Question :

The Dorilane Company specializes in producing a set of wood patio furniture

consisting of a table and four chairs. The set enjoys great popularity, and the
company has ample orders to keep production going at its full capacity of 2,000 sets
per year. Annual cost data at full capacity follow:

Factory labor, direct $118,000

Advertising $50,000
Factory supervision $40,000
Property taxes, factory building $3,500
Sales commissions $80,000
Insurance, factory $2,500
Depreciation, administrative office equipment $4,000
Lease cost, factory equipment $12,000
Indirect materials, factory $6,000
Depreciation, factory building $10,000
Administrative office supplies (billing) $3,000
Administrative office salaries $60,000
Direct materials used (wood, bolts, etc.) $94,000
Utilities, factory $20,000
Required:

1. Prepare an answer sheet with the column headings shown below. Enter each cost
item on your answer sheet, placing the dollar amount under the appropriate
headings. As examples, this has been done already for the first two items in the list
above. Note that each cost item is classified in two ways: first, as variable or fixed
with respect to the number of units produced and sold: and second, as a selling and
administrative cost or a product cost. (If the item is a product cost, it should also be
classified as either direct or indirect as shown.)

Cost xc2xa0prod
Behavior uct Cost

Facto
Selling or ry
Cost Variab Administrat Direc Indire labor, $1,18,0 xc2xa $50,0 $1,18,0 xc2xa
Item le Fixed ive Cost t ct direct 00 0 00 00 0
Advertisi xc2xa $50,0 xc2xa xc2xa xc2xa xc2xa
ng 0 00 0 0 0 0
* To
units of
product.
2. Total the dollar amounts in each of the columns in (1) above. Compute the average
product cost of one patio set.
3. Assume that production drops to only 1,000 sets annually. Would you expect the
average product cost per set to increase, decrease, or remain unchanged? Explain.
No computations are necessary.

4. Refer to the original data. The president's brother-in-law has considered making
himself a patio set and has priced the necessary materials at a building supply store.
The brother-in-law has asked the president if he could purchase a patio set from the
Dorilane Company xc2xa0"at cost," and the president agreed to let him do so.

a. Would you expect any disagreement between the two men over the price the
brother-in-law should pay? Explain. What price does the president probably have in
mind?The brother-in-law?

b. Because the company is operating at full capacity, what cost term used in the
chapter might be justification for the president to charge the full, regular price to the
brother-in-law and still be selling "at cost"?

Answer :

Step 1
1.

Selling
  Cost Behavior orAdministrative Product Cost
Cost Item Variable Fixed Cost Direct Indirect
Factory labor, direct  $118,000     $118,000  
Advertising    $50,000 $50,000    
Factory supervision    40,000     $40,000
Property taxes, factory
building    3,500     3,500
Sales commissions  80,000   80,000    
Insurance, factory    2,500     2,500
Depreciation, administrative
office equipment    4,000 4,000    
Lease cost, factory equipment    12,000     12,000
Indirect materials, factory  6,000       6,000
Depreciation, factory building    10,000     10,000
Administrative office supplies  3,000   3,000    
Administrative office salaries    60,000 60,000    
Direct materials used  94,000     94,000  
Utilities, factory     20,000                                             20,000
Total costs  $321,000 $182,000 $197,000 $212,000 $94,000

Step 2
2.

Direct  $212,000
Indirect     94,000
Total  $306,000
$306,000 ÷ 2,000 sets = $153 per set  

Step 3
3. The average product cost per set would increase if the production drops. This is
because the fixed costs would be spread over fewer units, causing the average cost
per unit to rise.

Step 4
4. a. Yes, the president may expect a minimum price of $153, which is the average
cost to manufacture one set. He might expect a price even higher than this to cover a
portion of the administrative costs as well. The brother-in-law probably is thinking of
cost as including only direct materials, or, at most, direct materials and direct labor.
Direct materials alone would be only $47 per set, and direct materials and direct
labor would be only $106.

Step 5
  b. The term is opportunity cost. The full, regular price of a set might be
appropriate here, because the company is operating at full capacity, and this is the
amount that must be given up (benefit forgone) to sell a set to the brother-in-law.