You have been approached by a potential customer who could bring considerable business. She says, “I’d like to find an alternative vendor for my future orders of 5,000/yr., but their pricing to me must be competitive.”
Your CFO has supplied you with the following information. Current product standard costs are as follows:
- $1,400/unit direct material
- $400/unit direct labor
- $200/unit variable overhead
- $200/unit fixed overhead (this figure is the result of budgeted fixed overhead of $2,000,000 and budgeted sales volume of 10,000 units)
The board of directors requests a quick but thorough presentation to determine whether taking on this potential customer is a good idea. Assume that your factory is fully operational and that you will not have any learning curve impacts. Answer the board’s following questions based on data from the CFO:
- What is meant by budget variance?
- What is an effective way to incorporate variance analysis into the budget process?
- What are the differences between labor and material variances?
- How is a quantity variance different from a rate variance?
- What are the subcomponents of fixed overhead?
- What are the subcomponents of variable overhead?
- What is the lowest possible price you could offer to this potential customer (You know that we have sufficient capacity, without working overtime and without adding any new equipment, to make this order)? Please show the calculations.
- In terms of capacity, under what conditions would offering this lowest possible price be a bad decision? Why?
- You have been considering investing in automation to eliminate some factory labor if you get this large order. This technology advancement will cost an added $100,000/yr. to lease (net of taxes), but it will reduce labor cost/unit on the customer’s units by 50%. How would this change the lowest possible price you could offer to this potential customer and at least still break even? Please show the calculations.