Application of marginal costing in decision making- Questions

Example 1: Make or buy

The budgeted manufacturing costs of Product X are as follows:
Direct materials per unit - $ 24
Direct labour per unit - $ 24
Fixed production costs (predetermined OAR) - $ 20.
A supplier has offered to supply the good at a guaranteed price of $60. Should the company buy the
product or continue making it?

Example 2: Acceptance of a one-off order

A company manufactures one product, with current production being at 80% of the firm’s total capacity.
Costs and revenue data are as follows:
Sales(10,000 units) $200,000
Costs:
Variable production costs $150,000
Fixed production costs $30,000
Variable selling costs $5,000
Fixed selling&admin costs $1,000
Total costs $186,000
Profit $14,000

An overseas customer has placed a one-off bulk purchase order of 2,000 units, but the maximum price
he is willing to pay is $16 per unit. No variable costs would be incurred if the order is accepted. Should
the firm accept the order?

Example 3: Selecting from a number of alternatives

ABC Ltd manufactures a product called Astro. The normal output for this product is 200,000 units. The
following is a summarized cost statement relating to production of Astro:

$ $
Materials 5.00
Direct Wages 7.00
Factory overheads: Fixed 4.50
Variable 1.00 5.50
Administration overhead: Fixed 2.00
Selling overheads: Fixed 3.50
Variable 3.00 6.50
26.00
The selling price of the product is $36.
During the year, the company received 2 special orders, each involving the production of 2,000 units.
Option 1 related to the production of a Super Astro. Under this option, variable costs would increase by
25% but selling price cannot exceed $25.00 per unit.
Option 2 related to the production of Hyper Astro, under which variable costs would decrease by 25%
but the selling price would be $19.00 per unit.
Due to normal production commitments, only one of the 2 options can be selected.
Required:
(a) What would be the profits in normal trading if:
(i) The selling price was increased to $40 per unit and output restricted to 160,000 units.
(ii) The selling price was decreased to $28 per unit and output increased to 260,000 units.
(b) Advise the firm as to which option should be accepted.

Example 4: Discontinuing a product

DEF Ltd produces 4 products, and details of costs and revenues are as follows, based on absorption
costing approach:
Total Product A Product B Product C Product D
Sales 122,600 45,000 55,000 20,000 2,600
Variable costs (81,200) (33,000) (25,000) (21,000) (2,200)
Fixed costs (25,500) (10,000) (12,000) (2,500) (1,000)
Profit/(Loss) 15,900 2,000 18,000 (3,500) (600)

It has been suggested that Products C and D should be discontinued given that they are loss-making.
Should the firm drop these 2 products?

Example 5: whether to close down

GHI Ltd has been making losses at one of their branches for some time and is considering its closure. The
branch budget extract for the following year is as follows:
Turnover $30,000
Contribution margin ratio 20%
Fixed costs $ 40,000
The firm has determined that fixed costs will be $31,000 if the branch is closed as it will no longer have
to pay for rent of the branch building.
Determine whether to close down or to continue operation of the branch.

Example 6: Limiting Factor (choice of a product where a shortage of resources exists)

ABC Ltd produces and sells 3 products A, B and C:

A($) B($) C($)

Selling price per unit 106 154 300
Costs per unit:
Direct materials 40 80 200
Direct labour 16 24 16
Variable overheads 20 30 10
Maximum demand 100 units 200 units 150 units
Fixed overheads amount to $ 200,000 per annum. It is known that direct materials would be in short
supply and only 1,000 units would be available. 1 unit of direct materials cost $ 40.

Required: (a) Calculate the shortfall in direct materials in units.

(b) find the optimal production plan

Question 1 (limiting factor)

Buttercup Ltd manufactures and sells 3 products (R, S and T). These products are made using the same
machinery. The total machining time available each month is 10,500 hours but this is insufficient to
produce all the units of R, S and T required to meet maximum demands. No stocks of these products are
held.
The following information is available:
Product R Product S Product T
Selling price per unit $ 60 $ 75 $ 84
Contribution to sales ratio 20% 24% 25%
Machining minutes per unit 40 54 75
Maximum monthly demand (units) 9,000 6,000 3,000

Required:
(a) Calculate the monthly shortfall in machining hours.
(b) Determine the monthly production plan in units that will maximise the company’s total
contribution.