Determine The Cost Of Manufacturing One Custom Kitche 148932

Determine the cost of manufacturing one custom kitchen assuming the units given

T&J Manufacturing produces custom kitchen cabinets with multiple product lines and uses an average cost approach for simplicity. The direct materials per job include $1,000 for wood and $200 for other direct materials. Each kitchen requires approximately 20 hours of labor at a rate of $10 per hour. The firm sets the sales price at a markup of 65% over cost.

The company's total estimated direct labor hours for all product lines are 16,000 hours annually, with expected sales of 800 units per year. An overview of fixed and variable costs includes salaries, rent, utilities, insurance, depreciation, advertising, commissions, taxes, and maintenance, totaling significant period costs. Manufacturing overhead (MOH) costs are allocated based on direct labor hours, an important consideration influencing product costing accuracy.

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Calculating the manufacturing cost per custom kitchen

To determine the manufacturing cost per unit, we begin with the direct costs, then allocate the MOH based on direct labor hours. The direct materials per kitchen total $1,200, combining wood and other materials. Labor cost per unit is derived from 20 hours at $10/hour, equaling $200. The total direct cost per unit before MOH is therefore $1,400.

Next, calculate the MOH rate per labor hour: total estimated MOH costs include factory rent ($20,000), factory depreciation ($70,000), factory taxes ($10,000), and maintenance ($80,000). Summing these yields MOH costs of $180,000 annually. Since total direct labor hours are 16,000, the MOH rate per labor hour is $180,000 / 16,000 hours = $11.25 per hour.

Applying this rate, MOH allocated per unit is 20 hours * $11.25 = $225. Therefore, the total manufacturing cost per kitchen is $1,400 (direct costs) + $225 (allocated MOH) = $1,625.

The sales price, set with a 65% markup, is calculated as $1,625 * 1.65 = $2,681.25, rounded to approximately $2,681.

Alternatives for Activity Bases and MOH Allocation

While direct labor hours serve as a common activity base for MOH allocation, other options include machine hours and material costs. Machine hours are particularly relevant when manufacturing processes are machine-intensive, whereas material costs may better reflect resource consumption for product-specific expenses. The choice of an activity base impacts costing accuracy, affecting product pricing and profitability analysis.

Multiple product lines complicate MOH allocation as shared costs must be fairly distributed. Using a single activity base like labor hours may overlook specific cost drivers, leading to under- or over-costing of certain products. Implementing activity-based costing (ABC) addresses this by assigning costs based on actual activities involved, resulting in more accurate product costing.

If MOH is incorrectly allocated, products may appear more or less profitable than they truly are, leading to misinformed managerial decisions, such as pricing, product mix, and cost control strategies. Accurate allocation ensures informed decisions that enhance profitability and efficiency.

Discussion of Variable and Fixed Costs

Variable costs include direct materials ($1,200 per unit) and direct labor ($200 per unit), totaling $1,400 per unit for the product line. Fixed costs encompass salaries, rent, depreciation, advertising, and other period expenses, which are allocated yearly regardless of production volume. For illustration, fixed costs total approximately $887,000 annually, which can be broken down per unit at 800 units: $887,000 / 800 units = $1,109.375 per unit.

Identifying costs involves analyzing whether they change with the level of production. Variable costs fluctuate with output, whereas fixed costs remain constant over a relevant period. Over time, a cost classification can change due to automation, outsourcing, or other process improvements. For example, if a manual process becomes automated, direct labor may transition from variable to fixed, and vice versa if automation is removed.

Job Order Cost Sheet and Pricing

For a custom kitchen with materials costing $3,500 and 30 hours of labor, the direct costs are $3,500 + (30 hours $10) = $3,500 + $300 = $3,800. Applying the same markup of 65%, the customer price is $3,800 1.65 = $6,270.

Other factors influencing pricing include market demand, competitor pricing, customization level, and perceived quality. Setting prices solely based on a percentage of cost ignores market dynamics and perceived value, potentially leading to lost sales or undervaluing products. A comprehensive pricing strategy balances cost, competition, value, and customer willingness to pay.

