Part A: Absorption and Marginal Costing
Golden Star Company manufactures and sells a unique product that has been quickly accepted by the consumers. The results of last month s operations are shown below (absorption costing basis):
|
Sales (10,000 units @ $20) |
$200,000 |
|
Less: cost of goods sold (10,000 units @ $14) |
140,000 |
|
Gross margin |
60,000 |
|
Less: selling and administrative expenses |
45,000 |
|
Net income |
$ 15,000 |
Variable selling and administrative expenses are $2 per unit. Variable manufacturing costs total $10 per unit, and fixed manufacturing overhead costs total $48,000 per month. There was no beginning inventory. The company produced 12,000 units during the month.
Required:
1- Restate Golden Star s income statement in contribution margin format, using variable costing.
2- Reconcile the variable costing and absorption costing net income figures.
3- State which costing approach is used in published financial statements, and briefly explain the usefulness of the other approach.
4- The easiest way to distinguish between relevant and irrelevant costs is by cost behavior; variable costs are relevant costs and fixed costs are irrelevant costs. Explain why you do or do not agree with this statement and support your answer with suitable example(s).
[Marks (Words): 15(150) + 10(150) + 10(200) + 10(200) = 45(700)]
Part B:Capital Investment Decisions
The management of a New Hotel Group is deciding whether to scrap an old but still serviceable machine bought five years ago to produce fruit pies, and replace it with a newer type of machine. It is expected that the demand for the fruit pies will last for further five years only and will be as follows:
|
Year |
Number of pies produced and sold |
|
1 |
70,000 |
|
2 |
50,000 |
|
3 |
40,000 |
|
4 |
30,000 |
|
5 |
25,000 |
Each machine is capable of meeting these requirements. Data for two machines are as follows:
|
|
Existing Machine ($) |
New Machine ($) |
|
Capital cost |
400,000 |
180,000 |
|
Operating cost per unit: |
|
|
|
Direct labor |
0.70 |
0.50 |
|
Materials |
0.70 |
0.70 |
|
Variable overheads |
0.40 |
0.30 |
|
Fixed overheads per unit: |
|
|
|
Depreciation |
0.90 |
1.10 |
|
Allocated costs (75% direct labor) |
0.525 |
0.375 |
|
3.225 |
2.975 |
The fruit pies are currently sold for $4 per pie. Unit operating costs, fixed overhead costs and selling price are expected to remain constant throughout the five year period.
Required:
a- Using data relating only to the new machine:
1- Calculate the net present value of the new machine. The New Hotel Group expects that its cost of capital will be 8% throughout the period.
2- Calculate the payback period of the new machine.
b- Using present value calculations, determine whether the existing machine should bereplaced by the new machine. Assume that the existing machinery could be sold for$150,000 immediately, if it were replaced.
c- Discuss the nonfinancial factors would you recommend that Hotel Group executives take into consideration regarding this proposal.
d- If the Hotel Group s management is uncertain about the accuracy of the cost savings that have been estimated for this proposal. Explain the actions that they can take to ensure that the estimates of: costs, revenues, and cash flows are not overly optimistic or pessimistic.