MAC3761_2021_Assignment_2.pdf.pdf

QUESTION 1 (45 marks; 81 minutes) Qhubeka (Pty) Ltd (“Qhubeka”) is a small company and was formed three years ago by Nelson Mthembu, in an effort to make locally produced electronic appliances more accessible to South Africans. Qhubeka produces two types of microwave ovens for domestic use and, at this stage, these are the only products manufactured by the company. Qhubeka’s financial year-end is 31 March, and the company uses the absorption costing system and values all its inventories using the first-in-first-out (FIFO) method. The company generates revenue as follows: (i) the sale of the two types of microwave ovens: Instaheat and Grillmaster; (ii) the after-sale service, maintenance and repairs of the microwaves. The Instaheat unit is an entry-level microwave and the Grillmaster has a convenient grill and bake function in addition to only heating. Various divisions are involved in the manufacturing process such as the Cover Division, Magnetron Division and the Control Switches division. Each division is responsible for its own operational and investment decisions and “controllable net assets” are used as the investment figure when divisional performance is evaluated. Qhubeka’s head office is responsible for all the financing decisions, and the respective divisions may not use their own discretion on how they borrow funds. The Qhubeka Head Office is responsible for all administration-related decisions relating to the divisions. A required rate of return of 8% is used in the divisional performance measurement. 1. THE COVER DIVISION Manufacturing and sales The cover or outer case of a microwave oven is usually a one-piece, wrap-around metal enclosure. The oven’s inside panels and door are made of stainless steel and are given a coating of acrylic enamel. Some of the covers used in Qhubeka’s microwave ovens are bought from the Cover Division. The Cover Division manufactures two types of covers. The covers are manufactured in batches of 50 units, but each cover is sold as a single unit. The division has a maximum annual manufacturing capacity of 150 000 Instaheat covers and 180 000 Grillmaster covers. The Cover Division is deciding whether to discontinue one of its product types, and if so, which one. The decision is a short-term decision. The following budgeted management information relates to the Cover Division for the year ended 31 March 2022: Note Instaheat Covers Grillmaster Covers Total Number of units sold 22 000 Direct labour hours 000 Machine hours 000 R R R Sales 1 ? ? ? Direct labour (950 000) (1 140 000) (2 090 000) Direct materials 2 (700 000) (910 000) (1 610 000) Manufacturing overheads as per the original budgeted absorption costing income statement 3 (522 000) (928 000) (1 450 000) Additional information In the original budgeted absorption costing income statement, total manufacturing overheads were allocated between the product types using a single divisional overhead allocation rate that was arbitrarily MAC3761/Assignment02/0/2021 4 [TURN OVER] based on machine hours. However, some of the manufacturing overheads are variable by nature, of which a portion varies based on direct labour hours worked, and the remainder varies based on the number of batches manufactured. In addition, some of the manufacturing overheads are product-specific fixed costs and can be avoided if the manufacturing of the specific product is discontinued. The rest of the manufacturing overheads are general fixed manufacturing overheads (FMO) and can only be avoided if the Cover Division factory in its entirety is closed down. The Cover Division suspects that using the original absorption costing income statement could potentially result in the incorrect discontinuation decision being taken but is not sure why. As a result, the division requested you to prepare a revised 2022 budgeted income statement by: (i) Applying direct costing principles; (ii) Assigning the exact amount of FMO specifically related to a product type to the associated product type; and (iii) No longer allocating general FMO to individual product types. Notes 1. The budgeted selling price per Instaheat cover is R250, whereas the budgeted selling price per Grillmaster cover is R237,50. Budgeted opening and closing inventory of finished goods were both Rnil for the 2022 financial year. 2. Budgeted opening and closing inventory of direct materials were both Rnil for the 2022 financial year. 3. The following information relates to the total manufacturing overheads: Total manufacturing overhead costs R Variable based on labour hours 280 000 Variable based on number of batches 70 000 FMO specifically related to the product: 725 000 - Instaheat - Grillmaster 300 000 425 000 “General” FMO allocated 375 000 1 450 000 2. THE MAGNETRON DIVISION AND THE CONTROL SWITCHES DIVISION The internal components of a microwave include a magnetron tube, which is a high-powered vacuum tube that generates microwave energy. Without this component, a microwave will not be able to heat at all and therefore is considered the most essential component in a microwave. This magnetron tube is manufactured by the Magnetron Division and then sold to external customers as well as to the Control Switches division, which, in turn, manufactures various control switches, relays and motors that are fitted inside of each microwave unit. The following information relating to these two divisions was extracted from the actual management accounts records for the year ended 31 March 2021: Detail Magnetron R Control switches R Sales 000 Variable costs Contribution Fixed costs Finance costs During the year ended 31 March 2021, the Magnetron Division manufactured 100% of its capacity of 125 000 units. 50 000 units were transferred to the Control Switches Division, which met 80% of that division’s demand. A further 75 000 units were sold to external customers but their demand was 85 000 units. The current market price is R5,85 per magnetron tube. MAC3761/Assignment02/0/2021 5 [TURN OVER] Currently, the policy of Qhubeka is to transfer internal sales at marginal or variable cost and if relevant, including an opportunity cost. Due to this policy, some of the magnetron tubes were transferred to the Control Switches Division at market price and some at variable cost. The fixed costs of the Magnetron Division include depreciation of R400 000. Of the depreciation amount, 25% relates to depreciation of the existing machinery used in the divisional production process. This machinery is an asset controllable by the division and has correctly been accounted for in the controllable net asset amount of the division (refer below). The remainder of the depreciation relates to an allocated amount with regard to administration equipment of the Head Office. Fixed administration costs allocated to the Control Switches Division amounted to R355 000 for the year ended 31 March 2021. The total divisional controllable net assets were R1 244 440 and R2 099 000 for the Magnetron Division and the Control Switches Division, respectively.