ACT 1107_STRATCO_RELEVANT COSTING_07 (OPTIMIZATION OF SCARCE RESOURCES)
OPTIMIZATION OF SCARCE RESOURCES
Resources are finite. Money, machine hours, direct
labor hours, supply of materials, and technology are
subject to scarcity. Therefore it is incumbent on
businesses to produce extraordinary results from
limited resources.
To optimize scarce resources, sales and production
should be allotted to a product that gives the
highest profit per scarce resource. If the scarce
resource is direct labor hour, then produce the
product that gives the highest contribution margin
per direct labor hour.
As much as possible, use all your resources in
producing the product that has the highest
contribution margin per hour unless such product
has market limitation. In such case, after satisfying
all the market need of the product that has the
highest CM per hour, produce and sell the product
that has the next highest CM per hour, and so on.
Illustration
Breathe Corporation has 52,000 available machine
hours and has a fixed overhead rate of ₱4 per hour.
It is considering producing two popular products
with the following production and costs data:
KAYA KOTO
Cost if purchased from outside
₱70 ₱105
supplier
Direct materials ₱11 ₱22
Direct labor ₱25 ₱38
Factory overhead at ₱9/hour ₱18 ₱27
Annual demand in units 20,000 15,000
Required:
1. Assuming that there is no market limitation,
which product should Breathe Corporation
produce?
2. Considering the market limits, how would
Breathe Corporation use its limited machine
hours to maximize profit?
3. Assuming that the unit direct materials cost
of KOTO decreases to ₱10 and considering
the market limit, how would the limited
machine hours be used to maximize profit?
Solutions/Discussions:
1.
The market limit pertained here is the annual
demand in units. Meaning for the first question, we
ignore the stated annual demand in units and
assume the market will take infinite number of units
of any of the two products.
Recall that the product to be produced and sold
must give the highest contribution margin per
machine hour. The unit sales price to be used shall
be the unit price offered by competitors.
First, we must determine how many machine hours
does each product take. Note that the factory
overhead for KAYA and KOTO are ₱18 and ₱27,
respectively. We can see from the data presented in
the problem that a machine hour costs ₱9.
Accordingly, we can deduce that KAYA takes 2
machine hours (₱18/9), while KOTO takes 3
machine hours (₱27/9).
Also, it was stated in the problem that the fixed
overhead rate is ₱4 per hour. Therefore, we can
conclude that:
KAYA KOTO
Fixed overhead per unit ₱81 ₱122
Variable overhead per unit ₱103 ₱154
1
₱4 per hour x 2 hours per unit
2
₱4 per hour x 3 hours per unit
3
₱18 total factory overhead less ₱81
4
₱27 total factory overhead less ₱122
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ACT 1107_STRATCO_RELEVANT COSTING_07 (OPTIMIZATION OF SCARCE RESOURCES)

We have to separate the variable and the fixed 2.

overhead to get the unit contribution margin. Recall This time we consider the market demand per
that contribution margin income statement product. Recall that:
classifies cost as to their behavior—whether fixed
or variable. KAYA KOTO
Annual demand in units 20,000 15,000
The contribution margin per hour is computed
below: The above means that market will only take up to
20,000 units of KAYA and 15,000 units of KOTO.
KAYA KOTO
Unit sales price 70 105 We have already determined in number 1 that KAYA
Unit direct materials cost (11) (22) has a greater CM per hour so it is given priority for
Unit direct labor cost (25) (38) the 52,000 machine hours available. We can
Variable factory overhead (10) (15) produce up to 20,000 units of KAYA, so we
Unit contribution margin 24 30 maximize and produce up to that number. Make
÷ Number of hours per unit 2 3
sure that the 52,000 available machine hours can
CM per hour 12 10
take it!
Based on our computation, KAYA has a bigger CM
KAYA takes 2 machine hours so producing 20,000
per hour. Therefore, the company must produce
units would need 40,000 machine hours, which is
and sell KAYA to maximize profit given their limited
still lower than the 52,000 available machine hours.
resource—which is the machine hours.
If we produce 20,000 units of KAYA, we would still
have 12,000 remaining machine hours (52,000 less
To check:
40,000 used for KAYA). We can now allot the
If we exhaust all 52,000 machine hours on KAYA and
remaining hours to the product that produced the
KOTO independently, we would get:
next highest CM per hour, which is KOTO. Using up
the 12,000 remaining hours, we could produce
KAYA KOTO
Unit contribution margin 24 30 4,000 units of KOTO (12,000/3).
X number of units produced 26,0001 17,3332
Total contribution margin 624,000 519,990 In summary, the 52,000 machine hours will be
allocated as follows:
Note that, profit is maximized when KAYA is
produced. Total
Product Units Hours/Unit
Hours
1
KAYA needs 2 machine hours per unit, therefore KAYA 20,000 2 hours 40,000
KOTO 4,000 3 hours 12,000
52,000 available machine hours can produce 26,000
52,000
units.
2
KOTO needs 3 machine hours per unit, therefore
3.
52,000 available machine hours can produce 17,333
Similar with number 2, we just change the
units.
computation of our unit contribution margin.

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ACT 1107_STRATCO_RELEVANT COSTING_07 (OPTIMIZATION OF SCARCE RESOURCES)

KAYA KOTO Now try this on you own:

Unit sales price 70 105 Dasal Corporation has 1 hour of the stitching
Unit direct materials cost (11) (10) machine left for the day. It is considering producing
Unit direct labor cost (25) (38) two popular products with the following data:
Variable factory overhead (10) (15)
Unit contribution margin 24 42
÷ Number of hours per unit 2 3 PHIL 413
CM per hour 12 14 Selling price per unit ₱25 ₱30
Variable cost per unit ₱10 ₱18
Now, KOTO has a larger CM per hour. Therefore,
PHIL takes two minutes at the stitching machine,
the company must produce and sell KOTO to
while 413 takes only one minute.
maximize profit given their limited resource—which
is the machine hours.
Assume the market can still take 45 units of product
413 and 20 units of product PHIL.
Consider the market demand per product.

Required:
KAYA KOTO
1. Assuming that there is no market limitation,
Annual demand in units 20,000 15,000
which product should Dasal Corporation
Our priority for the scare resource is KOTO. We can produce?
produce up to 15,000 units of KOTO, so we 2. Considering the market limits, how would
maximize and produce up to that number. Make Dasal Corporation use its limited stitching
sure that the 52,000 available machine hours can machine minutes to maximize profit?
take it as well!

KOTO takes 3 machine hours so producing 15,000

units would need 45,000 machine hours, which is
still lower than the 52,000 available machine hours.
If we produce 15,000 units of KOTO, we would still
have 7,000 remaining machine hours (52,000 less
45,000 used for KOTO). We can now allot the
remaining hours to the product that produced the
next highest CM per hour, which is KAYA. Using up
the 7,000 remaining hours, we could produce 3,500
units of KAYA (7,000/2).

In summary, the 52,000 machine hours will be

allocated as follows:

Product Units Hours/Unit Total Hours

KOTO 15,000 3 hours 45,000
KAYA 3,500 2 hours 7,000
52,000

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