Chapter 14, Problem 2PA

Strategic initiatives and CSR

Get Hitched Inc. is a production company that is in the process of testing a strategic initiative aimed at increasing gross profit. The company’s current sales revenue is $1.5 million. Currently, the company’s gross profit is 35% of sales, but the company’s target gross profit percentage is 40%. The company’s current monthly cost of production is $975,000. Of this cost, 60% is for labor, 30% is for materials, and 10% is for overhead.

The strategic initiative being tested at Get Hitched is a redesign of its production process that splits the process into two sequential procedures. The makeup of the costs of production for Procedure 1 is currently 50% direct labor, 45% direct materials, and 5% overhead. The makeup of the costs of production for Procedure 2 is currently 55% direct labor, 25% direct materials, and 20% overhead. Company management estimates that Procedure 1 costs twice as much as Procedure 2.

Instructions

Determine what the cost of labor, materials, and overhead for both Procedures 1 and 2 would need to be for the company to meet its target gross profit at the current level of sales.

The company’s actual direct materials cost is $279,000 for Procedure 1. Determine the actual cost of direct labor, direct materials, and overhead for each procedure, and the total cost of production for each procedure.

The company is planning a CSR initiative to reuse some of the indirect materials used in production during Procedure 2. These indirect materials normally make up 60% of the overhead cost for Procedure 2, but the CSR initiative would reduce the usage of indirect materials. Determine what the maximum new cost of these indirect materials could be for Procedure 2 if this CSR initiative is expected to enable the company to meet its target gross profit percentage (holding all other costs constant).

To determine

Identify the cost of labor, material and overhead required by Company H to meet the target gross profit with the existing sales level for Procedure 1 and Procedure 2.

Explanation of Solution

Strategic Initiatives: Strategic initiatives refer to the process implemented by the organization to attain those goals which it aims at achieving in the given period or in a long run.

Compute the cost makeup for Procedure 1 and Procedure 2:

Target gross profit percentage – 40% of sales

Total cost of production percentage – 60% of sales

Particulars	Amount ($)
Total sales	$1,500,000
Multiply: Total cost of production percentage	$(\times )$60%
Total cost of production	$900,000

Table (1)

Total cost of production is $900,000.

$\begin{array}{c}\text{Total cost of production = }\left(\begin{array}{l}\text{Cost of Procedure 1}\left(\text{P}1\right)+\\ \text{Cost of Procedure 2 }\left(\text{P}2\right)\end{array}\right)\\ \text{Cost of Procedure 1}\left(\text{P}1\right)=\left(\text{Cost of Procedure 2 }\left(\text{P}2\right)\right)\times 2\\ \text{P}1=2\left(\text{P}2\right)\\ \text{Total cost of production = }3\left(\text{P}2\right)\end{array}$

Compute the value of Cost of Procedure 2:

$\begin{array}{c}\text{Total cost of production = }3\left(\text{P}2\right)\\ \$900,000=3\left(\text{P}2\right)\\ \left(\text{P}2\right)=\frac{\$900,000}{3}\\ \left(\text{P}2\right)=\$300,000\end{array}$

Compute the value of Cost of Procedure 1:

$\begin{array}{c}\text{Cost of Procedure 1}\left(\text{P}1\right)=\left(\text{Cost of Procedure 2 }\left(\text{P}2\right)\right)\times 2\\ \left(\text{P}1\right)=2\left(\text{P}2\right)\\ \left(\text{P}1\right)=\$300,000\times 2\\ \left(\text{P}1\right)=\$600,000\end{array}$

Compute the Cost makeup of Procedure 1:

Particulars	Amount ($)
Labor (50%)	$300,000
Materials (45%)	$270,000
Overhead (5%)	$30,000
Total cost of production	$600,000

Table (2)

The Cost makeup of Procedure 1 is $600,000.

Compute the Cost makeup of Procedure 2:

Particulars	Amount ($)
Labor (55%)	$165,000
Materials (25%)	$75,000
Overhead (20%)	$60,000
Total cost of production	$300,000

Table (3)

The Cost makeup of Procedure 2 is $300,000.

To determine

Identify the cost of direct labor, direct material and overhead for Procedure 1 and Procedure 2.

Explanation of Solution

Compute the Material Cost of Procedure 1:

$\begin{array}{c}\text{Material Cost of }\left(\text{P}1\right)=45\%\text{ of Cost of }\left(\text{P}1\right)\\ \text{Cost of }\left(\text{P}1\right)=\frac{\$279,000}{45\%}\\ \left(\text{P}1\right)=\$620,000\end{array}$

Compute the value of Cost of Procedure 2:

$\begin{array}{c}\text{Material Cost of }\left(\text{P}1\right)\text{ = }2\left(\text{P}2\right)\\ \left(\text{P}2\right)=\frac{\left(\text{P}1\right)}{2}\\ \left(\text{P}2\right)=\frac{\$620,000}{2}\\ \left(\text{P}2\right)=\$310,000\end{array}$

Compute the Cost makeup of Procedure 1:

Particulars	Amount ($)
Labor (50%)	$310,000
Materials (45%)	$279,000
Overhead (5%)	$31,000
Total cost of production	$620,000

Table (4)

The Cost makeup of Procedure 1 is $620,000.

Compute the Cost makeup of Procedure 2:

Particulars	Amount ($)
Labor (55%)	$170,500
Materials (25%)	$77,500
Overhead (20%)	$62,000
Total cost of production	$310,000

Table (5)

The Cost makeup of Procedure 2 is $310,000.

To determine

Identify the maximum new cost for the indirect materials for Procedure 2.

Explanation of Solution

Compute the maximum new cost for the indirect materials for Procedure 2:

Particulars	Amount ($)
Current total cost of production	$ 930,000
Less: Target total cost of production	$(-)$ ($ 900,000)
P2 materials cost savings needed	$ 30,000
Current P2 overhead materials cost	$ 37,200
Less: P2 overhead materials cost savings needed	$(-)$ ($ 30,000)
Maximum new cost of P2 overhead materials	$ 7,200

Table (6)

The maximum new cost for the indirect materials for Procedure 2 is $ 7,200.