Manufactured
Purchased Bike
WVD Drums WVD Drums Frames
Selling price $ 149.00 $ 149.00 $ 239.00
Variable costs:
Direct materials 138.00 52.10 99.40
Direct labor 0 3.60 28.80
Variable manufacturing overhead 0 1.35 1.90
Variable selling and administrative 0.75 0.75 1.30
Total variable cost 138.75 57.80 131.40
Contribution margin $ 10.25 $ 91.20 $ 107.60
6.
Assuming direct labor is a variable cost, the contribution margin per welding hour for each product is calculated as follows:
Manufactured
WVD Drums Bike Frames
Contribution margin per unit (above) (a) $ 91.20 $107.60
Welding hours per unit (b) 0.4 hour 0.5 hour
Contribution margin per welding hour (a) ÷ (b) $ 228.00 per hour $215.20 per hour
When direct labor is assumed to be a variable cost, the conclusion is reversed from the case in which direct labor is assumed to be a
fixed cost—the WVD drums appear to be a better use of the constraint than the bike frames. The assumption about the behavior of
direct labor really does matter.
7.
(a) (b) (c) (a) × (c) (a) × (b)
Unit Total Balance of
Contribution Welding Time Welding Welding Total
Quantity Margin per Unit Time Time Contribution
Total hours available 2,000
WVD Drums—make 5,000 $ 91.20 0.4 2,000 0 $456,000
Bike frames produced 0 107.60 0.5 0 0 0
WVD Drums—buy 1,000 10.25 10,250
Total contribution margin 466,250
Less: Contribution margin from present
operations: 5,000 drums × $91.20 CM per
drum 456,000
Increased contribution margin and net
operating income $ 10,250
References
Worksheet Learning Objective: 12-01 Learning Objective: 12-05 Determine the most profitable
Identify relevant and use of a constrained resource.
irrelevant costs and benefits
in a decision.
Difficulty: 3 Hard Learning Objective: 12-03
Prepare a make or buy
analysis.
74. Award: 10.00 points Problems? Adjust credit for all students.
TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the
company’s products is a heavy-duty corrosion-resistant metal drum, called the WVD drum, used to store toxic wastes. Production is
constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,000 hours of welding
time is available annually on the machine. Because each drum requires 0.4 hours of welding machine time, annual production is limited
to 5,000 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided
the following financial data concerning the WVD drums:
WVD Drums
Selling price per drum $ 149.00
Cost per drum:
Direct materials $52.10
Direct labor ($18 per hour) 3.60
Manufacturing overhead 4.50
Selling and administrative expense 29.80 90.00
Margin per drum $ 59.00
Management believes 6,000 WVD drums could be sold each year if the company had sufficient manufacturing capacity. As an
alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Harcor
Industries, Inc., a supplier of quality products, would be able to provide up to 4,000 WVD-type drums per year at a price of $138 per
drum, which TufStuff would resell to its customers at its normal selling price after appropriate relabeling.
Megan Flores, TufStuff’s production manager, has suggested that the company could make better use of the welding machine by
manufacturing bike frames, which would require only 0.5 hours of welding machine time per frame and yet sell for far more than the
drums. Megan believes that TufStuff could sell up to 1,600 bike frames per year to bike manufacturers at a price of $239 each. The
accounting department has provided the following data concerning the proposed new product:
Bike Frames
Selling price per frame $ 239.00
Cost per frame:
Direct materials $99.40
Direct labor ($18 per hour) 28.80
Manufacturing overhead 36.00
Selling and administrative expense 47.80 212.00
Margin per frame $ 27.00
The bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the
basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but
some of it is variable. The variable manufacturing overhead has been estimated at $1.35 per WVD drum and $1.90 per bike frame. The
variable manufacturing overhead cost would not be incurred on drums acquired from the outside supplier.
Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative
expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $0.75 per
WVD drum whether made or purchased and would be $1.30 per bike frame.
All of the company’s employees—direct and indirect—are paid for full 40-hour work weeks and the company has a policy of laying off
workers only in major recessions.
As soon as your analysis was shown to the top management team at TufStuff, several managers got into an argument concerning how
direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable
cost in textbooks and in practice and has always been considered a variable cost at TufStuff. After all, “direct” means you can directly
trace the cost to products. “If direct labor is not a variable cost, what is?” Another manager argued just as strenuously that direct labor
should be considered a fixed cost at TufStuff. No one had been laid off in over a decade, and for all practical purposes, everyone at the
plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary
since the company adopted Lean Production techniques. Whether the welding machine is used to make drums or frames, the total
payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time
that the bike frames would require.
Required:
1. Would you be comfortable relying on the financial data provided by the accounting department for making decisions related to the
WVD drums and bike frames?
2. Compute the contribution margin per unit. [assume direct labor is a fixed cost]
3. Compute the contribution margin per welding hour. [assume direct labor is a fixed cost]
4. Assuming direct labor is a fixed cost:
a. Determine the number of WVD drums (if any) that should be purchased and the number of WVD drums and/or bike frames (if any)
that should be manufactured.
b. What is the increase (decrease) in net operating income that would result from this plan over current operations?
