Assignment #1 The problem that is brought to our attention would be an argument between Monroe Company executives. Jim, the Ceo, believes that the product should use plant wide manufacturing overhead, which brings the retail sale of the product to $29. 40/per unit. Meanwhile frank, the Sale Manager, believes the product should not absorb the entire manufacturing overhead and be based off the variable cost it incurs and sold at $16. 00/per unit.
The issue occurs when deciding whether to choose between variable costing, not including fixed cost, which is usually acceptable on small orders, or choosing absorption costing which includes a portion of the fixed costs. Of course choosing between the two different costing approaches makes a big difference in this case. One keeps the product above market price while the other cuts the competitors prices by 20%. With out thinking you would go with cutting competitors prices and still gaining sales.
What to keep in mind is using the variable costing approach you aren’t accounting for the manufacturing overhead that the new timer is incurring. It is possible that the new timer isn’t incurring much overhead considering it is simply a new addition to the old timer. The modifications to create the new addition are simple and at low cost because the resources are already there. They did not have to create or purchase a new warehouse because they already had recently purchased one and were going to use it regardless.
Other than the initial set up cost of approximately $20000 for tables, lighting and small tools, the other overhead cost would already be accounted for and the new incurred overhead cost would not go beyond the relevant range of fixed cost.. One thing not accounted for in the calculations is the location of the new warehouse. There will clearly be transportation cost because one warehouse is in Texas and the other in Pennsylvania.
Of course we don’t know which warehouse will be used but still a cost to consider. With the new timer absorbing the full manufacturing overhead cost it would of course increase the price of the product almost doubling it but does not run the risk of creating a product that actually has them loosing money in the long run. The variable costing approach of course will create sales and revenue in the short run but in the long run can possibly create losses by not accounting for all the cost actually incurred.
My conclusion (due to space restriction) would be to use the variable costing approach due to everything mentioned and one more determining factor. The forecasted sales projection is 50 000 units. At this production level advertising would be $50 000 regardless of how many units they sale. By using the cheaper pricing you are creating a better chance of you getting those sales and after you sell a unit past 50 000 you will be creating more profit because the budget of sales, which is $1. 00 per unit, would be divided among more units.
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