19-32 Quality improvement, relevant costs, and relevant revenues. The Crimson Co

Question

19-32 Quality improvement, relevant costs, and relevant revenues. The Crimson Corporation uses multi- colored molding to make plastic lamps. The molding operation has a capacity of 200,000 units per year. The demand for lamps is very strong. Crimson will be able to sell whatever output quantities it can produce at S40 per lamp Crimson can start only 200,000 units into production in the molding department because of capacity constraints on the molding machines. If a defective unit is produced at the molding operation, it must be scrapped at a net disposal value of zero. Of the 200,000 units started at the molding operation, 20,000 defec tive units (10%) are produced. The cost of a defective unit, based on total (fixed and variable) manufacturing costs incurred up to the molding operation, equals $20 per unit, as follows: $10 per unit 2 per unit 8 per unit Direct materials (variable) Direct manufacturing labor, setup labor, and materials-handling labor (variable) Equipment, rent, and other allocated overhead, including inspection and testing costs on scrapped parts (fixed Total S20 per unit Crimson's designers have determined that adding a different type of material to the existing direct materials would result in no defective units being produced, but it would increase the variable costs by $3 per lamp in the molding department. 1. Should Crimson use the new material? Show your calculations. 2. What nonfinancial and qualitative factors should Crimson consider in making the decision?

Explanation / Answer

Particulars Current Material New Material a. No. of units produced                   200,000                      200,000 b. Less: Defective units                      20,000                                   -   c. Units available for sale                   180,000                      200,000 d. Selling price per unit                               40                                 40 e. Less: Direct material p.u                               10                                 10 f. Less: Direct manufacturing labour                                 2                                    5 g. Contribution p.u                               28                                 25 h. Total contribution (g*c)               5,040,000                  5,000,000 1 Conclusion: Crimson should not use the new material as it results in a loss of $40,000 Note: Fixed costs are ignored as they will be incurred irrespective of the material used. 2 Non-financial and qualitative factors Crimson should consider are as follows: a. With the new material all the wastage of defective products is saved. b. In case the new material is of higher quality then the same should be used as the customers get a product which is of better quality which ultimately affects the goodwill of the company. Please hit the like button if the answer helped you else leave a comment for further clarification. Thank you! All the best!

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