A company manufactures a single product. The selling price, production cost and contribution per unit for this product for 2013 have been predicted as follows:
$ per unit Selling price 90.00 Direct materials (components) 30.00 Direct labour 35.00 Variable overhead 10.00 Contribution 75.00 15.00 The company has forecast that demand for the product during 2013 will be 24,000 units. However to satisfy this level of demand, production of 35,294 units will be required because:
• 15% of the items delivered to customers (4,235 units) will be rejected as faulty and will require free replacement. The cost of delivering the replacement item is $5 per unit;
• 20% of the items manufactured (7,059 units) will be discovered to be faulty before they are despatched to customers.
In addition, before production commences, 10% of the components that the company purchases are damaged while in storage.
As a consequence of all of the above, total quality costs for the year amount to $985,885.
The company is now considering the following proposal:
1. Spending $30,000 per annum on a quality inspector which would reduce the percentage of faulty items delivered to customers to 13%; and
2. Spending $500,000 per annum on training courses for the production workers which management believes will reduce and sustain the level of faulty production to 10%.
Required:
(a) Prepare a statement that shows the quality costs that the company would expect to incur if it accepted the above proposal. Your answer should clearly show the costs analysed using the four recognised quality cost headings.
(b) Recommend with reasons, whether or not the company should accept the proposal.