Q15E - Horngren'S Financial And Managerial Accounting

Question

Tread Light produces two types of exercise treadmills: regular and deluxe. The exercise craze is such that Tread Light could use all its available machine hours to produce either model. The two models are processed through the same production departments. Data for both models are as follows:

                                                                                                            Per Unit         

                                                                                                Deluxe                       Regular 

Sales price                                                                           \(1,030                        \)610

Costs:

Direct materials                                                                   320                             130

Direct labor                                                                          88                                180

Variable manufacturing overhead                                 270                             90

Fixed manufacturing overhead*                                                102                             34

Variable operating expenses                                          121                             63

Total costs                                                                           901                             497     

Operating income                                                              \(129                           \)113

 

*allocated on the basis of machine hours

 

Requirements 

 

1. What is the constraint? 

2. Which model should Tread Light produce? (Hint: Use the allocation of fixed manufacturing overhead to determine the proportion of machine hours used by each product.) 

3. If Tread Light should produce both models, compute the mix that will maximize operating income.

 

Step-by-Step Solution

Answer

The company should produce regular treadmills for profit maximization.

 

Step 1: Meaning of Contribution Margin

Acontribution margin represents the profit left with acompany after recovering all the variable costs from the sales revenue generated by a business entity. It is computed by taking the difference between net sales revenues and associated variable costs.

Step 2: Identification of constraint

In the given set of data, machine hours are the major constraint in the company because the production process is dependent on the machine hours.

Step 3: Computation of per-unit contribution margin

 

Particulars	Deluxe ($)	Regular ($)
Selling price per treadmill	1,030	610
Less: Variable cost	(799)	(463)
Contribution margin per unit	231	147
Machine hours used in proportion of $102:34	3.00	1.00
Hence, units produced per hour	1.00	3.00
Contribution margin per machine hour
Proportion of units produced per equivalent hour (A)	1	3
Contribution margin per unit (B)	231	147
Contribution margin per equivalent machine hour (A*B)	$231	$441

 

Step 4: Decisionon product mix

The company should produce 100% regular treadmills with zero deluxe because it will provide a higher contribution margin per machine hour.