Jastu TruDao, CEO of ChessPerfect was very impressed with your analysis of the management meeting notes. He has now called you in for another consultation and has shown you some numbers of the gold chess set business last 12 months. The two of you had a long conversation, going over a few crucial points: Jastu said, "I just reviewed our financial results for the past 12 months and we made a profit in some months, and had losses in other months. From what I can tell, we sell each chess set for $255, with a variable cost of $155 per unit, and our fixed cost, including all administrative and selling costs, is $85 per unit. If we sell just one chess set each month, we should still show a profit of $25, and any additional units sold should increase the total profit. Our fixed cost was $55,000 a month." You looked at Jastu and asked, "How did you come up with a $85 fixed cost per unit?"

Jastu answered, "Well, the $85 per unit for fixed costs was my estimate based on last year's sales,I think it makes sense to do that per unit, but I'm not sure if there is anything wrong with that. I want to avoid having losses. Can we determine how many units we must sell each month to at least cover our expenses? Also, I've heard of something called "margin of safety". Can someone explain what that is and if we are doing well with that?" He continued. "I'd also like to discuss what it will take to make a decent profit. At our company, we often have high-budgeted sales, but I want to play around a little bit with the area that we can be flexible with sales, just in case we have competition or the economy goes down. With the recent outlook of the Canadian economy, I am afraid the sales target might not be met. Can you give me some advice on this area?" As both of you were talking, the General Manager (GM) waved her hand at you and walked toward you to engage in your conversation. "It is great to see both of you, I just had a meeting with my production team and it looks like we should be looking at purchasing a painting machine. We currently hire a third party to manually paint our chess sets, and even though it does have a nice human touch which is great for our marketing, it is too much work and increases labor costs." She continued. "Suppose we switch to an automatic painting machine. With that approach, we can grow production without customers noticing- and I think we can even sell more! We can just keep the same marketing message of "human touch" as we have been doing before. I'm sure not many would notice the difference. Also, that space where we are storing the finished products shipped back from the third party- we can use that space to operate the machine. I am sure the safety committees will be fine with this." The GM then showed both you and Jastu a cost summary. "These are our current rough annual numbers but here, take a look."

Cost to third party	$705,000
Direct Materials	$ 155,000
Labor to operate the machine	$ 165,000
Manufacturing Overhead related	$ 105,000
Machine	$ 115,000
Building Rent	$ 295,000
Production supervisors' salaries	$145000
Quality control on third-party's production	$95,000

Jastu considers the numbers in front of him. "$115,000.... Hmmm. That machine is not cheap. Do you have any idea how long we will use the machine for and if we can get anything for it when we dispose of it?" The GM responds that, at the current levels of usage, the machine would last three years, but there would be no salvage value. She then checks her watch and rushes off to an important meeting. Jastu turns to you and says, "I would like some more insight on buying this machine and how we would treat the asset from and accounting perspective through the three years- is the $115,000 cost expensed right away? If not, what do we do?"

"Also, that marketing advice the GM just gave us is a bit concerning to me. I think that our sales would dip 25% if we no longer advertised the chess pieces as hand-painted, so maybe we should just keep marketing as is- I don't know." please answer

Answer rating: 100% (QA)

From an accounting perspective the cost of the machine which is 115000 should not be expensed right ... View the full answer