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Fixed Manufacturing Case Study: Cost Allocation

835 Words4 Pages

Issue 1: Cost Allocation
Cost allocation needs to refine in order to accurately measure the unit cost of each product SCL is producing.

Qualitative analysis
SCL is using the traditional allocation based model for allocating its overhead cost whereas, activity based costing method would be best for SCL as it is producing five different products. ABC method will enable SCL to accurately calculate the production cost of each product. Consequently, SCL will be able to determine the profitability of each product, which will lead to proper product mix decision. The cost driver in SCL’s case is machine hours; therefore, fixed manufacturing overhead should be allocated on the basis of required machine hours per unit of each product. Variable manufacturing …show more content…

Issue 3: Wrench Proposal & capacity increase
Qualitative analysis: SCL is operating at full capacity. In order to start the new wrench proposal, SCL requires additional casting machinery, which will increase the overall operating capacity by 5000 hours per year.

Quantitative analysis
The additional casting machinery will increase the total fixed cost by $78,850. The contribution margin per wrench is $6.9 and it needs 11,385 wrenches to breakeven. However, the scheduled production of 36,000 units will require more than 5000 hours, which can conflict with other products but by using the right product mix planning, SCL will be able to generate more operating income.

Recommendation
I would recommend SCL to start this new project as it requires minimal investment and is profitable.

Issue 4: Capacity Increase

Qualitative analysis
At present, SCL is producing five different products and is operating at full capacity. SCL is able to meet the demand of expected unit sales under current capacity …show more content…

Recommendation
If SCL is not implementing wrench proposal then it does not need any additional investment in the machinery to increase its capacity.

Issue 5: Production Mix
Qualitative analysis
After implementing the new wrench proposal and analyzing the demand and gross margin of each product, SCL should choose the right production schedule. This will allow SCL to allocate its resource on profitable product.

Quantitative analysis
Exhibit 3 shows the product mix planning after accounting all factors (allocation of cost, pricing strategy, new wrench proposal, capacity increase). If SCL, follows this schedule then it is able to generate a net operating income of $1,135,513.
Recommendation
In order to maximize the overall operating income, SCL should produce the product according to the production schedule provided.

Issue 6: Management Reporting

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