Problem 1: Iron Pit Foundry

The Iron Pit Foundry manufactures dumbbells for gyms. The Iron Pit’s owners, Matt Andrews and Doug
Ballard, provide you with the following information regarding raw materials (cast iron & steel):
Raw materials beginning balance $80,000
Raw materials ending balance $150,000

Matt and Doug also inform you that materials issued to production during the year equaled 80% of the
materials purchased during the year. You gather the following additional information:
WIP beginning balance $200,000
WIP ending balance $150,000
Finished goods beginning balance $125,000
Total manufacturing costs charged to production
= direct materials issued to production + direct labor
+ manufacturing overhead $800,000

Manufacturing overhead 150% of direct labor

Revenues for the year totaled $1,500,000, and The Iron Pit’s gross margin percentage (i.e., gross margin
as a percentage of revenues) was 40%. Matt and Doug paid sales commissions equal to 3% of revenues
and shipping costs (from the foundry to the gyms) equaled 2% of revenues. Finally, Matt and Doug
inform you that they spent $60,000 on advertising during the year and that fixed administration costs were
$140,000 for the year.

Required:
a) Calculate materials purchases for the year.
b) Calculate the direct materials issued to production.
c) Calculate direct labor cost.
d) Calculate overhead costs.
e) Calculate prime costs.
f) Calculate conversion costs.
g) Calculate cost of goods manufactured.
h) Calculate the ending balance in the finished goods account
i) Calculate cost of goods sold.
j) Prepare an income statement for The Iron Pit for the year.
k) Suppose The Iron Pit decides to start producing barbells in addition to dumbbells. The yearly
labor costs associated with producing barbells would equal $152,000 and the firm’s overall
expenditures on manufacturing overhead would increase by $138,000 per year. Matt and Doug
would allocate overhead costs to dumbbells and barbells using direct labor cost as the allocation
basis. If the Iron Pit produces barbells, by how much would the gross margin (in $) from
dumbbells increase? (assume materials and labor costs have not changed in several years). What
can you conclude about why firms frequently offer multiple products?

Solution to Iron Pit Foundry

a. Using the inventory equation, and labeling materials purchases as “x” we have the following:

$80,000 + x (purchases) – 0.80x (materials usage) = $150,000

b. Materials issued to production = 80% of materials purchases.

Thus, we have: materials issued to production = $280,000 = 0.80 * $350,000

c. We know that total manufacturing costs charged to production = DM + DL + OH

Additionally, we know that manufacturing overhead = 150% of direct labor

Thus, we have: $800,000 = $280,000 + DL + 1.50*DL

Solving, we find: DL = $208,000

d. Overhead costs = 1.5*DL; Thus, overhead costs = $312,000 = 1.5*$208,000

e. Prime costs = DM used + DL

Thus, prime costs = $488,000 = $208,000 + $280,000

f. Conversion costs = DL + OH

Thus, we have: conversion costs = $520,000 = $208,000 + $312,000

g. Let us use the inventory equation for WIP, which is:

Beginning WIP + materials usage + direct labor + manufacturing overhead – Ending WIP =
COGM

Thus, we have:

COGM = $850,000 = $200,000 + $280,000 + $208,000 + $312,000 – $150,000

h. Using the inventory equation for FG, we know:

Beginning FG + COGM – Ending FG = COGS

Thus, we have: Ending FG = $75,000 = $125,000 + $850,000 – $900,000.

i. As computed above COGS = $900,000.

j. We have the following for Iron Pit for the year:

Revenues $1,500,000
Cost of goods sold 900,000
Gross margin $600,000
Sales commissions (3% of revenues) 45,000
Shipping costs (2% of revenues) 30,000
Advertising 60,000
Fixed administration costs 140,000
Profit before taxes $325,000

k. The current overhead rate for the Iron Pit = 150% of direct labor costs and the overhead
associated with producing dumbbells is, as computed in part (d), $312,000.

If Doug and Matt start producing barbells, total overhead will equal $450,000 (= $312,000 +
$138,000), and total labor costs will equal $360,000 (= $208,000 + $152,000). Thus, the new
overhead rate will be 125% of direct labor (=$450,000/$360,000).

In turn, the overhead allocated to dumbbells will equal 1.25 * $208,000 = $260,000. This is
$52,000 less than is currently being allocated and, in steady state, is the amount by which the
gross margin from producing dumbbells will increase. This example illustrates why firms
frequently produce multiple products – there are economies of scope (in addition to the
economies of scale associated with producing more units of the same product).