Problem 13 - Accounting

Question

Power Serve Company expects to operate at 85% of productive capacity during April. The total manufacturing costs for April for the production of 30,000 batteries are budgeted as follows: $$ \begin{array}{lr} \text { Direct materials } & \$ 285,000 \\ \text { Direct labor } & 104,000 \\ \text { Variable factory overhead } & 31,000 \\ \text { Fixed factory overhead } & 58,000 \\ \cline { 2 } \text { Total manufacturing costs } & \$ 478,000 \\ \hline \end{array} $$ The company has an opportunity to submit a bid for 2,000 batteries to be delivered by April 30 to a government agency. If the contract is obtained, it is anticipated that the additional activity will not interfere with normal production during April or increase the selling or administrative expenses. What is the unit cost below which Power Serve Company should not go in bidding on the government contract?

Step-by-Step Solution

Answer

Power Serve Company's minimum bid price for the government contract is $14.00 per battery.

Step 1: Understanding the Problem

The goal is to find the minimum unit cost for the additional production of 2,000 batteries, considering both variable and total costs. The company's production capacity is sufficient to handle the additional production without impacting normal operations.

Step 2: Identify Relevant Costs

To determine the lowest bid price per unit, include all variable costs (such as direct materials, direct labor, and variable factory overhead) as these will increase with production. Fixed costs remain the same, so they are not part of the incremental cost.

Step 3: Calculate Relevant Costs

Add up the variable costs for 30,000 batteries to determine the cost per unit. Variable costs include direct materials ( per unit), direct labor ( per unit), and variable factory overhead ( per unit). Calculate total variable cost per battery:

Step 4: Compute Unit Variable Cost

Divide each cost component by 30,000 (the total number of batteries produced) to find the unit variable costs:- Direct materials: \( \frac{285,000}{30,000} = 9.50 \)- Direct labor: \( \frac{104,000}{30,000} = 3.47 \)- Variable factory overhead: \( \frac{31,000}{30,000} = 1.03 \)

Step 5: Calculate Total Variable Cost Per Unit

Sum the unit costs to find the total variable cost per battery:\( 9.50 + 3.47 + 1.03 = 14.00 \).

Step 6: Determine Minimum Bid Price

The minimum bid price per unit should cover the variable costs. Thus, Power Serve Company should bid at least $14.00 per battery for the government contract.

Key Concepts

Variable Costs

Variable costs are expenses that change directly with the production volume. As Power Serve Company produces more batteries, these costs will rise. They are directly tied to the production activities and include:

• Direct Materials: The raw materials needed for production. For each battery, Power Serve budgets $9.50 in direct materials.
• Direct Labor: The wages paid to employees who directly work on manufacturing the batteries. The company allocates $3.47 for direct labor per battery.
• Variable Factory Overhead: These are other variable expenses necessary for production, such as utilities related to machinery use, budgeted at $1.03 per battery.

By understanding these costs, companies like Power Serve can determine what it will cost them to produce an additional batch, ensuring that bids cover these expenses.

Fixed Costs

Fixed costs, in contrast to variable costs, do not change with the level of production. They are expenses that are constant regardless of the number of units manufactured. For Power Serve Company, fixed factory overhead amounts to $58,000.

Examples of fixed costs include:

• Rent of the production facility.
• Salaries of permanent staff.
• Depreciation of equipment.

These costs remain the same even if Power Serve decides to produce the additional 2,000 batteries. It's crucial to note that when determining the minimum bid price for a specific contract, like the government bid, fixed costs are not part of the calculation necessary to cover additional production. The decision focuses solely on covering variable costs since those will rise with the increased production level.

Incremental Analysis

Incremental analysis is the decision-making process that involves examining the costs and benefits of different options. This method is critical for Power Serve Company when considering whether to take on the additional contract for the 2,000 batteries.

In this scenario, Power Serve needs to decide:

• What is the additional (incremental) cost of producing these extra batteries?
• Will the bid price cover these incremental costs?

To perform this analysis, the company considers the variable costs as they represent the additional expenses that result from increasing production. Fixed costs are excluded because they remain constant, regardless of whether the contract is accepted.

Through incremental analysis, Power Serve ascertains that the minimum price they should bid must cover at least the variable costs of $14 per battery, ensuring that the operation remains financially viable without affecting the fixed cost structure.