F Co makes and sells two products, A and B, each of which passes through the same automated...1 answer below »

Bottlenecks

F Co makes and sells two products, A and B, each of which passes through the same automated production operations. The following estimated information is available for period 1.

· Product unit data

· Original estimates of production/sales of products A and B are 120,000 units and 45,000 units respectively. The selling prices per unit for A and B are $60 and $70 respectively.

· Maximum demand for each product is 20% above the estimated sales levels.

· Total fixed production overhead cost is $1,470,000. This is absorbed by products A and B at an average rate per hour based on the estimated production levels.

One of the production operations has a maximum capacity of 3,075 hours which has been identified as a bottleneck which limits the overall estimated production/sales of products A and B. The bottleneck hours required per product unit for products A and B are 0.02 and 0.015 respectively.

Required

(a) Calculate the mix (in units) of products A and B which will maximise net profit and the value (in $) of the maximum net profit.

(b) F Co has now decided to determine the profit-maximising mix of products A and B based on the throughput accounting principle of maximising the throughput return per production hour of the bottleneck resource.

Given that the variable overhead cost, based on the value (in $) which applies to the original estimated production/sales mix, is now considered to be fixed for the short/intermediate term:

(i) Calculate the mix (of units) of products A and B which will maximise net profit and the value of that net profit.

(ii) Calculate the throughput accounting ratio for product B and comment on it.

(iii) It is estimated that the direct material cost per unit of product B may increase by 20% due to shortage of supply. Calculate the revised throughput accounting ratio for product B and comment on it.

1 Approved Answer

Cecilia
answered on
November 03, 2020

3
Ratings,(11 Votes)

Answer: (a) We need to carry out limiting factor analysis. Step 1 Establish scarce resources, if any We are told that one of the production operations is the bottleneck, limiting production/sales. Step 2 Rank products on the basis of contribution per unit of the limiting factor Step 3 Determine profit-maximising product mix (b) (i) Throughput return per production hour of the bottleneck resource = (selling price – material cost)/hours on the bottleneck resource Step 1 Rank products on the basis of throughput return per bottleneck hour Step 2 Determine profit-maximising product mix Hours Hours Units of Product Demand required Available production A 144,000 2,880 2,880 (÷0.02) 144,000 B 54,000 810 195 (bal) (÷0.015) 13,000 3,690 3,075 Maximum profit calculation (ii) TA ratio = throughput return per hour/conversion cost per hour Conversion cost per hour = overhead costs/bottleneck hours = $(3,540,000 + 1,470,000)/3,075 = $1,629.27 ?TA ratio for B = $2,000/ $1,629.27 = 1.2275 Efforts should be made to improve the size of the TA ratio as follows. (1) Improving throughput ($) per unit by increasing selling price or reducing material cost per unit. Product B has a very high material cost element ($40). (2) Improving the throughput return per hour by reducing the time spent on the bottleneck resource. If product B spent 0.012 hours instead of 0.015 hours on the bottleneck resource, say, its TA ratio would improve. The organisation's overall position can be...

improved by reducing conversion costs and/or by reducing or eliminating the impact of any bottlenecks. Product B's TA ratio, at 1.2275, is greater than 1 and so the product is worth producing. Product A's ratio is 1.780 ($2,900/$1,629.27), however, and hence priority should be given to product A. (iii) If the direct material cost of B increases by 20%, its throughput return becomes $(70 – (40 x120%)) = $22. Its return per bottleneck hour is then $22÷0.015 = $1,467. Its TA ratio becomes $1,467/$1,629.27 = 0.900. The return from B is now less than the associated production cost through the bottleneck resource and so production of B is not worthwhile in a TA environment. Product A is being produced to maximum demand, however, and the residual capacity used by product B has no incremental cost since all overhead cost is fixed in the short and intermediate term. In these circumstances, product B is still generating a positive cash flow of $1,467 per hour (or $22 per unit).

## 1 Approved Answer

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