Problem:
Melody Instruments Co. Ltd ('the Company') is a global supplier of guitars for large chains of music stores. A key customer has asked Bob, the Sales Manager, if the Company is able to supply a new guitar-like instrument, the ukulele. The initial order is expected to be 10,000 units. Bob is keen to clinch the new contract. He approaches you, the Financial Controller, to help him estimate the unit cost of producing the ukulele. He needs the information to finalize a sales proposal to the customer, including an appropriate pricing strategy that will increase the probability of securing the order. Wendy, the Production Manager, agrees with Bob that the new order presents an excellent opportunity for the Company to expand its product lines. With some additional resources and processes, a completed mass-produced guitar can be made into a ukulele. She provided you with the following information:
Production Data for the six months ended 30 June 2013
|
Work-in-progress ('WIP') as at 1 January
|
Units
|
Material
|
Labor
|
Overhead
|
|
Units
|
600
|
$5,000
|
$11,600
|
$4,200
|
|
Percentage of completion
|
50%
|
|
|
|
|
During the first six months of 2013
|
|
|
|
|
|
Units started production
|
3,000
|
|
|
|
|
Costs incurred
|
|
$30,200
|
$78,000
|
$15,000
|
|
WIP as at 30 June
|
|
|
|
|
|
Units
|
500
|
|
|
|
|
Percentage of completion
|
20%
|
|
|
|
Additional information:
i. Estimated annual overhead and direct labor costs for 2013 are $150,000 and $200,000 respectively.
ii. Estimated additional costs to be incurred to produce 10,000 units of ukulele
Strings made from a special material $20,000
Carpenters $3,000
Tuning technicians $2,000
iii. Similar to the guitar, direct materials and conversion costs are incurred evenly throughout the process.
(a) Using completed guitars as the base, apply a job-costing system to prepare a Job-Order Cost Report for the ukulele. Overheads are allocated using direct labor costs.
(b) The net profit margin of the Company has been declining over the past three years. Wendy is under pressure to play her part in improving profitability by reducing the unit cost of each guitar. You recently discovered that she has been substituting some components of the guitar with cheaper but lower-grade materials since the beginning of 2013. You recalled your casual conversation with Bob two weeks ago on the increasing frequency of customer complaints on the quality of products over the last few months. Sales report shows that the sales volume has not been affected so far. As the Financial Controller, discuss what should you do?