Shut-down decision

5)The management of Fiona Co is considering the closure of one of its

operations, department 3, and the financial accountant has submitted

the following report:

Department

1

2

3

Total

Sales (units)

5000

6000

2000

13000

Sales ($)

150000

240000

24000

414000

Cost of sales ($)

Direct material

75000

150000

10000

235000

Direct labour

25000

30000

8000

53000

Production overhead

5769

6923

2308

15000

Total costs

105769

186923

20308

303000

Gross profit

44231

53077

3692

101000

Less expenses

15384

18461

6155

40000

Net profit

28847

34616

-2463

61000

Additional information:

• production overheads of $15,000 have been apportioned to the

three departments on the basis of unit sales volume

• expenses are head office overheads, again apportioned to

departments on sales volume.

As management accountant, you further ascertain that, on a cost driver

basis:

50% of the production overheads can be directly traced to

departments and so could be allocated on the basis 2:2:1.

• Similarly 60% of the expenses can be allocated 3:3:2, with the

remainder not being possible to allocate.

• 80% of the so called

direct labour is fixed and cannot be readily

allocated. The remaining 20% is variable and can be better

allocated on the basis of sales volume.

(a) Restate the financial position in terms of the contribution made by

each department and, based on these figures, make a clear

recommendation.

(b) Discuss any other factors that should be considered before a final

decision is made.

I don’t know how to calculate direct labour, production overhead and expenses before contribution. What does mean 2:2:1??
Thanks