Q1 is a practice problem (solution is attached), Q2 is for submission. Q1. Magma Services processes disability and life insurance claims for insurance companies. Magma is paid $75 for each Disability claim processed and $85 for each Life Insurance claim processed. There are 2 activities (with short-term fixed capacities and costs): Recording and then Evaluation. Weekly capacity is 120 man hours in Recording and 78 man hours in Evaluation. Weekly costs are $2,400 for Recording and $4,680 for Evaluation. Additionally, there are direct costs of $5 per disability claim and $10 per life insurance claim. Organization sustaining costs (long-term fixed) are $2,000. Last week Magma processed 150 Disability & 150 Life Insurance claims. A time utilization study revealed the following resource utilization. Activity Disability claims Life Insurance Claims Recording 75 man hours 45 man hours Evaluation 37.5 man hours 36 man hours Required: 1. What are the per unit activity costs ($ per man hour) for: Recording: 2,400/120 = $20 per man hour; Evaluation: 4,680/78 = $60 per man hour. 2. Prepare good form activity-based profitability statements for each claim type and the total firm for the past week Line Item Disability Life Insurance Total # of claims 150 150 300 3. What do these statements tell you (if anything at all) about the impact of dropping Private Insurer claims (a) In the short run Nothing, ABC addresses long run product profitability. (b) Alternatively, in the long run (state any implicit assumptions) Q1. SOLUTION 1. What are the per unit activity costs ($ per man hour) for: Recording: 2,400/120 = $20 per man hour; Evaluation: 4,680/78 = $60 per man hour. 2. Prepare good form activity-based profitability statements for each claim type and the total firm for the past week Line Item Disability Life Insurance Total # of claims 150 150 300 Revenue $11,250 $12,750 24,000 Less Direct cost (750) (1,500) (2,250) Less Activity costs: Recording 75?20 = (1,500) 45?20 = (900) (2,400) Evaluation 37.5?60 = (2,250) 36?60 = (2,160) (4,410) Profit before unallocated costs $6,750 $8,190 $14,940 Organization sustaining costs (2,000) Idle time costs: Evaluation (270) Total Profit $12,670 3. What these statements tell you about the impact of dropping Life insurance claims: (a) in the short run: Nothing, ABC addresses long run product profitability. (b) alternatively, in the long run: The firm would forgo $8,190 of profit weekly. (This assumes that Recording and Evaluation manpower can be adjusted exactly to needs at the per unit costs identified in 1 above). Q2. Decision Making Review problem. We will discuss the solution in class. It is important that you complete the analysis. I may call upon you to contribute to the discussion. The Fancy Glove Company has been manufacturing leather gloves for some time. It has a monthly manufacturing capacity of 4,000 pairs a month. However, demand is only 2,500 pairs a month. It is 9/1/16. The owner wants to retire on 12/31/16. The accountant reports that the company has enough leather supplies on hand for the next four months of production, but will be losing $2.20 per pair of gloves as follows. Selling price $28.00 Direct Material (10.00) Direct Labor (15.00) Variable Factory overhead (0.80) Fixed Factory overhead (4.40) Profit ($2.20) The monthly fixed factory overhead consists of: Manager’s salary $5,000, Building rent $3,000, Depreciation on machinery $2,000, and Utilities $1,000. The machinery has a book value of $8,000. It was not expected to have any resale value, but the owner has an unexpected one-time offer for it for $4,000. He reasons, “The building is on a non-cancelable lease till 12/31/16, but I can sublet it for $2,500 a month with the tenant paying the utilities. If I am losing money on each pair of gloves, then I should stop production, get what I can for the machinery now, give the manager his $2,000 in promised severance and sublet the building.” His accountant responds with the following. “Don’t forget we have an offer from ACME for 1,000 handbags a month, at $60 each, for the next four months. We can accommodate their order using the existing machinery, but would have no capacity left over to make any gloves. The existing leather supplies cannot be used. Instead, new handbag grade leather supplies would have to be bought. The manager would also need to be paid $1,500 in overtime each month if we make handbags. But I have factored all of this into the following.” Selling price $60.00 Direct Material (25.00) Direct Labor (20.00) Variable Factory overhead (1.00) Fixed Factory overhead (12.50) Profit $1.50 Considering that we will profit $6,000 by selling 4,000 handbags over the next four months, and adding to that the $60,000 we can get by selling the leather supplies that we have in stock, I suggest we should take the ACME order. REQUIRED: What should Fancy Glove do? Make gloves Frame the choices as: Make handbags and sell glove supplies Sublet building sell machinery and sell glove supplies Make gloves Alternatively, frame the choices as: Make handbags Sublet building If you do not understand what I mean by “frame”, just go ahead and tell me what Fancy Glove should do and why.
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