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containing a statement comparing the original budgeted profits of comfort and seats 644922

Seats Ltd (‘Seats’) manufactures seats for installation in buses. It obtains its raw materials from Comfort Ltd (‘Comfort’), a wholly owned subsidiary which sells only to Seats. The raw materials of foam and covering are cut to shape by Comfort and sold to Seats in packages ready for assembly. Seats could obtain raw materials from suppliers other than Comfort but would pay a price 10% higher than that charged by Comfort. One third of the output of Seats is bought by Buses Ltd (‘Buses’), a company which produces buses. Buses has at present significant unutilised production capacity and could produce and sell more buses if the price of buses could be reduced. To achieve this, Buses would require Seats to reduce its selling prices and has asked Seats to quote a lower price. Buses has indicated its willingness to increase its total purchases from Seats to one of the following options:

 

If the price charged by Seats is:

Then Buses will buy a total of:

Option I

£24 per seat

35,000 seats

Option II

£23 per seat

45,000 seats

Option III

£22 per seat

60,000 seats

The total volume includes in each case the number of seats currently being purchased by Buses from Seats. The directors of Seats are prepared to offer a lower price to Buses subject to the following restrictions:

1 Other existing customers must be guaranteed to receive their present level of supplies at present day prices.

2 There can be no expansion of the productive capacity of either Seats or Comfort.

Sales and production volumes are always equal. The following budgets for the year to 30 June Year 9 were prepared before Buses made the request for a price reduction:

Comfort

Seats

Sales in units

50,000

75,000

Unutilised productive capacity

20%

25%

 

£

£

Unit selling price

8.00

25.00

Unit cost of production

 

 

Materials

2.00

8.00

Labour

1.50

7.00

Variable overhead

1.00

5.00

Fixed overhead per annum

60,000

110,000

Required

Write a report to the directors of Seats Ltd:

(a) advising on the effect of each of the options proposed by Buses; and

(b) containing a statement comparing the original budgeted profits of Comfort and Seats with the profits which would arise if Seats group were to adopt the most advantageous option.

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