Required:
1. Given the margins of the two products as indicated in the reports submitted by the accounting department, does it make sense to consider producing the bike frames? Explain.
2. Compute the contribution margin per unit for:
a. Purchased WVD drums.
b. Manufactured WVD drums.
c. Manufactured bike frames.
3. Determine the number of WVD drums (if any) that should be purchased and the number of WVD drums and/or bike frames (if any) that should be manufactured. What is the increase in net operating income that would result from this plan over current operations? As soon as your analysis was shown to the top management team at TufStuff, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable cost in
textbooks and in practice and has always been considered a variable cost at TufStuff. After all,"direct" means you can directly trace the cost to products. "If direct labor is not a variable cost,what is?" Another manager argued just as strenuously that direct labor should be considered a fixed cost at TufStuff. No one had been laid off in over a decade, and for all practical purposes,everyone at the plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted Lean Production techniques. Whether the welding machine is used to make drums or frames, the total payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the bike frames would require.