Problem 4 - Accounting

Question

Steelcase Inc. is one of the largest manufacturers of office furniture in the United States. In Grand Rapids, Michigan, it produces filing cabinets in two departments: Fabrication and Trim Assembly. Assume the following information for the Fabrication Department: Steel per filing cabinet . . . . . . . . . . . . . . 45 pounds Direct labor per filing cabinet . . . . . . . . . 20 minutes Supervisor salaries . . . . . . . . . . . . . . . . . \(140,000 per month Depreciation . . . . . . . . . . . . . . . . . . . . . . \)22,000 per month Direct labor rate . . . . . . . . . . . . . . . . . . . \(21 per hour Steel cost . . . . . . . . . . . . . . . . . . . . . . . . \)1.45 per pound Prepare a flexible budget for \(12,000,15,000\), and 18,000 filing cabinets for the month of October 2010, similar to Exhibit 5, assuming that inventories are not significant.

Step-by-Step Solution

Answer

The flexible budgets for 12,000, 15,000, and 18,000 filing cabinets are $1,029,000, $1,245,750, and $1,462,500, respectively.

Step 1: Understand the Costs Components

To prepare a flexible budget, we first distinguish between fixed and variable costs. Variable costs per filing cabinet include the cost of steel and direct labor. Fixed costs include supervisor salaries and depreciation.

Step 2: Calculate Variable Cost per Filing Cabinet

Each filing cabinet requires 45 pounds of steel at $1.45 per pound, which totals \( 45 \, \text{pounds} \times 1.45 \, \text{USD/pound} = 65.25 \, \text{USD} \). Direct labor is 20 minutes per cabinet, or \( \frac{20}{60} = \frac{1}{3} \) of an hour. Thus, direct labor cost is \( \frac{1}{3} \times 21 \; \text{USD/hour} = 7 \; \text{USD} \). So, the total variable cost per filing cabinet is \( 65.25 + 7 = 72.25 \; \text{USD} \).

Step 3: Calculate Total Variable Costs for Each Production Level

For 12,000 cabinets: \( 12,000 \times 72.25 = 867,000 \; \text{USD} \). For 15,000 cabinets: \( 15,000 \times 72.25 = 1,083,750 \; \text{USD} \). For 18,000 cabinets: \( 18,000 \times 72.25 = 1,300,500 \; \text{USD} \).

Step 4: Add Fixed Costs

The fixed costs for supervisor salaries and depreciation are \( 140,000 + 22,000 = 162,000 \; \text{USD/month} \). This remains constant regardless of production level.

Step 5: Prepare the Flexible Budget

For 12,000 cabinets: Total costs = Variable costs (867,000 USD) + Fixed costs (162,000 USD) = 1,029,000 USD. For 15,000 cabinets: Total costs = Variable costs (1,083,750 USD) + Fixed costs (162,000 USD) = 1,245,750 USD. For 18,000 cabinets: Total costs = Variable costs (1,300,500 USD) + Fixed costs (162,000 USD) = 1,462,500 USD.

Key Concepts

Fixed Costs

Fixed costs are expenses that do not change with the level of production or sales volume. They are the baseline costs a company must pay regardless of how much they produce. For Steelcase Inc., the fixed costs include:

• Supervisor salaries of $140,000 per month
• Depreciation, which is $22,000 per month

These fixed costs total $162,000 per month. Importantly, they remain constant even when the number of filing cabinets produced increases from 12,000 to 18,000. Fixed costs are critical for budgeting because they allow companies to forecast the minimum expenses needed to maintain operations, irrespective of output levels.

Variable Costs

Variable costs fluctuate based on production volume. For each filing cabinet produced, variable costs comprise the costs of steel and direct labor. In this scenario, the variable costs per filing cabinet are calculated as follows:

• Steel cost: 45 pounds of steel at $1.45 per pound equals $65.25 per cabinet.
• Direct labor: 20 minutes per cabinet, equating to one-third of an hour at $21 per hour, results in $7 per cabinet.

The total variable cost per filing cabinet comes to $72.25. Therefore, when production increases, the total variable costs multiply accordingly. For instance, producing 12,000 cabinets leads to total variable costs of $867,000.

Direct Labor

Direct labor involves the human effort directly attributable to the production of goods. In this exercise, direct labor is calculated based on the time taken to produce each filing cabinet. Specifically, 20 minutes of labor per cabinet is required, which is equivalent to one-third of an hour.
The cost for direct labor is thus calculated by multiplying the time taken (in hours) by the hourly labor rate, which is $21 per hour. This results in a direct labor cost of $7 per cabinet. Direct labor is an essential component of production costs that directly affects the variable cost per unit.

Cost Components

Understanding the cost components in manufacturing is vital for preparing accurate budgets and forecasts. The cost components are divided into fixed and variable costs. In Steelcase Inc.'s exercise:

• Fixed costs total $162,000 monthly, covering supervisor salaries and depreciation.
• Variable costs include steel costs and direct labor, totaling $72.25 per filing cabinet.

By accurately assigning costs into fixed and variable categories, businesses like Steelcase can better anticipate how changes in production volumes will affect their overall expenses. This distinction is crucial for creating a flexible budget that adjusts to production levels.

Steel Costs

Steel costs are a fundamental component of the variable expenses in manufacturing. For Steelcase Inc., each filing cabinet requires 45 pounds of steel, priced at $1.45 per pound. This results in a steel cost of $65.25 per filing cabinet.
As steel is the primary raw material in this scenario, fluctuations in steel prices directly impact the overall cost of producing filing cabinets. Thus, monitoring steel market trends is important for businesses to manage their production costs effectively. Understanding the contribution of steel costs to the total variable cost allows companies to better strategize their purchasing and inventory management.