ACCT222 questions with answers

University of Canterbury 	                                               
Department of Accounting and Information Systems
ACCT222

ACCT222

Tutorial Questions

11.39

Rightway Printers, a book printing shop, is operating at 95 per cent capacity. The entity has been offered a special order for book printing at $8.50 per book; the order requires 10 per cent of capacity. No other use for the remaining 5 per cent idle capacity can be found. The average cost per book is $8, and the contribution margin per book for regular sales is $1.50.

Required

• Which type of non-routine operating decision is involved here? What are the managers’ decision options?
• What information is relevant for this decision? Does the problem give you all of the information the managers need to make a decision? What other information is needed?
• Using the general decision rule, what premium are the managers willing to pay (per book) to relax the constrained capacity, assuming no qualitative factors are relevant?
• Explain how capacity affects the quantitative analysis for this decision.
• What qualitative factors could affect this decision?

11.25

Johnson and Sons Ltd produces organic orange juice from oranges it grows. Unfortunately, it has been a bad year for oranges because of severe frosts. Johnson only has 10,000 litres of juice. It usually sells 15,000 litres at $3 per litre. The variable costs of raising the oranges are $0.50 per litre. Johnson has loyal customers, but its managers are worried the company will lose customers if it does not have juice available for sale when people stop by the farm. A neighbour is willing to sell 5000 litres of extra orange juice at $2.95 per litre.

Required

• Which type of non-routine operating decision is involved here? What are the managers’ decision options?
• Using the general decision rule, what is the most per litre Johnson’s managers would be willing to pay for additional juice?
• Why would Johnson be willing to pay the amount calculated in part (b) for more juice?
• Is the quality of the neighbour’s juice a concern to Johnson’s managers in making this decision? Why or why not?
• List another qualitative factor that might affect the managers’ decision.

ACCT222

Tutorial Solutions

11.39 Special order capacity constraint; relevant information; qualitative factors

• This is a special order problem with a capacity constraint. The manager chooses whether to take the special order or not, but capacity limits will be exceeded if the order is taken.
• Relevant information for the decision includes the variable cost, the contribution margin, and the selling price for regular business. The problem does not provide the variable cost or the selling price per book for regular business – if either one of these were provided, you could calculate the other. Additional information that would be needed includes relevant qualitative factors.
• The manager can pay up to $1.50 per book, plus the amount of variable cost that is related to capacity, to relax the constraint. See the "general rule for relaxing constraints" in Fig. 11.3 in the textbook: "… managers would be willing to pay not only what they are already paying, but also some [of] or the entire contribution margin per unit of constrained resource".
• Capacity makes a difference in the minimum price that can be set. If Rightway is close to capacity limits, it would replace regular business with the special order and need to price the order the same as regular business that it would forego to take the order. In this problem, 5% of capacity would be used for regular business, and 5% would be excess capacity. So, the special order would need to be priced high enough to replace the lost contribution margin of the 5% of regular business.
• Usually when operations get close to capacity limits, costs go up. Bottlenecks are more common, there is congestion in the plant, and production slows down. These costs need to be considered when setting a price for a special order that will move an organisation out of its normal operating range (relevant range). In addition, managers need to think about whether the business will lose some customers because demand cannot be filled.

11.25 Constrained resource; qualitative factors

• Constrained resource problem. The manager needs to decide whether or not to buy more juice from a neighbour.
• The manager will be prepared to pay up to $3.00 ($2.50 contribution margin plus $0.50 variable cost) to relax the constraint, that is, to satisfy customer demand.
• If the company can supply its total demand this year, it is likely to affect its demand next year. If it cannot fill orders this year, customers may find another supplier.
• Yes, quality is a concern. If the neighbour’s juice is lower quality, customers will be disappointed and may not come back. If the neighbour’s juice is much higher quality, customers may be disappointed later, and not come back. Customers may even seek out the true supplier of this higher quality juice.
• The timeliness of delivery could be a factor, and the reliability of the supplier is important.