Question

Billy Davidson operates Billy’s Worm Farm in Mississippi. Davidson raises worms for fishing. He sells a box of 20 worms for \(12.60. Davidson has invested \)400,000 in the worm farm. He had hoped to earn a 24% annual rate of return (net income divided by total assets), which works out to a 2% monthly return on his investment. After looking at the farm’s bank balance, Davidson fears he is not achieving this return. To evaluate the farm’s performance, he prepared the following production cost report. The Finished Goods Inventory is zero because the worms ship out as soon as they reach the required size. Monthly operating expenses total \(2,000 (in addition to the costs below).

BILLY’S WORM FARM Production cost report – BROODING DEPARTMENT Month Ended June 30, 2018
		Equivalent units
Units	Physical units	Transferred in	Direct materials	Conversion costs
Units to account for:
Beginning WIP	9,000
Transferred in	21,000
Total units to account for	30,000
Units accounted for:
Completed and transferred out	20,000	20,000	20,000	20,000
Ending WIP	10,000	10,000	6,000	3,600
Total units accounted for	30,000	30,000	26,000	23,600
COSTS		Transferred in	Direct materials	Conversion costs	Total costs
Cost to account for:
Beginning WIP		\)21,000	\(39,940	\)5,020	\(65,960
Cost added during period		46,200	152,460	56,340	255,000
Total cost to account for		67,200	192,400	61,360	320,960
Divided by total EUP		30,000	26,000	23,600
Cost per equivalent units		\)2.24	\(7.40	\)2.60
Costs accounted for:
Completed and transferred out		\(44,800	\)148,000	\(52,000	\)244,800
Ending WIP		22,400	44,400	9,360	76,160
Total costs accounted for		\(67,200	\)192,400	\(61,360	\)320,960

Requirements

Billy Davidson has the following questions about the farm’s performance during June.

1. What is the cost per box of worms sold? (Hint: This is the unit cost of the boxes completed and shipped out of brooding.)

2. What is the gross profit per box?

3. How much operating income did Billy’s Worm Farm make in June?

4. What is the return on Davidson’s investment of \(400,000 for the month of

June? (Compute this as June’s operating income divided by Davidson’s \)400,000

investment, expressed as a percentage.)

5. What monthly operating income would provide a 2% monthly rate of return?

What sales price per box would Billy’s Worm Farm have had to charge in June to

achieve a 2% monthly rate of return?

Short answer

1. Cost per box of worms sold = $12.24

2. Gross profit per box = $0.36

3. Operating income earned by Billy’s worm farm = $5,200

4. Return on investment of Davidson = 1.30%

5. The required monthly operating income should be $8,000 for providing a 2% monthly rate of return, and the sale price should be $13.10

Step-by-step solution

Step-by-Step Solution:Step 1: Work-in-process Inventory

The work in process inventory means the stock that is partially completed through the manufacturing process. It is treated as the current asset in the financial statements.

Cost per box of worms sold

$\begin{array}{c}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{Cost}\mathbf{}\mathbf{per}\mathbf{}\mathbf{box}\mathbf{=}\frac{\mathrm{Total}\mathrm{cost}\mathrm{of}\mathrm{th}\mathrm{ecompleted}\mathrm{units}}{\mathbf{No}\mathbf{.}\mathbf{}\mathbf{of}\mathbf{}\mathbf{completed}\mathbf{}\mathbf{units}}\\ \mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\$244,800}{20,000}\\ \mathbf{=}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{24}\end{array}$

Gross profit per box

$\begin{array}{c}\mathrm{Gross}\mathrm{profit}\mathrm{perbox}=\mathrm{Sales}\mathrm{price}\mathrm{perbox}-\mathrm{Cost}\mathrm{per}\mathrm{box}\\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{60}\mathbf{-}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{24}\\ \mathbf{=}\mathbf{\$}\mathbf{0}\mathbf{.}\mathbf{36}\end{array}$

Operating income of June

Particulars	Amount ($)
Sales (20,000 x $12.60)	252,000
Less: Total cost (20,000 x $12.24)	244,800
Less: Operating expense	2,000
Operating income	5,200

Return on Investment

$$\begin{gathered} \mathbf{Return}\mathbf{}\mathbf{on}\mathbf{}\mathbf{investment}\mathbf{=}\frac{\mathrm{Operating}\mathrm{income}\mathrm{of}\mathrm{June}}{\mathrm{Total}\mathrm{investment}}\mathbf{\times }\mathbf{100} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\$5,200}{400,000}\mathbf{\times }\mathbf{100} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{1}\mathbf{.}\mathbf{30}\mathbf{\%} \end{gathered}$$

Required operating income to earn 2% monthly rate of return

$$\begin{gathered} \mathbf{Required}\mathbf{}\mathbf{operating}\mathbf{}\mathbf{income}\mathbf{=}\mathbf{Investment}\mathbf{\times }\mathbf{Required}\mathbf{}\mathbf{rate}\mathbf{}\mathbf{of}\mathbf{}\mathbf{return} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{400}\mathbf{,}\mathbf{000}\mathbf{\times }\mathbf{2}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{8}\mathbf{,}\mathbf{000} \end{gathered}$$

Sales price to earning the operating income of $8,000 for achieving the 2% monthly rate of return

$$\begin{gathered} \mathbf{Operating}\mathbf{}\mathbf{income}\mathbf{=}\mathbf{Units}(\mathbf{Sale}\mathbf{}\mathbf{price}\mathbf{-}\mathbf{Cost})\mathbf{-}\mathbf{Operating}\mathbf{}\mathbf{expenses} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{\$}\mathbf{8}\mathbf{,}\mathbf{000}\mathbf{=}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{(}\mathbf{S}\mathbf{-}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{60}\mathbf{)}\mathbf{-}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{000} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{\$}\mathbf{8}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{2}\mathbf{,}\mathbf{000}\mathbf{=}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{(}\mathbf{S}\mathbf{-}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{60}\mathbf{)} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{000}\mathbf{=}\mathbf{20}\mathbf{,}\mathbf{000}\mathbf{(}\mathbf{S}\mathbf{-}\mathbf{\$}\mathbf{12}\mathbf{.}\mathbf{60}\mathbf{)} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{Selling}\mathbf{}\mathbf{price}\mathbf{=}\mathbf{\$}\mathbf{13}\mathbf{.}\mathbf{10} \end{gathered}$$