Decision Making

Lecture 12 Decision Making

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ABC Ltd manufactures two components A & B. There are to be 5000 of each component manufactured next year. The following information is available for each unit of A & B.

Machine Hrs

Variable Cost

Unit of A

Unit of B

A total of 30,000 machine hours are available.

A sub-contractor is willing supply ABC with units of A & B for $27 and $38 respectively. Advise ABC.

Solution

Considerations

There are only 30,000 machine hours available.

To produce 5,000 of each product would take

A (5,000 x 4)

B (5,000 x 6)

We will have to buy in some of the product but wh ut which one? The one with the LOWEST EXTRA VARIABLE CO ABLE COST TO BUY PER MAC MACHINE HOUR.

ABC Ltd manufactures two components A & B. There are to be 3,000 of unit A and 4,000 of unit B manufactured next year. The following information is available for each unit of A & B.

Labour Hrs

Variable Cost

Unit of A

Unit of B

A total of 17,000 labour hours are available.

A sub-contractor is willing supply ABC with units of A & B for $25 and $40 respectively. Advise ABC on which components should be made and calculate how many units of the

other should be bought in.

Solution

Considerations

There are only 17,000 Labour hours available.

For the required production we will need

A (3,000 x 3)

B (4,000 x 5)

Variable cost of making

22 37 Variable cost of buying

25 40 Extra Variable cost of buying

3 3 Labour Hrs Saved by buying

3 5 Extra cost of buying P/hr saved

(3/5) = $0.60 The company should make all of pro of product A and as much as possi as possible of product B before

buying in the rest. Total hours required to make

20,000 Available for each (Total 17,000)

8,000 In House Production

(8,000 / 5) = 1,600 Buy In

0 (4,000 - 1,600) = 2,400

ABC Ltd produces two products out of a joint process - products A & B. At split off, 100,000 units of A and 50,000 units of B are produced. At this point A can be sold for $1.25 and B can be sold for $2.00. ABC can further process product A to produce A+ but it will incur further set up costs of

$20,000 and variable costs of $0.30 per unit introduced into the further process to do so. 60,000 units of A+ could be produced. A+ would be sold at $3.25 per unit. Should ABC sell product A or A+?

Solution

A A+

Selling Price Per Unit

1.25 3.25 Units sold

60,000 Total Sales Revenue

195,000 Set up costs

0 20,000 Additional Variable Costs

0 30,000 Total Profit

Elco Co. has decided to close department 3 in it’s operations. You have been asked to review the decision based on the following information:

1 2 3 Total

Sales (units)

13,000 Sales Revenue

414,000 Cost of Sales Direct Material

235,000 Direct Labour

63,000 Production Overhead

15,000 Gross Profit

40,000 Net Profit

1. The production overheads of $15,000 have been allocated to the 3 departments on the basis of sales revenue. On further investigation you realise that only 50% of these can

be traced directly to these departments and can be allocated on the basis 2:2:1.

2. Expenses are head office expenses of which 60% can be traced to the departments and can be allocated on the basis 3:3:2.

3. 80% of the labour is a fixed cost and the remaining amounts would be better allocated on the basis of sales volume.

Recommend to management whether their decision to close department 3 is justified.

1 2 3 Total

13,000 Sales Revenue