PROBLEM 3-18. You Get What You Measure! The Plastic Glow Company makes glow stic

Question

PROBLEM 3-18. You Get What You Measure! The Plastic Glow Company makes glow sticks. It uses a process costing system and has had a just-in-time inventory policy. The plant has a capacity to produce 500,000,000 units a year but currently operates at 300,000,000 units per year. Direct 118 CHAPTER 3 Process Costing material and direct labor costs are variable, and manufacturing overhead is primarily fixed. Production costs for 2017 are as follows: Number of units produced and sold 300,000,000 Direct materials $ 15,000,000 Direct labor 30,000,000 Manufacturing overhead 105,000,000 Total costs $150,000,000 Equivalent cost per unit $0.50 Jim Taylor, the president, receives a bonus each year based on net operating profit and would like to reduce costs in 2018 so that profit will increase. He decides to take advantage of the excess plant capacity and increase production to 350,000,000 even though he expects the company will be unable to increase unit sales in 2018. REQUIRED a. If Jim increases production to 350,000 units per year, what will be the new equivalent cost per unit? b. Would increasing the production level be a good idea? Why or why not?

Explanation / Answer

A. Equivalent cost per unit will be $.45. if production is increased upto 350,000,000 units.

B.

Increasing the level of production from 300,000,000 units to 350,000,000 units would reduce the cost per unit to .45 . But, if sales stay at 300,000,000 units it would also increase inventory levels. The increase of50,000,000 units would increase total costs by $22,500,000 (50,000,000×.45). Overall costs would increase not decrease even though gross margin per unit would look better fir Jim. This is not a good idea for a company as whole.

Unit produce 350,000,000 units Direct material $17,500,000{(15,000,000/300,000,000)×350,000,000} Direct labour $35,000,000{(30,000,000/300,000,000)×350,000,000} Manufacturing overhead $105,000,000 Total cost $157,500,000 Equivalent cost per unit $0.45($157,500,000/350,000,000)

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