Financial Statements for a Mega Brand Company - Assignment Example

Week 3 – Exercises 2-48 CVP and Financial ments for a Mega Brand Company Income ment 2006 2007 Net Sales $68,222 $75,044 Cost of Products Sold $33,125 $36,438 Selling, general and administrative expenses $21,848 $21,848 Operating Income $13,249 $16,759 % Increase in income 26% Though the sales increased by only 10% in 2007, the operating income increased by 26%. The main reason is that the fixed costs which include the selling, general and administrative expenses do not vary with sales. Only the variable cost component, in this case, the cost of products sold has increased in line with the sales (10%). Hence the percentage increase in the sales and the operating income are not equivalent. 2-61 CVP in a Modern Manufacturing Environment 1. Compute the budgeted profit at the expected volume of 600,000 units under both the old and the new production environments. Budgeted Profit @ 600,000 units   Old Production New Production Sales $1,860,000 $1,860,000 Variable Cost $1,260,000 $660,000 Fixed Costs $580,000 $1,140,000 Budgeted Profit $20,000 $60,000 2. Compute the budgeted break-even point under both the old and the new production environments. Budgeted Break-even Point   Old Production New Production Selling Price per unit $3.10 $3.10 Variable Cost per unit $2.10 $1.10 Contribution Margin $1.00 $2.00 Fixed Costs $580,000 $1,140,000 Break-even Point 580,000 570,000 3. Discuss the effect on profits if volume falls to 500,000 units under both the old and the new production environments. Budgeted Profit @ 500,000 units   Old Production New Production Sales $1,550,000 $1,550,000 Variable Cost $1,050,000 $550,000 Fixed Costs $580,000 $1,140,000 Budgeted Profit -$80,000 -$140,000 When the number of units falls to 500,000, the company will incur losses under both the old and new production environment, as 500,000 units is below the break-even points of the two production methods (580,000 for old and 570,000 for new). 4. Discuss the effect on profits if volume increases to 700,000 units under both the old and the new production environments. Budgeted Profit @ 700,000 units   Old Production New Production Sales $2,170,000 $2,170,000 Variable Cost $1,470,000 $770,000 Fixed Costs $580,000 $1,140,000 Budgeted Profit $120,000 $260,000 When the number of units increases to 700,000, the profits using the new production method are relatively higher than that of the old production method. The main reason is that the fixed cost component for the new production is high whereas the variable cost component is comparatively lesser. Hence with the increase in the number of units, the contribution margin also increases and hence results in a higher profit. 5. Comment on the riskiness of the new operation versus the old operation. The new operation has a higher risk, as the fixed costs are very high. In case the sales goes down below 570,000 units (break-even for new production), the company will incur heavy losses. For the new production to be profitable, it is essential that the volume is always high. On the contrary, in case the estimated demand is much higher than the break-even point of the old method (580,000 units), the profits will be comparatively lower (due to the higher variable cost component). 3-38 Mixed Cost, Choosing Cost Drivers, and High-Low and Visual-Fit Methods 1. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit using the visual-fit method based on each potential cost driver. Explain how you treated the April data. In order to identify the monthly fixed maintenance cost and the variable maintenance cost per driver unit using the visual-fit method, a line of best fit is drawn is connect the dots in the graph. 1. Units Produced: The fixed cost is the point at which the line crosses the Y-axis. It is found to be $10,000. Considering the point on the line (2,000 units, $17,000), Maintenance Cost = Fixed Cost + Variable Cost $17,000 = $10,000 + (2,000 units * VC) VC = ($17,000 - $10,000) / 2,000 = $3.50 2. Number of Set-ups: The fixed cost is the point at which the line crosses the Y-axis. It is found to be $1,000. Considering the point on the line (13 set-ups, $14,000), Maintenance Cost = Fixed Cost + Variable Cost $14,000 = $1,000 + (13 set-ups * VC) VC = ($14,000 - $1,000) / 13 = $1,000 per set-up The April data is not taken into consideration since the plant was closed and hence the data is irrelevant and misleading in both the cases. 2. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit using the high-low method based on each potential cost driver. High – low method is the technique used to separate the mixed costs into fixed and variable components, based upon the difference between costs at the highest and lowest observed levels of activity. 1. Units Produced: Lowest Activity Level = 1,100 units @ $15,000 Highest Activity Level = 4,000 units @ $20,000 The difference in activity level between the highest and the lowest is (4,000 – 1,100) 2,900 units. Hence, the variable cost associated with the change in activity level for the 2,900 units is $5,000 ($20,000 - $15,000). Variable cost per additional unit = $5,000 / 2,900 = $1.72 Fixed cost can be computed by substituting the variable cost in any one of the high or low activity levels. Fixed Cost = $20,000 – (4,000 units * $1.72) = $13,120 2. Number of Set-ups: Lowest Activity Level = 12 set-ups @ $15,000 Highest Activity Level = 28 set-ups @ $25,000 The difference in activity level between the highest and the lowest is (28 - 12) 16 set-ups. Hence, the variable cost associated with the change in activity level for the 16 set-ups is $10,000 ($25,000 - $15,000). Variable cost per additional unit = $10,000 / 16 = $625 Fixed cost can be computed by substituting the variable cost in any one of the high or low activity levels. Fixed Cost = $25,000 – (28 set-ups * $625) = $7,500 3. Which cost driver best meets the criteria for choosing cost functions? Explain. Cost driver should give an accurate measure on the impact on the costs incurred. It is evident from the above calculations, that the fixed cost component, when using the ‘units produced’, is much higher compared to that of ‘number of set-ups’. Hence the variable cost will be relatively higher for the ‘number of set-ups’ and this will provide a better measure for the additional costs involved in an additional unit level of activity. Hence it can be concluded that the ‘number of set-ups’ is the best cost driver. Aunt Connie Cookies Final Screen Shot: Cost Accounting System: Currently, the various options, costs involved and the profit margins are done on a case – to case basis at Aunt Connie Cookies. It is essential that a cost accounting system is set-up, so that any new business opportunities, sales forecast, profit margins involved, etc can be easily obtained for any period of time. Cost accounting will involve clearly breaking down the costs into fixed and variable components. The fixed costs, as the name indicates, will remain fixed irrespective of the production volume and sales, for instance, rental costs. However, the variable costs depends on the number of units of produced, for instance, raw materials. Once the components are identified, it will be simple to identify the contribution margin and the break-even point. This will also indicate the break-even point which is the minimum level of sales to be achieved in order to avoid losses. Based on the cost components and other information, it will be easier for Aunt Connie Cookies to determine the additional costs involved in taking up a contract and also the additional profits that will be earned. This will take into account the opportunity costs and the relevant costs related to the contract. The cost accounting will be very effective in analyzing any new contracts, any price changes and increase or decrease in sales. Read More