University Press produces textbooks for university courses. They recently hired a new editor, Leslie White, to handle production and sales of books for an introduction to accounting course. Leslie’s compensation depends on the gross margin associated with sales of this book. Leslie needs to decide how many copies of the book to produce. The following information is available for the fall semester 2013:
Estimated sales .............. 10,000 books
Beginning inventory ............ 0 books
Average selling price ........... $100 per book
Variable production costs ......... $60 per book
Fixed production costs .......... $120,000 per semester
The fixed-cost allocation rate is based on expected sales and is therefore equal to $120,000 -5- 10,000 books = $12 per book.
Leslie must decide whether to produce 10,000, 12,000, or 16,000 books.
1. Calculate expected gross margin if Leslie produces 10,000, 12,000, or 16,000 books.
2. Calculate ending inventory in units and in dollars for each production level.
3. Managers who are paid a bonus that is a function of gross margin may be inspired to produce product in excess of demand to maximize their own bonus. The chapter suggested metrics to discourage managers from producing products in excess of demand. Do you think the following metrics will accomplish this objective? Show your work.
a. Incorporate a charge of 10% of the cost of the ending inventory as an expense for evaluating the manager.
b. Include nonfinancial measures when evaluating management and rewarding performance.