Silven Industries, which manufactures and sells a highly successful line of summ
ID: 2565819 • Letter: S
Question
Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.
After considerable research, a winter products line has been developed. However, Silven’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.
The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $112,000 charge for fixed manufacturing overhead will be absorbed by the product under the company’s absorption costing system.
Using the estimated sales and production of 140,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:
The costs above relate to making both the lip balm and the tube that contains it. As an alternative to making the tubes for Chap-Off, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $1.20 per box of 24 tubes. If Silven Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 20%.
Required:
1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able to avoid? (Hint: You need to separate the manufacturing overhead of $1.60 per box that is shown above into its variable and fixed components to derive the correct answer.)
2. What is the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier?
3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 140,000 boxes of tubes from the outside supplier?
4. Should Silven Industries make or buy the tubes?
5. What is the maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes?
6. Instead of sales of 140,000 boxes of tubes, revised estimates show a sales volume of 173,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra equipment at a cost of $53,000 per year to make the additional 33,000 boxes of tubes. Assuming that the outside supplier will not accept an order for less than 173,000 boxes of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven buys 173,000 boxes of tubes from the outside supplier? Given this new information, should Silven Industries make or buy the tubes?
7. Refer to the data in (6) above. Assume that the outside supplier will accept an order of any size for the tubes at a price of $1.20 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?
Direct material $ 3.70 Direct labor 2.00 Manufacturing overhead 1.60 Total cost $ 7.30Explanation / Answer
Solution:
Working Note:1: Division of Manufacturing Overhead into fixed and variable components:
Total Manufacturing overhead per box absorbed = $1.60
Total Fixed Manufacturing overhead to be absorbed = $112,000
Fixed Manufacturing overhead per box = $112,000/140,000 boxes = $1.25 per box
Variable Manufacturing overhead per box = $1.60 - $ 1.25 = $0.35 per box.
Answer to 1:
If Silven Industries manufacture full product (both tube and balm), the cost per box is as below:
Particulars
Amount $
Amount $ per box
Direct Material
3.70
Direct Labour
2.00
Manufacturing Overhead
Fixed (as above Working Note 1)
1.25
Variable (as above Working Note 1)
0.35
1.30
Total Manufacturing Cost
7.30
If Silven Industries buys tubes from the outside supplier, the cost per box is as below:
Particulars
Workings
Amount $
Amount $ per box
Direct Material (reduced by 20%)
3.70*80%
2.96
Direct Labour (reduced by 10%)
2.00*90%
1.80
Manufacturing Overhead
Fixed (as above Working Note 1)
1.25
Variable (reduced by 10%)
0.35*90%
0.32
1.57
Total Manufacturing Cost
6.33
The purchase cost of empty tube is $1.20
The amount of manufacturing cost saved = 7.30 - 6.30 = 0.98
But the amount of saving is less that of the amount of purchase cost of empty tube. Hence there is negative contribution.
However, the entity has the excess capacity unutilised, so, we have to consider only Variable cost for the purpose of decision making.
Thus the comparison is as below:
Particulars
If manufactured both
If bought tubes from outside
Direct Material
3.70
2.96
Direct Labour
2.00
1.80
Variable Manufacturing Overhead
0.35
0.32
6.05
5.08
Saving in Variable Manufacturing cost
(6.05-5.08)
0.98
Thus, the saving is $0.98 per box which is less than the purchase price of empty tube.
Answer to 2:
The saving in manufacturing cost per box if empty tube is bought outside = $0.98
The cost of purchase of empty tube outside = $1.20
Thus, the financial advantage is negative i.e., contribution loss of $0.23 per box.
Answer to 3:
Total financial disadvantage is loss of $31,500 if silven buys 140,000 boxes of tubes from outside supplier.
Answer to 4:
The cost of making empty tube is equal to saving in manufacturing cost as below:
Particulars
Workings
Amount $
Amount $ per box
Direct Material (reduced by 20%)
3.70*20%
0.74
Direct Labour (reduced by 10%)
2.00*10%
0.20
Variable (reduced by 10%)
0.35*10%
0.40
Total Manufacturing Cost
0.98
It is advisable to manufacture the empty tube since it is beneficial to Silven.
Answer to 5:
The maximum price that Silven can afford to buy the empty tube is its manufacturing cost i.e., $0.98 per box of empty tubes.
Answer to 6:
Profit per box if manufactured and sold = 8.00 - 7.30 = $0.70 per box.
Total Profit for 173000 boxes = $1,21,100
Cost of hiring machine for manufacturing extra 33,000 boxes = $ 53,000
Net profit if manufactured and sold 173000 boxes = $ 121100 - $53,000 = $68,100
Profit per box if empty tube is bought outside = 8.00 - (6.33+1.20) = 0.47 per box.
Total profit for 173000 boxes = $ 82,175
Net profit if bought empty tubes outside = $82,175 - $53,100 = $ 29,175
Thus, it advisable to manufacture and sell.
Answer to 7:
The indifference between the making and buying of empty tubes is to be calculated as below:
Cost Indifference point = Additional cost / financial advantage per unit.
= 53100/0.23
= 235556 boxes.
Thus, if order is more than 235,556 boxes, it can be bought outside.
Hence, in this case, it is advisable to manufacture the empty tubes by Silven to gain advantage.
Particulars
Amount $
Amount $ per box
Direct Material
3.70
Direct Labour
2.00
Manufacturing Overhead
Fixed (as above Working Note 1)
1.25
Variable (as above Working Note 1)
0.35
1.30
Total Manufacturing Cost
7.30
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