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JOSEPH CHRISTIAN TOPULAR MONREAL

Masters in Business Administration

De La Salle University

ACC510M – Management Accounting

CASE 16-1: HOSPITAL SUPPLY INC.

I. BACKGROUND OF THE CASE

Hospital Supply, Inc., a producer of hydraulic hoists used by hospitals to move bedridden patients

operates at a normal level of 3,000 units per month. However, the company believes it can actually earn

more profits by structuring its volume of production.

II. PROBLEMS

The company has the opportunity to:

a. Increase the volume to maximize capacity

b. Accept contracts to manufacture stated number of units

c. Enter new markets; and

d. Outsource some of its production to outside contractors

III. ACTION PLAN

1. Break-even volume in units and dollar

A. Break-even Sales in Units

= Total Fixed Costs / Unit Contribution Margin

= (660 + 770) * 3,000

4,350 - 2,070

= 4,290,000

2,280

= 1,882 units

B. Break-even Sales in Dollar

= Total Fixed Costs / Contribution Margin Ratio

= (660 + 770) * 3,000

4,350 - 2,070

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= 4,290,000

(4,350-2,070)/4,350

= $8,185,461

2. What would you recommend that this action be taken? What would be the impact on monthly

sales, costs, and income?

It would only take 1,882 units to break even in the old estimate whereas 2,812 units in the new

estimate. It means they need to produce more units just to recover all the costs they incurred. In

addition, reducing the selling price means a clear reduction in net profits. Kindly see below table for the

effects on sales, costs, and income.

Old Estimate New Estimate Net Effect

Price

4,350 3,850 (500) Quantity

3,000 3,500 500

Total Sales

$13,050,000 $13,475,000

$(250,000)

Variable costs Materials 550 $1,650,000 $1,925,000 $275,000

Labor 825 2,475,000 2,887,500 412,500 Overhead 420 1,260,000 1,470,000 210,000 Variable Marketing 275 825,000 962,500 137,500

Total Variable

6,210,000 7,245,000 1,035,000

Contribution Margin

6,840,000 6,230,000 (610,000)

Fixed Costs Overhead 660 1,980,000 1,980,000

Fixed Manufacturing 770 2,310,000 2,310,000

Total Fixed Costs

4,290,000 4,290,000 -

Income

$2,550,000 $1,940,000

$(610,000)

3. The impact of accepting the government contract on Hospital Supply’s income.

The consequence of accepting the government contract would result to lesser sales from Hospital

Supply since it would incur more profit if they continue to hold on to the existing customers. The

recommendation for this is “do not accept.”

Share of contribution margin from original customers $1,140,000 (500*2280)

New contract from government

Fixed payment from government $275,000

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Share of fixed costs-manufacturing 247,500 (500/4,000)*1,980,000

Should have been income from government contract 522,500

Difference in profit from 2 alternatives $(617,500)

4. Minimum unit price Hospital Supply should consider for the order of $1,000 units.

Variable costs Materials $550

Labor 825

Overhead 420

Shipping costs 410

Ordering costs ($22,000/1000 units) 22

Unit Revenue $2227

5. Minimum price that is acceptable in selling an obsolete model.

The acceptable minimum price for the obsolete model is the total variable marketing cost of $275. It is

given in the case that it’ll be sold thru regular channels. It shouldn’t have any share in the fixed costs

since the expense allocated to the product has been long charged to the period when the old hoist was

manufactured.

6. In house cost to be used to compare to the quotation received from the supplier.

The $2,475 (payment to the contractor) purchase price will slightly decrease income and should not be

accepted. Kindly see computation below.

Variable costs Materials $550

Labor 825 Overhead 420

Variable marketing opportunity cost ($275-220) 55 Fixed manufacturing opportunity cost [($1,980,000-$1,386,000)/1000] 594

$2,444

7. Should the proposal be accepted for a price of $2,475 per unit to the contractor?

Proposal should be accepted since maximum payment is $2,950,000.

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3,000 Regular Hoists

Produced in-House

Regular (in)

Regular (Out)

Modified Total

Total Sales

13,050,000

8,700,000

4,350,000

3,960,000

17,010,000

Variable Manufacturing

5,385,000

3,590,000

2,420,000

6,010,000

Variable Marketing

825,000

550,000

220,000

440,000

1,210,000

Contribution Margin

6,840,000

4,560,000

4,130,000

1,100,000

9,790,000

Fixed Manufacturing

1,980,000

1,980,000

Fixed Marketing

2,310,000

2,310,000

(x)

(x)

Income

2,550,000

5,500,000 - X

To get maximum payment:

$2,550,000 = $5,500,000 – X

X = 5,500,000 - 2,550,000

X = $2,950,000