Downward demand spiral Spirelli Company is about to enter the highly competitive personal electronics market with a new optical reader. In anticipation of future growth, the company has leased a large manufacturing facility, and has purchased several expensive pieces of equipment. In 2011, the company’s first year, Spirelli budgets for production and sales of 25,000 units, compared with its practical capacity of 50,000. The company’s cost data follow:
Variable manufacturing costs per unit:
Direct materials $ 24
Direct manufacturing labor 36
Manufacturing overhead12
Fixed manufacturing overhead$ 700,000
Required
1. Assume that Spirelli uses absorption costing, and uses budgeted units produced as the denominator for calculating its fixed manufacturing overhead rate. Selling price is set at 120% of manufacturing cost. Compute Spirelli’s selling price.
2. Spirelli enters the market with the selling price computed previously. However, despite growth in the overall market, sales are not as robust as had been expected, and a competitor has priced its product $15 lower than Spirelli’s. Enrico Spirelli, the company’s president, insists that the competitor must be pricing its product at a loss, and that the competitor will be unable to sustain that. In response, Spirelli makes no price adjustments, but budgets production and sales for 2012 at 22,000 units. Variable and fixed costs are not expected to change. Compute Spirelli’s new selling price. Comment on how Spirelli’s choice of budgeted production affected its selling price and competitive position.
3. Recompute the selling price using practical capacity as the denominator level of activity. How would this choice have affected Spirelli’s position in the marketplace? Generally, how would this choice affect the production-volume variance?