5. Compute the contribution margin per unit. [assume direct labor is a variable cost]
6. Compute the contribution margin per welding hour. [assume direct labor is a variable cost]
7. Assuming direct labor is a variable cost:
a. Determine the number of WVD drums (if any) that should be purchased and the number of WVD drums and/or bike frames (if any)
that should be manufactured. [Assume direct labor is a variable cost]
b. What is the increase (decrease) in net operating income that would result from this plan over current operations?
Complete this question by entering your answers in the tabs below.
Req 1 Req 2 Req 3 Req 4A Req 4B Req 5 Req 6 Req 7A Req 7B
Compute the contribution margin per unit. [assume direct labor is a fixed cost] (Do not round intermediate calculations.
Round your answers to 2 decimal places.)
Contribution Margin
a. Purchased WVD drums $ 10.25 per unit
b. Manufactured WVD drums $ 94.80 per unit
c. Manufactured bike frames $ 136.40 per unit
Req 1 Req 3
Garrison 16e Rechecks 2017-05-19, 2017-11-14, 2017-11-22
Explanation:
1.
The product margins computed by the accounting department for the drums and bike frames should not be used in the decision of which
product to make. The product margins are lower than they should be due to the presence of allocated fixed common costs that are
irrelevant in this decision. Moreover, even after the irrelevant costs have been removed, what matters is the profitability of the two
products in relation to the amount of the constrained resource—welding time—that they use. A product with a very low margin may be
desirable if it uses very little of the constrained resource. In short, the financial data provided by the accounting department are useless
and potentially misleading for making this decision.
2.
Assuming direct labor is a fixed cost, the contribution margin per unit for each product is calculated as follows:
Manufactured
Purchased WVD Bike
WVD Drums Drums Frames
Selling price $ 149.00 $ 149.00 $ 239.00
Variable costs:
Direct materials 138.00 52.10 99.40
Variable manufacturing overhead 0 1.35 1.90
Variable selling and administrative 0.75 0.75 1.30
Total variable cost 138.75 54.20 102.60
Contribution margin $ 10.25 $ 94.80 $ 136.40
3.
Assuming direct labor is a fixed cost, the contribution margin per welding machine hour for each product is calculated as follows:
Manufactured
WVD Drums Bike Frames
Contribution margin per unit (above) (a) $ 94.80 $136.40
Welding hours per unit (b) 0.4 hour 0.5 hour
Contribution margin per welding hour (a) ÷ (b) $ 237.00 per hour $272.80 per hour
4.
Because the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the bike frames than for the WVD
drums, the frames make the most profitable use of the welding machine. Consequently, the company should manufacture as many bike
frames as possible up to demand and then use any leftover capacity to produce WVD drums. Buying the drums from the outside
supplier can fill any remaining unsatisfied demand for WVD drums. The necessary calculations are carried out below.
(a) (b) (c) (a) × (c) (a) × (b)
Unit Total Balance of
Contribution Welding Time Welding Welding Total
Quantity Margin per Unit Time Time Contribution
Total hours available 2,000
Bike frames produced 1,600 $ 136.40 0.5 800 1,200 $218,240
WVD Drums—make 3,000 94.80 0.4 1,200 0 284,400
WVD Drums—buy 3,000 10.25 30,750
Total contribution margin 533,390
Less: Contribution margin from present
operations: 5,000 drums × $94.80 CM per
drum 474,000
Increased contribution margin and net operating
income $ 59,390
5.
Assuming direct labor is a variable cost, the contribution margin per unit for each product is calculated as follows:
Manufactured
Purchased Bike
WVD Drums WVD Drums Frames
Selling price $ 149.00 $ 149.00 $ 239.00
Variable costs:
Direct materials 138.00 52.10 99.40
Direct labor 0 3.60 28.80
Variable manufacturing overhead 0 1.35 1.90
Variable selling and administrative 0.75 0.75 1.30
Total variable cost 138.75 57.80 131.40
Contribution margin $ 10.25 $ 91.20 $ 107.60
6.
Assuming direct labor is a variable cost, the contribution margin per welding hour for each product is calculated as follows:
Manufactured
WVD Drums Bike Frames
Contribution margin per unit (above) (a) $ 91.20 $107.60
Welding hours per unit (b) 0.4 hour 0.5 hour
Contribution margin per welding hour (a) ÷ (b) $ 228.00 per hour $215.20 per hour
When direct labor is assumed to be a variable cost, the conclusion is reversed from the case in which direct labor is assumed to be a
fixed cost—the WVD drums appear to be a better use of the constraint than the bike frames. The assumption about the behavior of
direct labor really does matter.
7.
(a) (b) (c) (a) × (c) (a) × (b)
Unit Total Balance of
Contribution Welding Time Welding Welding Total
Quantity Margin per Unit Time Time Contribution
Total hours available 2,000
WVD Drums—make 5,000 $ 91.20 0.4 2,000 0 $456,000
Bike frames produced 0 107.60 0.5 0 0 0
WVD Drums—buy 1,000 10.25 10,250
Total contribution margin 466,250
Less: Contribution margin from present
operations: 5,000 drums × $91.20 CM per
drum 456,000
Increased contribution margin and net
operating income $ 10,250
References
Worksheet Learning Objective: 12-01 Learning Objective: 12-05 Determine the most profitable
Identify relevant and use of a constrained resource.
irrelevant costs and benefits
in a decision.
Difficulty: 3 Hard Learning Objective: 12-03
Prepare a make or buy
analysis.
