Question

Q.3 (a) Within the context of the manufacturing environment, explain the terms (i) Relevant cost (ii) Opportunity cost (iii) Contribution to profit (6 marks) (b) The Engineering Manager in ABC Ltd is responsible for maximising the profit from three product lines X, Y and Z. He/she has been provided with the following information Direct materials (E) Direct labour (hrs) Fabrication Assembly Finishing Selling price per unit (E) 100 85 120 4 2 3.75 550 210 3.5 2 3.5 480 220 3.75 4 625 180 Budgeted production (in units) Additional information is also provided There are no closing stocks The maximum sales achievable for each product in the period is 230 units The labour rate for fabrication and finishing is £13.50/hr. The labour rate for assembly work is £12.00/hr > The skilled labour required for the assembly process is in short supply although there is just enough to meet the current budgeted production Required () Prepare a statement showing the contribution from each product based on the budgeted production (6 marks) (ii) Calculate the contribution per unit of limiting factor (2 marks) (ii) Prepare a statement showing the maximum total contribution that can be obtained. Explain your rationale (6 marks)

Answer 1

(a)(i) relevant cost is the cost which is relevant for the purpose of decision making. In other words, costs which differs amongst different alternatives is known as Relevant Cost. For example variable cost per unit

(ii)Opportunity Cost: Income earned in the next best alternative is opportunity cost. In other words, Income that could have been earned in case the said was decision was not taken is opportunity cost for the decision.

(iii)Contribution to Profit: Contribution Margin is Sales – Variable Cost.

(b) (i)Contribution from each product:

	X	Y	Z
Selling price per Unit	550	480	625
Less: Variable Costs
Direct material	100	85	120
Direct Labor Hours*Cost per Hour
Fabrication	54	47.25	50.625
Assembly	24	24	18
Finishing	50.625	47.25	54
Contribution margin per Unit (A)	321.375	276.5	382.375
Budgeted Production (Units)	210	220	180
Total Contribution margin	67,488.75	60,830	68,827.5
Hours of Assembly Labor per Unit (B)	2	2	1.5
Contribution Margin per unit of limiting factor (A/B)	160.6875	138.25	254.917

(iii) Total hours available of limiting factor i.e. Assembly Labor = 210*2 +220*2 + 180*1.5

= 1,130 hours

Hours will first be used to produce Z since contribution per hours is highest in case of Z, followed by X and Y

Product	Units	Hours per Unit	Total Assembly Hours	Total Contribution Margin
X	230	2	460	73,916.25
Y	162.5	2	325	44,931.25
Z	230	1.5	345	87,946.25
Total			1,130	206,793.75

Hence, maximum contribution margin that can be obtained is $206,793.75

It has been assumed that half unit of Y will also be produced.