Question

IPort Products makes cases for portable music players in two processes, cutting and sewing. The cutting process has a capacity of 100,000 units per year; sewing has a capacity of 120,000 units per year. Cost information follows.

Inspection and testing costs	$	40,000
Scrap costs (all in the cutting dept.)		140,000

Demand is very strong. At a sales price of $12.00 per case, the company can sell whatever output it can produce.

IPort Products can start only 100,000 units into production in the Cutting Department because of capacity constraints. Defective units are detected at the end of production in the Cutting Department. At that point, defective units are scrapped. Of the 100,000 units started at the cutting operation, 15,000 units are scrapped. Unit costs in the Cutting Department for both good and defective units equal $10.10 per unit, including an allocation of the total fixed manufacturing costs of $200,000 per year to units.

Direct materials (variable)	$	6.00
Direct manufacturing, setup, and materials handling labor (variable)		2.10
Depreciation, rent, and other overhead (fixed)		2.00
Total unit cost	$	10.10

The fixed cost of $2.00 per unit is the allocation of the total fixed costs of the Cutting Department to each unit, whether good or defective. (The total fixed costs are the same whether the units produced in the Cutting Department are good or defective.)

The good units from the Cutting Department are sent to the Sewing Department. Variable manufacturing costs in the Sewing Department are $1.00 per unit and fixed manufacturing costs are $30,000 per year. There is no scrap in the Sewing Department. Therefore, the company’s total sales quantity equals the Cutting Department’s good output. The company incurs no other variable costs.

The company’s designers have discovered a new type of direct material that would reduce scrap in the Cutting Department to 5,000 units. However, using the new material would increase the direct materials costs to $5.50 per unit in the Cutting Department for all 100,000 units. Recall that only 100,000 units can be started each year.

Required:

a. Compute profit under each alternative. Assume that inspection and testing costs will be reduced by $10,000 if the new material is used. Fixed costs in the sewing department will remain the same whether 85,000 or 95,000 units are produced.

Current Material New Material Number of units sold Price per unit Sales revenue Variable cutting manufacturing costs Materials Other variable Fixed cutting manufacturing costs Variable sewing costs Fixed sewing costs Inspection and testing Profit

b. Should IPort use the new material and improve quality?

Answer 1

Requirement 1

Here is the computation of profit under both the alternatives

	Current Material	New Material
Units Produced	100,000	100,000
Less: Units scrapped	15,000	5,000
Number of units sold	85,000	95,000	Units Produced - Units Scrapped
Price per unit	12	12	Given
Sales revenue	1,020,000	1,140,000	unit sold*Price per unit
Variable cutting manufacturing costs:
Materials (100,0000*6,100,000*5.5)	600,000	550,000	DM$ x Units Produced
Other Variables i.e. direct manufacturing, setup and material handling labor	210,000	210,000	Other V$ x Units Produced
Fixed cutting manufacturing costs	200,000	200,000	Given
Variable sewing costs	85,000	95,000	85,000 *1 and 95,000*1 Units after scrappage * rate
Fixed sewing costs	30,000	30,000
Inspection and testing	40,000	30,000
Profit (loss)	(145,000)	25,000

Requirement 2

Iport shall use the new material and improve the quality as it will result in increased profit of 25000 +145000 = $ 170,000.

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