Management at Reynolds is considering process improvement. They have been told by a sales representative of a manufacturing equipment company that introduction of state-of-art equipment and several other measures in processing department #1 can significantly reduce the per unit cost of processing. This would allow competitive pricing of their finished product. Cost reduction will be accomplished by eliminating material wastage and eliminating direct labor cost (the new equipment will perform many functions that previously required manual labor). The new system will cost $ 6,320,000 and will have a useful life of ten years. Accordingly, new equipment and other measures were introduced on a trial basis. Management is eager to find out if this change would yield the desired results. At the end of the trial month, the per unit cost figures the following partial cost of production report in Process #1 prepared by the company accountant was made available.
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Beginning Work in Process 60,000 units
(100% Material, 75% Conversion)
Units Started during the month 40,000 units
Units to account for 100,000 units
Direct Material Conversion
Total number of units completed 85,000 units 85,0000 85,000
Ending Work in Process 15,000 units 15,000 12,000
(100% Material, 80% Conversion)
Units accounted for 100,000 100,000 97,000
Direct materials Conversion Total
Cost of Beginning Work in Process: $ 300,000 $ 450,000 $ 750,000
Cost incurred this month: $ 160,000 $ 116,00 $ 472,000
Total Cost $ 460,000 $ 566,000 $1,222,000
Divided by Equivalent units Ã· Ã·
= $ 4.60 $ 5.84 $ 10.44
Company CEO and the foreman in charge of the department are not very enthused by the performance of the new system as he sees no significant difference in per unit cost of processing and is wondering if such a huge investment is justified when the company is under intensive competitive pressure. However, the sales representative insists that other companies who have purchased this system have experienced significant reduction in cost of processing. You are a management consultant retained by the company. You have been asked to look into this issue make a recommendation to the CEO of the company.
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