Adam Ismail, chief operating officer of Clinton Sporting Supplies (CSS), a manufacturer of several sporting-related products, was faced with a difficult decision. One of his product managers, Annie Lu, had presented him with a proposal that, in her words, “. . .was guaranteed to make the company a bundle.” The new product, a skateboard, was designed to appeal to high school and college students who were seeking a source of low-cost bodily injury. Ms. Lu’s market research had led her to believe that the company could sell 7,000 skateboards annually at a price of $87.25. Her work with the company’s accounting department had resulted in the data contained in Exhibit 1.
The problem from Mr. Ismail’s perspective was that he had only one manufacturing plant to use for all his products. The plant had no excess capacity, and, due to some financial constraints, he would not be able to expand the plant’s size for several years. Knowing this, Ms. Lu also had presented him with a related option: to outsource the production of the fishing tackle boxes that the company currently manufactured. Since the tackle boxes required less manufacturing skill than the skateboards, outsourcing them would be feasible, whereas it would not be feasible to outsource the skateboards. The company currently sold 17,500 tackle boxes a year at $45 each. Ms. Lu had worked with the accounting staff to assemble financial data for the tackle boxes, shown in Exhibit 2.
In addition, Ms. Lu had informed Mr. Ismail that she had spoken with the plant manager who had told her that the production facilities used for tackle boxes would be adequate for assembling the skateboards, such that no new investment in equipment, no renovations to the facilities, nor any additional space would be required. The plant manager also had told her that there would be no need to undertake any retraining of the labor force, since the manufacturing tasks were similar for the two products. Finally, Ms. Lu informed Mr. Ismail that she had obtained an offer from Block N’ Tackle, a nearby company, to manufacture the tackle boxes for a price of $37.00 each, which included delivery to CSS’s warehouse.
The manufacturing labor force was paid on a salary basis, and the company had a strict policy of no layoffs as long as production stayed within 50 percent of normal volume. In addition, CSS’s accountants had informed Mr. Ismail that, if the tackle boxes were outsourced, all of the plant maintenance costs that presently were allocated to them would be reallocated to other products, including the skateboards. However, the $52,500 in selling and administrative costs currently allocated to the tackle boxes would remain allocated to them regardless of whether they were made in-house or outsourced. On the other hand, any additional overhead allocated to the skateboards would be because of the extra costs associated with skateboard production (e.g., insurance premiums).
Assignment
- How is plant maintenance allocated to products?
- What rationale might the accountants have for allocating $52,500 of Selling and Administrative costs to tackle boxes regardless of whether they are manufactured in-house or purchased from Block N’ Tackle?
- Mr. Ismail has told you that (a) the cost of materials is variable, (b) all direct labor costs are fixed, (c) the incremental $57,750 of allocated Selling and Administrative costs are fixed, and (d) all other Selling and Administrative and Plant Maintenance overhead costs are irrelevant. He has asked you to use these assumptions and compute the breakeven volume for skateboards.
- What should Mr. Ismail do?