Happy Kids has two plants: Yuen Long plant manufactures children accessories pla

Question

Happy Kids has two plants: Yuen Long plant manufactures children accessories plant manufactures children clothing. and Tai Po Yuen Long plant has three product lines of children wallets- A, B, and C-with contribution margins of S30, S20 and $10, respectively. John Chan, the 200,000 80,000 units of C. The com plant manager, foresees sales of units in the coming period, consisting of 20,000 units of A, 100,000 units of B, and pany's fixed costs for the period are S2,550,000. Jimmy Ho, the manager of Tai Po plant, has j statements. Ho receives a year-end bonus of 8% of the plant's operating year-end inc least. After reviewing the numbers, Ho demanded that the financial controller go back and work the numbers' again. Ho insisted that, if he didn't see a better operating income number the next time round, he would be forced to look for a new financial controller. st reviewed a draft of his year-end fin income before tax. The ome statement provided by the financial controller was disappointing to say the Happy Kids classifies all costs directly related to the manufacturing of its product as product costs. These costs are inventoried and later expensed as costs of goods sold when the products are sold. All other expenses, including finished goods warehousing costs of $1,428,000 in the Tai Po plant, are classified as period expenses. Ho had suggested that warehousing costs be included as product costs because they are ‘definitely related to our product. Happy Kids produced 210,000 units during the period and sold 190,000 units. As the controller reworked the numbers, he discovered that if he included warehousing costs as product costs, he could improve operating income by S136,000. He was also sure these new numbers would make Ho happy. Required (a) Compute the break-even point in units of children wallets, assuming that (b) If the sales mix is maintained, what is the total contribution margin when (c) What would operating income be if 20,000 units of A, 80,000 units of B, (8 marks) the given sales mix is maintained. 200,000 units are sold? What is the operating income? and 100,000 units of C were sold? What is the new breakeven point in (4 marks) (8 marks) units if these relationships persist in the next period? (d) Show numerically how operating income would improve by S136,000 in (8 marks)

Explanation / Answer

a. Break-even point in units of children's wallets : 150,000 units.

At break-even point,

Total Contribution Margin = Total Fixed Costs.

Let the break-even units be Q.

Therefore, $ 30 x 20,000 / 200,000 x Q + $ 20 x 100,000 / 200,000 x Q + $ 10 x 80,000 / 200,000 x Q = $ 2,550,000.

or 3Q + 10 Q+ 4Q = $ 2,550,000

or 17Q = $ 2,550,000

or Q = 150,000 units

b. Total Contribution Margin : $ 3,400,000; Operating Income : $ 850,000.

c. If 20,000 units of A , 80,000 units of B and 100,000 units of C were sold:

Operating Income = (20,000 x $ 30 + 80,000 x $ 20 + 100,000 x $ 10) - $ 2,550,000 = $ 650,000.

Break-even point in units ( Q) = $ 2,550,000 / ( 3 + 8 + 5) = 159,375 units.

d. Total finished goods warehousing costs = $ 1,428,000.

Ending inventory = Units produced - Units sold = 210,000 - 190,000 = 20,000.

If the warehousing cost of $ 1,428,000 is treated as product cost, the amount of the warehousing cost that can be deferred in ending inventory to the next accounting period = Units of Ending Inventory / Total Units Produced x Total Finished Goods Warehousing Costs = 20,000 / 210,000 x $ 1,428,000 = $ 136,000.

Therefore, if $ 136,000 of cost can be pushed to the next accounting period, the total costs for the current accounting period decreases by $ 136,000, and operating income increases by the same amount.

e. Inventory costs are those costs which are responsible for bringing the inventoriesJto the current location and condition.Jimmy Ho is incorrect in his justification, as finished goods warehousing costs are post production costs,and hence do not contribute to bringing the goods to their current location or condition. Hence they are not related to the product.

Jimmy Ho would benefit by $ 136,000 x 8% = $ 10,880.

f. Tai Po should bring the demands of Jimmy Ho to the notice of the top management.

A B C Total Units Sold 20,000 units 100,000 units 80,000 units 200,000 units Contribution Margin per Unit $ 30 $ 20 $ 10 Total Contribution Margin $ 600,000 $ 2,000,000 $ 800,000 $ 3,400,000 Less: Fixed Costs 2,550,000 Operating Income $ 850,000

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