Ch 23 scrap or rework example

Ch 23 scrap or rework example - Note 2 10,000 units at...

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Scrap or Re-work Example Manufacturing company often have mistakes are products end up not meeting quality standards. At that point, the product cannot be sold and is effectively a SUNK Cost. How do we determine whether to simply scrap the product for whatever a willing buyer will pay for it (i.e. fire sale it) OR elect to try to fix the problem and get the product into a saleable condition????? Example: Company has 10,000 defective units that cost $1.00 to make and cannot be sold due to quality control problems. The units can be scrapped right now for $0.40 per unit. The untis can be reworded at an ADDITIONAL COST of $0.80 per unit and then sold at the normal selling price of $1.50 each. HOWEVER, REWORKING THE UNITS WOULD PREVENT THE PRODUCTION OF 10,000 NEW UNITS THAT WOULD ALSO SELL FOR $1.50 EACH. Scrap NOW Rework (note 1) (note 2) Sale of defects $4,000 15,000 Less rework costs (note 3) 0 (8,000) Net return $4,000 $7,000 Note 1: 10,000 units at $0.40 per unit scrap price = $4,000
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Unformatted text preview: Note 2: 10,000 units at $1.50 per unit customer selling price = $15,000 Note 3: 10,000 units at $0.80 per unit additional rework costs = $8,000 NOT CONSIDERING OPPORTUNITY COSTS, THE COMPANY WOULD DEFINITELY ELECT TO REWORK THE UNITS SINCE THE RETURN IS $7,000 VERSUS $4,000. HOWEVER: Scrap NOW Rework (note 1) (note 2) Sale of defects $4,000 15,000 Less rework costs (note 3) (8,000) Less opportunity costs (note 4) (5,000) KEY STEP Net return $4,000 $2,000 Note 4: 10,000 units at contribution margin of $0.50 each = $5,000. Note that the selling price for the units is $1.50 and the cost to produce them in ordinary operations is $1.00 so the contribution per unit would be $0.50 and by not producing these units the company is giving up $0.50 per unit or $5,000 for the 10,000 units reworked. When you include opportunity costs, then the clear choice is NOT TO REWORK since you are better off simply producing more units and scapping the bad ones....
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