Question

Problem 12-18 Relevant Cost Analysis in a Variety of Situations [L012-2, LO12-3, LO12-4] Andretti Company has a single product called a Dak. The company normally produces and sells 86,000 Daks each year at a selling price of $60 per unit. The company's unit costs at this level of activity are given below: Direct materials $ 9.50 Direct labor 10.00 Variable manufacturing overhead 2.00 Fixed manufacturing overhead ($774,000 total) 9.00 Variable selling expenses 2.70 4.00 ($344, 000 total) Fixed selling expenses $37.20 Total cost per unit A number of questions relating to the production and sale of Daks follow. Each question is independent. quired: 4. Due to a strike in its suppliers plant, Andretti Company is unable to purchase more material for the production of Daks. The strike is expected to last for two months. Andretti Company has enough material on hand to operate at 25 % of normal levels for the two-month period. As an alternative, Andretti could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 30 % of their normal level during the two-month perlod and the foxed selling expenses would be reduced by 20% during the two-month perlod a. How much total contribution margin willl Andretti forgo if It closes the plant for two months? b. How much total fixed cost will the company avoid If it closes the plant for two months? C. What is the financlal advantage (disadvantage) of closing the plant for the two-month period? d. Should Andretti close the plant for two months?

Answer 1

Calculation of contribution per unit Amount (in $) Selling price per unit Less: Variable Costs 60.0 Direct material 9.5 Direct labour 10.0 Variable manufacturing overhead 2.0 Variable selling expenses 2.7 Contribution per unit 35.8 Calculation of Total fixed cost Fixed manufacturing overhead ($9X 86000 units) 774000 Fixed selling expenses 344000 ($4X86000 units) 1118000 Total Number of units per annum 86000 7166 Number of units per month (86000 12) Number of units for 2 months (7167 X 2) 14333 A Loss of contribution if the plant is closed for 2 months: 14333 Number of units lost during 2 months Company has enough material to manufacture 25% of normal levels, so the output will be 3583 (14333 X 25%) Amount (in $) Contribution per unit 35.8 Total loss of contribution (3583 X 35.5) 128280 B Fixed cost avoided if the plant is closed for 2 months: Total fixed cost for 2 months Fixed manufacturing overhead 129000 $ 774000 X (2/12)] Fixed selling expenses 57333

$ 344000 X (2/12)] Total (a) 186333 Fixed cost incurred during the closure of plant Fixed manufacturing overhead would 38700 continue at 30% of their normal level $ 129000 X 30%) Fixed selling expenses would be reduced by 20 % 45867 [$ 57333 X 80%] Total (b) 84567 Fixed cost avoided [a-b 101767 C Financial advantage/disadvantage if the plant is closed for 2 months: Calculation of profit during 2 months (if the plant is not closed) Number of units lost during 2 months 14333 Company has enough material to manufacture 25% of normal levels, so the output will be 3583 (14333 X 25%) Amount (in $) Contribution per unit 35.8 Total contribution (3583 X 35.8) 128280 Less: Total fixed cost for 2 months Fixed manufacturing overhead [$ 774000 X (2/12)] 129000 Fixed selling expenses 57333 [$ 344000 X (2/12)] Profit/(loss) -58053 Calculation of profit during 2 months if the plant is closed: Amount (in $) Contribution per unit 35.8 Total contribution (0X 35.5) 0 Less: Fixed cost incurred during the closure of plant -38700 Fixed manufacturing overhead would continue at 30% of their normal level [$129000 X 30% Fixed selling expenses would be -45867

reduced by 20% [$ 57333 X 80%] Profit/(loss) -84567 Financial advantage if the plant is not closed = Reduction in loss by $ 26,514 (84567-58053) Financial disadvantage if the plant is closed (84567) D If the company continues the plant it can reduce its loss by$ 26,514 so it is better not to close the plant.