Contribution Margin Analysis

The contribution margin (CM) per unit is calculated as sales price minus variable costs. Using the previous sales price estimate of $2,681 and variable costs of $1,400, the CM per unit is $2,681 - $1,400 = $1,281. The total contribution margin for 800 units is $1,281 * 800 = $1,024,800. The CM percentage is ($1,281 / $2,681) ≈ 47.8%.

Contribution margin is critical for assessing how much revenue contributes to covering fixed costs and generating profit. For example, increasing sales volume increases the total contribution margin, enabling a company to cover fixed costs more rapidly and increase profitability. If fixed costs are reduced, the break-even volume decreases, and profitability improves.

Income Statement and CVP Analysis

Assuming 800 units are sold, the sales revenue is 800 $2,681 = $2,144,800. Cost of goods sold (COGS), based on the per-unit cost of $1,625, totals $1,300,000 (800 $1,625). The gross profit is $844,800. Operating expenses include fixed costs such as salaries, rent, advertising, and insurance, totaling approximately $887,000. The net operating income, therefore, is about -$42,200, indicating a loss at current prices and costs; adjustments may be necessary.

Three CVP scenarios at different sales volumes (400, 800, 1,200 units) demonstrate how volume impacts net income. Breakeven analysis shows the minimum units needed to cover fixed costs at the current contribution margin, and target profit calculations determine required sales to reach $1 million profit. The margin of safety measure indicates how much sales can decline before profit turns negative. These analyses enable strategic planning and risk assessment.

Impact of Price, Cost, and Volume Changes

If direct material costs decrease by 10%, the variable component drops by $120 per unit, improving contribution margin. Conversely, a 15% increase in fixed costs raises total fixed expenses, reducing net income unless compensated by increased sales volume or prices. A 5% sales price increase enhances revenue per unit, positively affecting profitability.

Recalculating CVP outcomes under these assumptions demonstrates changes in breakeven point and profitability. For example, with increased prices and decreased variable costs, the company could achieve profitability at lower sales volumes. Conversely, increased fixed costs necessitate higher sales to cover fixed expenses.

From a strategic perspective, the CFO must consider the elasticity of demand, customers’ price sensitivity, and competitive environment before raising prices. Cost control measures on fixed costs, such as renegotiating rent or automating processes, may further improve margins. The firm should evaluate how these adjustments align with market conditions and long-term goals.

Effect of Sales Volume Changes on MOH Cost Per Unit and Adding a New Product Line

Fewer units sold result in a higher MOH cost per unit because MOH expenses are fixed over the period. This increases the unit product cost, potentially reducing profit margins. When a new product line like bookshelves is introduced, sharing existing MOH costs may dilute per-unit costs but could necessitate additional allocations if new costs arise, such as higher-skilled labor at $15/hour and an additional $150,000 in MOH costs.

Implementing Activity-Based Costing (ABC)

ABC offers more accurate cost allocation by assigning MOH based on activities that drive costs, such as machine hours, setups, or inspections. It can reveal true product profitability, especially when multiple products share diverse resources. For the company, ABC minimizes cost distortions, aiding strategic decisions like pricing, product discontinuation, or process improvements.

Without ABC, traditional costing may misallocate costs, leading to incorrect pricing strategies and profit assessments. ABC can identify inefficient processes, enabling targeted cost reductions and resource reallocations. For instance, if bookshelves require higher skilled labor, ABC can allocate these costs accurately, avoiding over or undercosting.

Conclusion

The comprehensive analysis of T&J Manufacturing's product costing, pricing, and cost management strategies underscores the importance of precise allocation methods such as ABC, particularly as product lines diversify. Understanding variable and fixed costs, contribution margins, and CVP analyses enables managers to make informed decisions to enhance profitability and competitiveness. Proper cost management, pricing strategies, and activity-based approaches are critical for sustaining growth and optimizing resources in a competitive market environment.

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