Relevant Costing and Decision Making

QUESTION 1

Consider the following details of the income statement of the Computer Division of the GK Electronics Company for the year ended December 31, 2016:

	$
Sales	10,000,000
Less: manufacturing cost of goods sold	6,000,000
Gross profit	4,000,000
Less: selling and administrative expenses	3,300,000
Operating income	700,000

Computer Division's fixed manufacturing costs were $2.4 million and its fixed selling and administrative costs were $2.5 million. Sales commissions of 3% of sales are included in selling and administrative expenses.

The division had sold 2 million computers. Near the end of the year, King Burger offered to buy 150,000 computers on a special order. To fill the order, a special King Burger logo would have to be added to each computer. King Burger intended to use the computers in special promotions in the western parishes during the early 2017.

Even though the Computer Division had some idle plant capacity, the president rejected the King Burger offer of $600,000 for the 150,000 computers. He said:

The King Burger offer is too low. We'd avoid paying sales commissions, but we'd have to incur an extra cost of $0.20 per computer to add the logo. If the Computer Division sells below its regular selling prices, it will begin a chain reaction of competitors' price cutting and of customers wanting special deals. I believe in pricing at no lower than 8% above our full costs of $9,300,000/2,000,000 units = $4.65 per unit plus the extra$0.20 per computer less savings in commissions.

Required:

1. Using the contribution approach, do an analysis using four columns: without the special order, the effect of the special order (total and per unit)and totals with special order. (10 marks)

1. By what percentage would operating income increase or decrease if the order had been accepted? (2 marks)

1. Do you agree with president's decision? Why? (3 marks)

(Total 15 marks)

QUESTION 2

Sunshine State Farm sells premium quality oranges and other citrus fruits by mail-order. Protecting the fruit during shipping is important, so the company has designed and produces shipping boxes. The annual cost of 80,000 boxes is:

	$
Materials	120,000
Labour	20,000
Overhead: Variable Fixed	16,000 60,000
Total	216,000

Therefore, the cost per box averages $2.70

Suppose Fresh Co. submits a bid to supply Sunshine State Farm with boxes for $2.40 per box. Sunshine State Farm must give Fresh Co. the box design specifications, and the boxes will be made according to those specs.

Required:

1. How much, if any, would Sunshine State Farm save by buying the boxes from Fresh Co.

(5 marks)

1. What subjective factors should affect Sunshine State's decision whether to make or buy the boxes? (4 marks)

1. Suppose all the fixed costs represent depreciation on equipment that was purchased for $600,000 and is just about at the end of its 10 year life. New replacement equipment will cost $1million and is also expected to last 10 years. In this case, how much, if any, would Sunshine State Farm save by buying the boxes from Fresh Co.?

(6 marks)