the only material used to make the anchors. The metal you need is produced by multiple suppliers and you've found one so far that will allow you to buy it at $1.50 per pound. The plastic used is also produced by multiple suppliers and you've found one so far that will allow you to buy it at $.15 per pound. It takes 15 minutes for the workers on the assembly line to box the screws and anchors because they are put in there in a way that prevents them from becoming disorderly. This is part of the quality aspect of the product. Assembly line workers are paid at a rate of $17.00 per hour.                                                                                                                                    

Your friend hired a Vice President (VP) who has a degree in Marketing from VSU. She did some market research and determined that in order to be competitive with your new product you are going to charge $20.75 per box of screws and anchors. The Vice President is paid $58,000 per year. He also hired a Chief Operating Officer who will be paid $58,000 per year. Your friend has also asked you to serve as a consultant to his company to make sure that the business gets off to a good start. Your fee has not yet been determined and is not part of this problem.               

Questions

Prepare a variable costing format income statement assuming that the company makes and sells the maximum possible number of units. If the income is negative, what is the reason? Your friend asks you for advice on how to increase the company income. Give him at least two possible solutions to the problem.Which solution did you recommend to your friend? Why did you choose this particular solution?

Prepare a memo addressed to your friend/client explaining your options and your recommendation. This memo should be no more than one page long.               

What is the new break-even point after implementing your solution?

What is the maximum income the company can make after implementing your solution? Is this enough profit to justify going into business? Why or why not?                                                                                                     

Prepare both an absorption costing income statement and a variable costing income statement to reflect your solution. State your assumptions about the number of units produced and the number sold.     

Answer 1

Answer for 1 Metal is a Variable cost As Metal is using as rawmaterial for Screw If Production of Screws increased or decreased, Consumption of Metal also increase or decrease with respect to production. So here Metal is a Variable cost. Plastic is a Variable cost As Plastic is using as rawmaterial for Anchors. If Production of Anchors increased or decreased, Consumption of Plastic also increase or decrease with respect to production. So here Plastic is a Variable cost. Assembly Labor is a Variable cost As Assembly Labor is used for make the assembly of Screws & Anchors in a box. If Production of Screws & Anchors are increased or decreased, Requirement of Assembly Labor also increase or decreased with respect to production. So here Assembly Labor is a Variable cost. Property Taxes are Fixed costs. Even if there is a huge production or No production, Property tax will be arised. So here Property Taxes are Fixed costs. Machinary depreciation is Fixed cost. Generally, Depreciation will be charged Irrespective of the production. So here Machinary depreciation is Fixed cost. COO Salary is a Fixed cost Even if there is a huge production or No production, COO Salary wouldn't increase or decrease. So here COO Salary is Fixed cost. VP Salary is a Fixed cost Even if there is a huge production or No production, VP Salary wouldn't increase or decrease. So here VP Salary also Fixed cost.

Answer for 2.1 Metal cost per box is (Metal required per box in ounces /No. of ounces per pound) x Metal cost per pound -(112 ounces/16 ounces) x $ 1.50 per pound -7 pounds x $ 1.50 per pound - 10.50 Plastic cost per box is -(Plastic required per box in ounces/No. of ounces per pound ) x Plastic cost per pound - (48 ounces / 16 ounces) x $ 0.15 per pound 3 pounds x $ 0.15 per pound 0.45 Direct material cost per box Metal cost per box + Plastic cost per box Direct material cost per box $ 10.50$ 0.45 Direct material cost per box-$ 10.95 Answer for 2.2 Direct Labor cost per box is (No. of hours required per box to assembly x Assembly labor paid per hour )/No. of mins. per hour 15 mins x $ 17.00)/60 mins (1x$17.00)/4 -$4.25 Answer for 2.3 Variable cost per box - Direct material cost per box + Direct Labor cost per box Variable cost per box $ 10.95 $ 4.25 Variable cost per box -$15.20 Answer for 2.4 Contribution margin per box Selling price per box - Variable cost per box Contribution margin per box -20.75 $ 15.20 Contribution margin per box-$ 5.55

Answer for 2.5 Machinery depreciation (Value of machinery - Salvage value) /Life of asset in years Machinery depreciation- ($ 175,000 $0)/25 years Machinery depreciation $ 175,000/25 years Machinery depreciation $7,000 Building depreciation = ( Value of Building-Salvage value ) / Life of asset in years Building depreciation (S 525,000 $ 25,000)/40 years Building depreciation 500,000/40 years Building depreciation $12,500 Total Annual Depreciation Machinery depreciation Total Annual Depreciation $7,000 +$ 12,500 Total Annual Depreciation = $ 19,500 Building depreciation Total Fixed Costs Annual Property taxes + Total Annual Depreciation + Annual COO SalaryAnnual VP Salary Total Fixed Costs $ 3,500 $ 19,500 S 58,000 $ 58,000 Total Fixed Costs -$ 139,000 Answer for 2.6 Break-Even Point in Boxes -Total Fixed costs / Contribution margin per box) -($ 139,000 $ 5.55) -($ 139,000/$ 5.55) - 25,045.05 or 25046 units