Question

Fast Photo operates four film developing labs in upstate New York. The four labs are identical: They employ the same production technology, process the same mix of films, and buy raw materials from the same companies at the same prices. Wage rates are also the same at the four plants. In reviewing operating results for November, the newly hired assistant controller, Matt Paige, became quite confused over the numbers:
Plant A

Plant B

Plant C

Plant D

Number of rolls processed

50,000

55,000

60,000

65,000

Revenue ($000s)

$500

$550

$600

$650

Less:

Variable costs

(195)

(242)

(298)

(352)

Fixed costs

(300)

(300)

(300)

(300)

Profit (loss)

$ 5

$ 8

$ 2

$ (2)

Upon further study, Matt learned that each plant had fixed overhead of $300,000. Matt remembered from his managerial accounting class that as volume increases, average fixed cost per unit falls. Because Plant D had much lower average fixed costs per roll than Plants A and B, Matt expected Plant D to be more profitable than Plants A and B. But the numbers show just the opposite. Write a concise but clear memo to Matt that will resolve his confusion.

Answer 1

Answer:

Fast Photo

Memo to Matt:

From: Financial Controller

To: Matt Paige (Asst Controller)

Subject: Fixed Overhead and Plant D's Profit

Date: June 5, 2020

The above subject refers.

I wish to clarify the issue of fixed cost per unit.  It is true that fixed cost per unit decreases with increased volume.  It is also true that Plant D had much lower average fixed costs per roll $4.62 ($300,000/65,000) than Plants A's $6 ($300,000/50,000), B's $5.45 ($300,000/55,000) and even C's $5 ($300,000/60,000).

However, the issue of profit is not dependent on the fixed cost per unit alone.  There are other variables.  Profit is also determined by the variable cost per unit and the selling price.  Since the four plants have the same selling price, we shall not consider selling price as a factor hence.

Therefore, note the variable cost per unit for each plant stated as follows: A = $3.90, B = $4.40, C= $4.97, and D = $5.42.  This shows that it costs more per unit of variable cost to produce in Plant D.  The difference will be explained by efficiencies in technology use, processing, quantity of materials used and wasted, and the number of labor hours spent in Plant D vis-a-vis other plants.

It is then necessary to review these variances as stated in order to explain why Plant D recorded a net loss of $2,000.

I hope that this issue has been clarified.

Regards,

FC

Explanation:

a) Operating Results for November:

                                             Plant A         Plant B        Plant C        Plant D

Number of rolls processed  50,000         55,000       60,000        65,000

Revenue ($000s)                 $500              $550           $600         $650

Less:  

Variable costs                       (195)               (242)           (298)          (352)

Fixed costs                           (300)               (300)           (300)          (300)

Profit (loss)                             $ 5                  $ 8              $ 2           $ (2)

b) Profit is not determined by fixed costs only.  It is also influenced by the variable costs and selling price.