Company employs 4 full-time staff who are each paid $36,000 per year to work five 8-hour days every week for 12 months of the year. At the start of the production process, the employees load the machine with the correct mould, required chemicals, ink cartridges and rolls of Kraft paper. The machine then combines the paper and chemicals to give it adequate strength before cutting it into shape and printing the design on it. The products then come out on a conveyor belt. By this stage 95% of the production process is complete. The remaining 5% is the manual part of the process where employees pick the boxes from the conveyor belt, inspect them for any defects and make a pile of 500 boxes which are shrink wrapped and transferred to the warehouse.
Due to the speed that the machine operates at, normal spoilage averages around 5% of the number of good units transferred to the warehouse. These are put away in the waste bins together with any residual paper cuts. There are two large waste bins located inside the facility. These are taken away by waste management trucks and Vkea gets paid $1,400 per month for the waste which the waste management company exports to an Asian country for recycling.
The company Directors have been exploring other recycling options and have found a waste grinding machine that can be installed at their facility. This machine can recycle the waste and transform it into rolls of Kraft paper suitable for re-use in the company's production process. The machine would fit in the space currently occupied by the waste bins and has an inbuilt waste storage unit. Hence the installation of this machine would make the waste bins redundant. The machine would cost the company $1.2million to purchase and will have a useful life of 20 years with no resale value. It would be an automated system so the company would not incur any additional labour costs, however, their energy bill will increase by $600 per month and will require $120 of chemicals per month. With the current production and waste levels, the machine should produce 6 rolls of Kraft paper every month.
The Directors of the company suspect that the issues with their profits might be caused by their conventional costing system where overheads are allocated based on the number of production runs. They are interested in seeing what the difference would be if an activity based costing was used.
They compiled the following information relating to the two products they manufacture:
Materials required per Pizza box Sandwich wedge box Cost
(production volume per run = 2500)(production volume per run = 5000)
Roll of Kraft paper 1 1 $1,200 per roll
Ink Cartridges 2 1 $60 each
Litres of Chemicals 5 3 $80 per litre
Metres of shrink wrap 20m per 500 pack 10m per 500 pack $10 per 100 metres
In March, the facility only produced pizza boxes which is currently its main product. 80 production runs were started and 365 packs of 500 boxes were transferred to the warehouse while 300 boxes were in work in process (WIP) that had been inspected but only partially packaged (i.e. WIP was 96% complete). There was no opening WIP in March
The manufacturing overheads for the month of March were as follows:
All 4 employees are only involved in the production process and hence the company regards their hours as direct labour costs. Monthly labour costs are distributed evenly across different product types i.e. pizza boxes and sandwich wedge boxes.
Rent and machine costs are also distributed evenly across different product types based on number of production run for each type of product.
Inspection point is at 95%.
Conversion costs are added evenly during the production run.
For each production run, setup costs are incurred as the employees need to clean the machine and add new raw materials. The cost of the mould change is $200 which is included in the setup costs stated above.
Using the weighted average method, make a process cost report for the month of March. (Hint: Your calculations should indicate how normal spoilage is treated in a process cost system as well as the physical flow of units and the equivalent unit calculations. You are also required to show the assignment of costs to abnormal spoilage and ending work in process.).
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