91Ó°ÊÓ

The Denver Corporation manufactures filing cabinets in two operations: machining and finishing. It provides the following information: Each cabinet sells for \(\$ 75\) and has direct material costs of \(\$ 35\) incurred at the start of the machining operation. Denver has no other variable costs. Denver can sell whatever output it produces. The following requirements refer only to the preceding data. There is no connection between the requirements. 1\. Denver is considering using some modern jigs and tools in the finishing operation that would increase annual finishing output by 1,150 units. The annual cost of these jigs and tools is \(\$ 35,000\). Should Denver acquire these tools? Show your calculations. 2\. The production manager of the Machining Department has submitted a proposal to do faster setups that would increase the annual capacity of the Machining Department by 9,000 units and would cost \(\$ 20,000\) per year. Should Denver implement the change? Show your calculations. 3\. An outside contractor offers to do the finishing operation for 10,000 units at \(\$ 9\) per unit, triple the \(\$ 3\) per unit that it costs Denver to do the finishing in-house. Should Denver accept the subcontractor's offer? Show your calculations. 4\. The Hammond Corporation offers to machine 5,000 units at \(\$ 3\) per unit, half the \(\$ 6\) per unit that it costs Denver to do the machining in-house. Should Denver accept Hammond's offer? Show your calculations. 5\. Denver produces 2,000 defective units at the machining operation. What is the cost to Denver of the defective items produced? Explain your answer briefly. 6\. Denver produces 2,000 defective units at the finishing operation. What is the cost to Denver of the defective items produced? Explain your answer briefly.

Step by step solution

01

1. Calculating the Incremental Profit from Using New Tools

First, we need to find out the incremental profit per unit by using the new tools in the finishing operation. Incremental profit can be calculated as the difference between the selling price and the direct material cost: Incremental Profit = Selling Price - Direct Material Cost Incremental Profit = \(75 - \)35 = $40 Next, calculate the total incremental profit for 1,150 additional units: Total Incremental Profit = Incremental Profit per Unit * Additional Units Total Incremental Profit = \(40 * 1,150 = \)46,000 Now, we need to calculate the net gain from using these new tools by subtracting the cost of the tools from the total incremental profit: Net Gain = Total Incremental Profit - Cost of Tools Net Gain = \(46,000 - \)35,000 = $11,000 Since the net gain is positive, Denver should acquire these tools as it will increase their profit by $11,000.

02

2. Evaluating the Machining Department's Proposal

First, calculate the incremental profit for the proposed 9,000 additional units: Incremental Profit = Selling Price - Direct Material Cost Incremental Profit = \(75 - \)35 = $40 Now, calculate the total incremental profit for 9,000 additional units: Total Incremental Profit = Incremental Profit per Unit * Additional Units Total Incremental Profit = \(40 * 9,000 = \)360,000 Next, we need to calculate the net gain from implementing the faster setup: Net Gain = Total Incremental Profit - Cost of Faster Setup Net Gain = \(360,000 - \)20,000 = $340,000 Since the net gain is positive, Denver should implement the change as it will increase their profit by $340,000.

03

3. Evaluating the Outside Contractor's Offer

Calculate the total cost of finishing 10,000 units in-house: Total In-house Cost = In-house Cost per Unit * Units Total In-house Cost = \(3 * 10,000 = \)30,000 Calculate the total cost of finishing 10,000 units by the outside contractor: Total Outsourced Cost = Outsourced Cost per Unit * Units Total Outsourced Cost = \(9 * 10,000 = \)90,000 Since the total cost of outsourcing the finishing to the contractor (\(90,000) is higher than the total cost of finishing the units in-house (\)30,000), Denver should not accept the subcontractor's offer.

04

4. Evaluating the Hammond Corporation's Offer

Calculate the total cost of machining 5,000 units in-house: Total In-house Cost = In-house Cost per Unit * Units Total In-house Cost = \(6 * 5,000 = \)30,000 Calculate the total cost of machining 5,000 units by Hammond Corporation: Total Outsourced Cost = Outsourced Cost per Unit * Units Total Outsourced Cost = \(3 * 5,000 = \)15,000 Since the total cost of outsourcing the machining to Hammond Corporation (\(15,000) is lower than the total cost of machining the units in-house (\)30,000), Denver should accept Hammond's offer.

05

5. Cost of Defective Units at the Machining Operation

The cost of defective units at the machining operation only includes the direct material cost since the machining process has not been completed. Therefore, the cost of the 2,000 defective units produced at the machining operation is: Cost of Defective Items = Direct Material Cost per Unit * Defective Units Cost of Defective Items = \(35 * 2,000 = \)70,000

06

6. Cost of Defective Units at the Finishing Operation

The cost of defective units at the finishing operation includes both the direct material cost and additional costs incurred in the machining process. Assuming that the direct material costs are the same for both the machining and finishing processes, the cost of 2,000 defective units produced at the finishing operation is: Cost of Defective Items = (Direct Material Cost per Unit + Additional Machining Costs) * Defective Units For this exercise, the additional machining costs are not provided, so we cannot calculate the final cost for the defective units in the finishing operation.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Incremental Profit Analysis

Incremental profit analysis is a crucial tool in managerial accounting, playing a significant role in decision-making processes. It involves calculating the additional profit or loss that a company will incur as a result of a specific decision. When faced with opportunities to increase production through investments like modern jigs and tools, companies must evaluate the additional revenues generated against the extra costs incurred.

For example, in the case of Denver Corporation, the company assessed the profitability of acquiring new tools by calculating the incremental profit, which is the difference between the additional selling price and the direct material costs of the newly produced units. After considering the annual cost of the tools, the analysis concluded that there would be a net gain, signifying a compelling reason to go forward with the purchase. It's a straightforward yet powerful framework that helps determine whether an investment will contribute to a company's bottom line.

Make or Buy Decision

The 'make or buy' decision is a crossroads that businesses often encounter, where they must choose between manufacturing a product in-house or outsourcing it to a third party. To navigate this decision, cost comparisons are vital. Companies weigh the internal costs to produce against the price quoted by potential suppliers.

In the context of Denver Corporation, they analyzed two 'make or buy' scenarios with their machining and finishing operations. When considering the offer from the Hammond Corporation, the incremental costs of outsourcing were found to be lower than those of in-house production, thereby justifying the decision to buy externally. However, when another contractor offered to finish units at a higher cost than Denver's internal cost, it was clear that Denver should continue to make these units. This strategic consideration can lead to substantial cost savings and efficiency improvements if executed correctly.

Cost Management Strategies

Effective cost management strategies enable businesses to optimize their operations and increase profitability. These strategies encompass a variety of practices including streamlining processes, reducing waste, and making informed spending decisions. Denver Corporation's proposal to do faster setups for an increase in production capacity is a prime example of a cost management strategy aimed at maximizing output while controlling costs.

Considering cost control and efficiency, the company broke down the proposal's costs and benefits to identify a net gain. This potential increase in profit supports the strategy's implementation. Additionally, understanding the costs of defective units contributes to effective cost management by highlighting areas where efficiencies can be gained, and highlighting the importance of quality control measures. This calculated approach ensures that companies like Denver can make informed decisions that align with their financial goals.