Strategic initiatives and CSR
Get Hitched Inc. is a production company that is in the process of testing a strategic initiative aimed at increasing gross profit. The company’s current sales revenue is $1.5 million. Currently, the company’s gross profit is 35% of sales, but the company’s target gross profit percentage is 40%. The company’s current monthly cost of production is $975,000. Of this cost, 60% is for labor, 30% is for materials, and 10% is for overhead.
The strategic initiative being tested at Get Hitched is a redesign of its production process that splits the process into two sequential procedures. The makeup of the costs of production for Procedure 1 is currently 50% direct labor, 45% direct materials, and 5% overhead. The makeup of the costs of production for Procedure 2 is currently 55% direct labor, 25% direct materials, and 20% overhead. Company management estimates that Procedure 1 costs twice as much as Procedure 2.
Instructions
Determine what the cost of labor, materials, and overhead for both Procedures 1 and 2 would need to be for the company to meet its target gross profit at the current level of sales.
The company’s actual direct materials cost is $279,000 for Procedure 1. Determine the actual cost of direct labor, direct materials, and overhead for each procedure, and the total cost of production for each procedure.
The company is planning a CSR initiative to reuse some of the indirect materials used in production during Procedure 2. These indirect materials normally make up 60% of the overhead cost for Procedure 2, but the CSR initiative would reduce the usage of indirect materials. Determine what the maximum new cost of these indirect materials could be for Procedure 2 if this CSR initiative is expected to enable the company to meet its target gross profit percentage (holding all other costs constant).
a.
Identify the cost of labor, material and overhead required by Company H to meet the target gross profit with the existing sales level for Procedure 1 and Procedure 2.
Explanation of Solution
Strategic Initiatives: Strategic initiatives refer to the process implemented by the organization to attain those goals which it aims at achieving in the given period or in a long run.
Compute the cost makeup for Procedure 1 and Procedure 2:
Target gross profit percentage – 40% of sales
Total cost of production percentage – 60% of sales
Particulars | Amount ($) |
Total sales | $1,500,000 |
Multiply: Total cost of production percentage | |
Total cost of production | $900,000 |
Table (1)
Total cost of production is $900,000.
Compute the value of Cost of Procedure 2:
Compute the value of Cost of Procedure 1:
Compute the Cost makeup of Procedure 1:
Particulars | Amount ($) |
Labor (50%) | $300,000 |
Materials (45%) | $270,000 |
Overhead (5%) | $30,000 |
Total cost of production | $600,000 |
Table (2)
The Cost makeup of Procedure 1 is $600,000.
Compute the Cost makeup of Procedure 2:
Particulars | Amount ($) |
Labor (55%) | $165,000 |
Materials (25%) | $75,000 |
Overhead (20%) | $60,000 |
Total cost of production | $300,000 |
Table (3)
The Cost makeup of Procedure 2 is $300,000.
b.
Identify the cost of direct labor, direct material and overhead for Procedure 1 and Procedure 2.
Explanation of Solution
Compute the Material Cost of Procedure 1:
Compute the value of Cost of Procedure 2:
Compute the Cost makeup of Procedure 1:
Particulars | Amount ($) |
Labor (50%) | $310,000 |
Materials (45%) | $279,000 |
Overhead (5%) | $31,000 |
Total cost of production | $620,000 |
Table (4)
The Cost makeup of Procedure 1 is $620,000.
Compute the Cost makeup of Procedure 2:
Particulars | Amount ($) |
Labor (55%) | $170,500 |
Materials (25%) | $77,500 |
Overhead (20%) | $62,000 |
Total cost of production | $310,000 |
Table (5)
The Cost makeup of Procedure 2 is $310,000.
c.
Identify the maximum new cost for the indirect materials for Procedure 2.
Explanation of Solution
Compute the maximum new cost for the indirect materials for Procedure 2:
Particulars | Amount ($) |
Current total cost of production | $ 930,000 |
Less: Target total cost of production | |
P2 materials cost savings needed | $ 30,000 |
Current P2 overhead materials cost | $ 37,200 |
Less: P2 overhead materials cost savings needed | |
Maximum new cost of P2 overhead materials | $ 7,200 |
Table (6)
The maximum new cost for the indirect materials for Procedure 2 is $ 7,200.
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Chapter 14 Solutions
Managerial Accounting
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