Simple Management Accounting
Grandmaster Ltd can also manufacture and sell hydraulic pressure valves. Assume that the company is
operating at about 70 per cent of capacity and has received an order from Glasgow Industries Ltd for
120,000 valves. Glasgow Industries manufactures a valve that is almost identical to the pressure valve
produced by Grandmaster Ltd; however, a fire in Glasgow Industries� valve plant has shut down its
manufacturing operations. Glasgow needs the 120,000 valves over the next four months to meet
commitments to its regular customers. Glasgow is prepared to pay $19 each for the valves. The cost of
the pressure valve produced by Grandmaster Ltd is $20, calculated as follows: �
�
Direct material $5.00 �
Direct labour 6.00 �
Manufacturing overhead 9.00 �
$20.00 �
�
Assume that manufacturing overhead is applied to production at the rate of $18 per standard direct labour
hour. This overhead is made up of the following components: �
�
Variable manufacturing overhead $6.00 �
Fixed manuf. overhead (traceable) 8.00 �
2 Simple Management Accounting
Fixed manuf. Overhead (allocated) 4.00 �
Applied manuf. overhead rate $18.00 �
�
Introduction
Overheads are the costs that are incurred indirectly by the manufacturing department. These
costs are all the manufacturing costs that are not direct labor or material expenses. The actual
overheads are the overhead costs that have been incurred indirectly during the manufacturing
process. These include utility expenses like water, electricity and gas. (Maher, Lanen and Rahan,
2005) The others are rent, repairs and maintenance expenses, depreciation, salaries for
production staff and many more related expenses. Applied overhead are the indirect
manufacturing expenses that are assigned to the manufactured goods. The assignment of
manufacturing costs is done using a predetermined formula to arrive at the rate chargeable per
labor or machine hour that becomes the standard hourly rate for the production department. For
instance if the company intends to spend a total of $100,000 in a financial year and also consume
over 1000 hours of labor hours, then the company will calculate the predetermined annual rate of
overhead as $100 per hour. (Hermanson, Edwards & Invacevich, 2011) However due
fluctuations and variances in the production standards, these rates usually vary with the actual
production rates. (Garrison, Noreen and Brewer, 2009)
3 Simple Management Accounting
a) labour hours per month = $6 per unit = 30000/6 =
5000
additional labor hours = 12000/6 = 2000
Total hours required per month = 5000 +2000 =
7000 hrs
(Khan, 1993
b) Profit Analysis on the Glasgow Order.
Price per unit 27 28 27 28
Variable overhead 6 6 6 6
Fixed manu O/H (Traceable) 8 8 8 8
Fixed Manu O/H (allocated) 4 4 4 4
Applied Manu O/H rate 18 18 18 18
Freight Exp 1 1 1 1
Additional costs
(12000/30000)
0 0 0.4 0.4
Profit (40%) 26.6 26.6 26.76 26.76
Contribution margin per unit 21 22 21 22
Breakeven units 0.619047619 0.619048 0.92381 0.881818
Breakeven sales in dollars 18571.42857 18571.43 27714.29 26454.55
4 Simple Management Accounting
(Vance, 2003)
c)
Cost per unit 27 * 30000
units
810000 27.16 814800
Total costs 19 * 30000 570000
Additional fixed cost 12,000
Total costs 582,000 19.4 582000
Profit 228,000 232800
Percentage profit 39.17525773 40
The minimum price that Grandmaster should accept is $27.16 that will guarantee a profit of 40%
on the total cost of production.
d) The following factors should be considered by Grandmaster before accepting the order from
Glasgow.
The order from Glasgow is almost similar to their own orders. The major difference would arise
on the terms of deliverance and if there are any fines or penalties that might arise on any late
deliveries. The cases of substandard quality and the way it should be handled should also be
discussed. (Drucker, 1999)
Grandmaster should also discuss the effects of a possible cancellation in the event that the
contract is cancelled and they have already made contracts with the concerned casual laborers for
the work or if they have ordered extra materials for the work and they are already incurring extra
storage charges. (Horngren, Datar and Foster, 2003)
5 Simple Management Accounting
Grandmaster should also produce a sample product that should be approved by Glasgow as well
as the client that has ordered the products from Glasgow. It would be disastrous to manufacture
the first lot of products that is against or below the standards or requirements of the client’s
specifications.
Finally to conclude, the order from Glasgow should have a least one representative from
Glasgow that will oversee the production process and ensure that the products are manufactured
to the standards of their client.
References
Drucker, F. (1999) Management Challenges of the 21st Century. New York: Harper Business,
Garrison, H., Noreen, E., Brewer, C. (2009) Managerial Accounting . McGraw-Hill Irwin.
2009.
Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting Principles: A Business
Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.
Horngren, Datar and Foster (2003) Cost Accounting – A Managerial Emphasis, 11th edition
Prentice Hall
Khan, M. (1993) Theory & Problems in Financial Management. Boston: McGraw Hill
Higher Education.
Maher, Lanen and Rahan (2005) Fundamentals of Cost Accounting, 1st Edition (McGraw-Hill
6 Simple Management Accounting
Vance, D. (2003) Financial analysis and decision making: tools and techniques to solve
financial problems and make effective business decisions. New York: McGraw-Hill.
