Fineprint Company, owned and managed by John Johnson, prints high color brochures for its clients primarily in the central Virginia area. The facility is located at Charlottesville, Virginia. 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: Table ‘1’ Monthly costs at 150,000 volume Manufacturing costs Direct material – variable
Direct labor – variable Direct labor – fixed Manufacturing overhead – variable Manufacturing overhead – fixed $6,000 1,500 3,000 1,500 3,375 Total manufacturing costs$15,375 Non-manufacturing costs Sales – variable Sales – fixed Corporate – fixed $1,500 1,875 3,750 Total non-manufacturing costs$7,125 Total costs$22,500 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. Cost Theory 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. Analysis
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. Table ‘2’
ABC Monthly costs at 150,000 volumeAverage variable costs(cost per unit) (A/150,000)Monthly costs at 25,000 volume (B*25000) Manufacturing costs Direct material – variable Direct labor – variable Direct labor – fixed Manufacturing overhead – variable Manufacturing overhead – fixed $6,000 1,500 3,000 1,500 3,375 $0. 04 0. 01 – 0. 01 – $1000 250 3000 250 3375 Total manufacturing costs$15,375$7,875 Non-manufacturing costs Sales – variable Sales – fixed Corporate – fixed $1,500 1,875 3,750 $0. 01 – – $0 1,875 3,750 Total non-manufacturing costs$7,125$5,625
Total costs$22,500$13,500 Table ‘3’given below shows profit/loss calculations for a volume of 150,000 and 25,000. The unit selling price at 150,000 units is $0. 17. The expected unit selling price for 25,000 units is $0. 1. Table ‘3’ Volume of 150,000Volume of 25,000 Revenue$25,500$2,500 Total costs$22,500$13,500 Profit/loss$3,000$(11,000) So the company is bound to make a loss of $11,000. Next we determine if the price quoted for the order is sufficient or not. Using Breakeven Analysis we calculate the breakeven price for a volume of 25,000.
From Table ‘2’ we are given the following information for a production volume of 25000: Variable cost per unit = $0. 06 Total fixed costs = $12000 Volume = 25000 Breakeven price =? BE = FC/ (SP-VC) SP = (FC/BE) +VC = (12000/25000) + 0. 06 = $0. 54 Hence the breakeven price is $54 per 100 brochures printed. Conclusion As is evident from Table ‘3’ the company would incur a loss of $11,000 if it were to accept the special order and print the brochures as a separate batch of 25,000. Also the price of $10 per 100 brochures is too low.
The breakeven price for a volume of 25,000 is $54 per 100. So ideally the selling price has to be $0. 54 or more, per unit. If the company plans to accommodate the special order along with the current production, it may have to forego some of the existing production, since it is operating at full capacity (and assuming it cannot expand capacity in any way). This does not seem worth since there does not seem to be a potential for future business from this client. Hence my conclusion is that John Johnson should not accept the special order.