2) The cost structure of Sackville Manufacturing Company (SMC) at two levels of

Question

2) The cost structure of Sackville Manufacturing Company (SMC) at two levels of production is as follows Units Costs: 60,000 80,000 $120,000 90,000 216,000 $160,000 120,000 248.000 Direct labour Total costs... . ? $426000-5528000 Average cost per unit. $7.10 Required: a. Classify and explain each production cost as either strictly variable or strictly fixed or mixed b. Determine the total production cost equation for SMC, using the units of production as the cost driver. (Be sure to identify clearly all the separate components of the equation.) c. Explain what causes the drop in average cost per unit from $7.10 to $6.60 when production is increased fro 60,000 to 80,000 units. Show all supporting calculations.

Explanation / Answer

Req a: Items of Cost Classify Direct material Variable Direct labour Variable Factory Overheads Mixed Req b: Mixed cost: At 60,000 units, Factory OH $ 216000 At 80000 Unts. Factory OH $ 248000 Variable cost per Unit: Change in Cost/ Change in units (248000-216000)/(80000-60000)= $ 1.60 per unit Fixed cost component: Total cost at 60000 units 216000 Lless: Variable cost (60000*1.60) 96000 Fixed cost component: 120000 Other variable cost per unit: Material (120,000/60,000 units): $ 2.00 per unit Labouor ($ 90,000/60,000 units): $ 1.50 per unit Production Cost line (Taken number of units produced as X) Material cost: 2*X labour Cost: 1.50 *X Variable OH: 1.60*X Fixed OH: $ 120,000 Therefore, production cost line C (X) = 2X + 1.50 X + 1.60 X+ 120,000 Req C: Average cost per unit has been dropped to $ 6.60 per unit from $ 7.10. This is because f the reson that the average fixed cost has fallen with the increase in increase as all other variable cost per unit remain same. The computation justifies as under: Average fixed OH at 60,000 units (120,000/60,000 units) 2.00 Less: Aaverage e fixed cost ($ 120,000/80,000 units) 1.60 Difference in average cost per r unit (7.10-6.60) 0.50

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