EXAMPLES OF SHORT TERM PROBLEMS

1- OPTIMUM PRODUCTION MIX: Illustration

A company makes two products A and B as follows:
Product A Product B
Selling price 30 20
- Variable costs 18 10
Unit contribution 12 10
Product A takes 3 hours to complete whereas B needs only 2 hours. Both product use the
same type of labor which happens to be in short supply i.e. labor is the limiting factor.
Assume that there is an existing demand for product A 300 units and B 400 units. Also there
is a limited supply of labor to 1,400 hours only.
Suggested solution:
To produce and satisfy the existing demand the company will need a total of 1,700 hours.
Therefore there is a shortage of 300 hours.
CM per limiting factor ratio for Product A is 4 (RM12/3hr) and Product B is 5 (RM10/2 hr).
Therefore the following allocations of hours are needed:
Total hours available 1,400 hours
- B: (400 x 2 hours) 800 This is the first priority product
Balance 600
- A: (600/3 x 3 hours) 600 This is the next ranking product
Balance 0

Thus the production mix or plan of the company will be 400 units of B and only 200 units of
A.

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2- THEORY OF CONSTRAINT & THROUGHPUT ACCOUNTING: Illustration
A company produces three products using three different machines. The following information
is available for a period:

Product X Y Z Total
Contribution (Sales –Variable RM12 RM10 RM6
cost)
Machine hours required per unit:
- Machine 1 6 2 1
- Machine 2 9 3 1.5
- Machine 3 3 1 1.5
Estimated sales demand 200 200 200
Required machine hours:
- Machine 1 1200 400 200 1800
- Machine 2 1800 600 300 2700
- Machine 3 600 200 300 1100

Machine capacity for each machine is limited to 1600 hours. Total factory cost for the period
is RM3,200
Required:
a) Identify which one is bottleneck activity.
b) Calculate the contribution per bottleneck hour to rank the products produced by the
bottleneck operation

Suggested Solution:
a) Machine utilization is as follows:
Machine 1 112% (1800/1600*100)
2 169% (2700/1600*100)
3 69% (1100/1600*100)
Machine 2 represents the bottleneck activity because it has the highest machine utilization.
b) We calculate the contribution per hour for machine 2 for each product. The result would
be as follows:
Product X Product Y Product Z
Contribution per unit RM12 RM10 RM6
Machine 2 hours required 9 3 1.5
Contribution per machine hour RM1.33 RM3.33 RM4
Ranking 3 2 1
The allocation of the 1600 hours for the bottleneck activity is:
Machine hours Balance of hours
Used available
Production
200 units of Z 300 1300
200 units of Y 600 700
77 units of X 700 -

Throughput accounting (TA) ratio:

Contribution per LF/ Total cost per LF; the highest ratio is desirable.
The TA ratios and product ranking for the bottleneck activity (Machine 2), are as follows:

Product X Product Y Product Z

Return per factory hour RM1.33 RM3.33 RM4
Cost per factory hour (RM3200/1600) RM2 RM2 RM2
TA ratio (Row 1/Row2) 0.665 1.665 2
Ranking 3 2 1
3- DISCONTINUING A SEGMENT: Illustration
A company produces 3 products as follows:
Kaka Kiki Koko Total
Sales (RM) 32,000 50,000 45,000 127,000
Total costs (RM) 36,000 38,000 34,000 108,000
Profit / Loss (4,000) 12,000 11,000 19,000

Total cost comprises of 2/3 variable and the remainder fixed. The management is considering
whether to discontinue the production and sale of product Kaka. If this product is
discontinued, half of its fixed cost can be saved. Advise them.
Suggested solution:

If drop Kaka, the relevant cost will be net contribution lost from its sale i.e.
= Sales –VC
= 32,000 – 24,000
= 8,000

However, the relevant benefit will be the savings that will be made i.e.
= ½ x RM12,000
= 6,000

Thus, relevant cost of discontinuing exceeds its relevant benefit by RM 2,000 and so this
product should not be discontinued.

Qualitative factors to be considered:

1. If continue: Is it the best way to utilize resources? How reliable are the projected figures
such as future demand?
2. If shut down / delete: What about the redundant employees? Some customers may be
frustrated, will there be any effect on customer goodwill?
4- SPECIAL ORDER DECISION: Illustration
A company produces a single product and has the capacity to produce 100,000 units for the
next period. The cost estimates per unit is as follows:
RM
Direct Material 2.00
Direct Labor 6.00
Variable Overhead 2.00
Fixed Overhead 4.00
14.00

The company is currently producing at 80% of capacity and is able to sell at RM 25 each. A
customer has approach the company to purchase the excess capacity at RM 20 each.
Should the company accept the offer?

Suggested solution:
If the special order is accepted:
RM
Additional Revenue = (20% X 100,000) X 20 400,000
Less: Relevant Costs:
Direct Material (2 X 20,000) (40,000)
Direct Labor (6 X 20,000 ) (120,000)
Variable Overhead (2 x 20,000) (40,000)
200,000

Since the incremental benefit is RM (400,000 – 200,000) = RM200,000, thus the order should
be accepted.
Qualitative factors:
a. Stability of price in the future
b. Customer loyalty
c. Sufficient capacity or not
d. Is the special order the best way to utilize the excess capacity?
5- MAKE OR BUY DECISION: Illustration
B Bhd. is considering whether to continue manufacturing component X or purchase it from
outside. The estimated cost of producing the components is as follows:
Material RM3,000
Labor RM1,000
Variable OH RM 500
Fixed OH RM2,000
Total RM6,500

The outside supplier has quoted a figure of RM5,000 to supply the components. If the
components are bought from outsiders, the company is able to rent out the free factory space
for RM5,000 per month. Transportation costs from the vendor will be RM500 and this will be
borne by B. Bhd.
Suggested solution
Relevant cost of making:
= variable costs of manufacturing + any other incremental costs + opportunity cost (any)
= Material 3,000 + Labour 1,000 + VOH 500 + OC 5,000
= RM9,500

Relevant cost of buying:

= purchase price from outsiders + any purchasing costs
= 5,000 + Transport 500
= RM5,500

Here, the rule is to choose the lower of the cost.

Hence, it is better to buy rather than make.

Qualitative factors to consider:

a. Quality of the externally supplied components
b. Will it be delivered on time?
c. Customers loyalty may be lost for the regular sales forgone (if full capacity)
6- FURTHER PROCESSING DECISION: Illustration (Refer to the diagram)

Questions:
If allocate the joint cost according to relative sales value method, how would the cost be split?
Does the allocation of joint cost make it relevant for the decision about processing further
Cocoa powder to become Instant cocoa mix?
Suggested solution:

No, because the RM1,100 joint cost will not change in total whether further process takes
place or not. Hence it is irrelevant.
Should consider only the incremental costs and incremental benefits of further processing.
RM
Incremental revenue: 2,000
Less Relevant cost:
Incremental cost: (800)
Opportunity cost:
Revenue lost at split off point (500)
Net incremental benefit: 700

Decision: Cocoa powder should be processed further to become Instant cocoa mix since has
net benefit by RM700
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