The company is currently operating at full capacity of 150,000 brochures per month. It employs one sales representative and one printing press operator, and also relies on temporary labor from time to time. The monthly operating costs summary for the company when it operates at full capacity is as given below:
Monthly costs at 150,000 volume
Direct material - variable
Direct labor – variable
Direct labor – fixed
Manufacturing overhead – variable
Manufacturing overhead - fixed
Total manufacturing costs$15,375
Sales – variable
Sales – fixed
Corporate - fixed
Total non-manufacturing costs$7,125
The company charges its customers $17 for every 100 brochures printed.
The case presents a typical situation faced by owner John Johnson – whether to accept a one-time printing order. The potential customer is capable of paying only $10 per 100 brochures. She requires 25000 brochures printed. There is no potential for future business.
The case provides details of certain kinds of costs as discussed below –
Direct costs – Direct costs can be directly traced to a cost object such as a product or department. They do not have to be allocated to a product, department or any cost object.
Indirect costs – These are not direct costs of the production department or items produced and hence need to be allocated to the department or product. Examples are taxes, administration and security costs.
Variable costs – Variable costs are costs that change with the volume of output. The cost of materials and labor are examples.
Fixed costs – Fixed costs remain unchanged regardless of the change in volume of output. Factory rent, insurance and property taxes are examples.
Product costs - Manufacturer’s product costs are the direct materials, direct labor, and manufacturing overhead used in making its products. The product costs of direct materials, direct labor, and manufacturing overhead are also “inventoriable” costs, since these are the necessary costs of manufacturing the products.
Period costs - are not a necessary part of the manufacturing process. As a result, period costs cannot be assigned to the products or to the cost of inventory. The period costs are usually associated with the selling function of the business or its general administration. The period costs are reported as expenses in the accounting period in which they 1) best match with revenues, 2) when they expire, or 3) in the current accounting period.
The theory used to arrive at the decision for this case uses Breakeven Analysis. The break-even point for a product is the point where total revenue received equals the total costs associated with the sale of the product (TR=TC). A break-even point is typically calculated in order for businesses to determine if it would be profitable to sell a proposed product, as opposed to attempting to modify an existing product instead so it can be made lucrative. In this case we use it to determine if it makes sense to accept the special order at the price of $10 per 100 brochures.
To analyze this case we need to understand the profit and loss implications to the company, if this order were to be accepted. An assumption made here is that this special order is produced as a separate batch. Table ‘2’ given below, Column ‘B’ shows calculations for average variable costs (cost per unit). Column ‘C’ shows costs calculations for a volume of 25000. Fixed costs remain the same. Costs associated with the item ‘Sales-variable’ are ‘zero’ because sales commission of $1 per 100 or 0.01 per unit is not required to be paid in this case....