Chapter 14, Problem 2PB

Strategic initiatives and CSR

Blue Skies Inc. is a retail gardening company that is piloting a new strategic initiative aimed at increasing gross profit. Currently, the company’s gross profit is 25% of sales, and its target gross profit percentage is 30%. The company’s current monthly sales revenue is $600,000.

The new initiative being piloted is to produce goods in-house instead of buying them from wholesale suppliers. Its in-house production process has two procedures. The makeup of the costs of production for Procedure 1 is 40% direct labor, 45% direct materials, and 15% overhead. The makeup of the costs of production for Procedure 2 is 60% direct labor, 30% direct materials, and 10% overhead. Assume 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.

The company’s actual labor cost is $114,000 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 recycle the indirect materials used in production during Procedure 1. The company is paid for any of the indirect materials it recycles, and it applies the income from these payments as a direct offset to the cost of the direct materials. These indirect materials normally make up 70% of the overhead cost for Procedure 1. Determine what the maximum new cost (net of recycling revenues) of these indirect materials could be for Procedure 1 if this CSR initiative were to enable the company to meet its target gross profit percentage without changing any other costs.

To determine

Identify the cost of labor, material and overhead required by Company B 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 – 30% of sales

Total cost of production percentage – 70% of sales

Particulars	Amount ($)
Total sales	$600,000
Multiply: Total cost of production percentage	$(\times )$70%
Total cost of production	$420,000

Table (1)

Total cost of production is $420,000.

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

Compute the value of Cost of Procedure 2:

$\begin{array}{c}\text{Total cost of production = }3\left(\text{P}2\right)\\ \$420,000=3\left(\text{P}2\right)\\ \left(\text{P}2\right)=\frac{\$420,000}{3}\\ \left(\text{P}2\right)=\$140,000\end{array}$

Compute the value of Cost of Procedure 1:

$\begin{array}{c}\text{Cost of Procedure 1}\left(\text{P}1\right)=\left(\text{Cost of Procedure 2 }\left(\text{P}2\right)\right)\times 2\\ \left(\text{P}1\right)=2\left(\text{P}2\right)\\ \left(\text{P}1\right)=\$140,000\times 2\\ \left(\text{P}1\right)=\$280,000\end{array}$

Compute the Cost makeup of Procedure 1:

Particulars	Amount ($)
Labor (40%)	$112,000
Materials (45%)	$126,000
Overhead (15%)	$42,000
Total cost of production	$280,000

Table (2)

The Cost makeup of Procedure 1 is $280,000.

Compute the Cost makeup of Procedure 2:

Particulars	Amount ($)
Labor (60%)	$84,000
Materials (30%)	$42,000
Overhead (10%)	$14,000
Total cost of production	$140,000

Table (3)

The Cost makeup of Procedure 2 is $140,000.

To determine

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

Explanation of Solution

Compute the Labor Cost of Procedure 1:

$\begin{array}{c}\text{Labor Cost of }\left(\text{P}1\right)=40\%\text{ of Cost of }\left(\text{P}1\right)\\ \text{Cost of }\left(\text{P}1\right)=\frac{\$114,000}{40\%}\\ \left(\text{P}1\right)=\$285,000\end{array}$

Compute the value of Cost of Procedure 2:

$\begin{array}{c}\text{Cost of }\left(\text{P}1\right)\text{ = }2\left(\text{P}2\right)\\ \text{Cost of }\left(\text{P}2\right)=\frac{\left(\text{P}1\right)}{2}\\ \left(\text{P}2\right)=\frac{\$285,000}{2}\\ \left(\text{P}2\right)=\$142,500\end{array}$

Compute the Cost makeup of Procedure 1:

Particulars	Amount ($)
Labor (40%)	$114,000
Materials (45%)	$128,250
Overhead (15%)	$42,750
Total cost of production	$285,000

Table (2)

The Cost makeup of Procedure 1 is $285,000.

Compute the Cost makeup of Procedure 2:

Particulars	Amount ($)
Labor (60%)	$85,500
Materials (30%)	$42,750
Overhead (10%)	$14,250
Total cost of production	$142,500

Table (3)

The Cost makeup of Procedure 2 is $142,500.

To determine

Identify the maximum new cost for the indirect materials for Procedure 1.

Explanation of Solution

Compute the maximum new cost for the indirect materials for Procedure 1:

Particulars	Amount ($)
Current total cost of production	$ 427,500
Less: Target total cost of production	$(-)$ ($ 420,000)
P1 materials cost savings needed	$ 7,500
Current P1 overhead materials cost	$ 29,925
Less: P1 overhead materials cost savings needed	$(-)$ ($ 7,500)
Maximum new cost of P1 overhead materials	$ 22,425

Table (6)

The maximum new cost for the indirect materials for Procedure 1 is $22,425.