Analysis of Management Accounting Situations - Assignment Example

QUESTION Mr. Sparkes is the CEO of a large manufacturing company. He believes strongly that he is the keeper of all the knowledge of what is best for the company. Mr. Sparkes has traditionally prepared all of the budget estimates himself and then communicated the results to his department managers. In the past several years, however, he as begun to notice that the department managers rarely manage to stay within their budgets and have many excuses for their failures. Mr. Sparkes has also noticed an increase in his employee turnover, particularly at the managerial level. A) Explain what is meant by the term participative budgeting and how the term relates to the current situation. When budgets are imposed, department managers feel they do not have full control in their departments, which results in low morale and job dissatisfaction. This is the cause of the high turnover among his employees. Participative budgeting encourage a bottom-down approach to budgeting, involving the lower-level managers in the process of planning. This bottom-down approach requires each department manager to submit their proposed budgets for their departments; and with the assessment of the top-level managers will be subject to either approval or revisions. This gives the department managers authority over their finances, without the feeling of being imposed by the top-level management, thus motivating the manager to stay within budgets’ and at the same time top-level management does not give up control over these departments so as not to let the costs balloon. B) How would you recommend that Mr. Sparkes change the budgeting procedures to gain more support from the department managers? I would recommend participative budgeting for Mr. Sparkes to encourage support from department managers. As previously noted, participative budgeting encourage a bottom-down approach to budgeting, involving the lower-level managers in the process of planning. This bottom-down approach requires each department manager to submit their proposed budgets for their departments; and with the assessment of the top-level managers will be subject to either approval or revisions. This gives the department managers authority over their finances, without the feeling of being imposed by the top-level management, thus motivating the manager to stay within budgets’ and at the same time top-level management does not give up control over these departments so as not to let the costs balloon. C) How does participative budgeting contribute to a positive budgeting culture (atmosphere)? Participative budgeting gives department managers the authority they need to feel motivated in doing their jobs, without the top-level management giving up control. By involving the department managers, they will be more motivated to stay within their budgets, thus keeping their morale up and lowering the employee turnover rate. Instead of managers trying to make excuses for deviating from the actual budget, by making them part of the actual budgeting procedure, it is easier for them to work on the given budget than accepting what has been imposed on them. QUESTION 2: For each responsibility center described below, indicate the type of responsibility level that is most appropriate, i.e., is it a cost center, a revenue center, a profit center, or an investment center. If more than one answer is appropriate for a given description, explain why that situation exists. A. A division sales office where the sales manager controls the acquisition of new customers, but has no authority to offer price discounts to customers. Advertising is handled by the corporate marketing department, but the sales office controls a SMALL operating budget for entertainment expenses. It is both a revenue center and a cost center, but not a profit center. It is a revenue center for one, because it is responsible for the acquisition of new customers, therefore revenues for the companies. However, the entertainment expenses that it incur are not expenses directly related to sales that it can control so it is not a profit center (revenues less cost, as a profit center is responsible entirely for these two activities); when it can control the budget for entertainment expenses, the sales office is also considered a cost center in this line. B. A manufacturing plant that has no responsibility for sales. This is a cost center, as the manufacturing plant will be responsible to control its costs related to manufacture, as is indicated in the budget for costs. C. A division of the corporation that handles a single product line and whose division manager has the authority to purchase manufacturing equipment, advertise, and make decisions about changes to the product line. All legal matters are handled by the corporate office. Also, computer systems are centralized and charged to the divisions based on actual usage. This is an example of a profit center—it is a segment autonomous of operations as it has the authority for investments and employment of capital: purchase manufacturing equipment, control of costs such as advertising expenses and other related manufacturing expenses, as well as overhead expenses such as computer systems; and handles and has the authority to make decisions about the product line. When the segment or a division like this one is responsible for both the revenues and costs, it is considered a profit center. D. A manufacturing plant that has responsibility for sales of the product it manufactures. The corporate accounting department that controls the majority of its operating budget including salaries, but not including office rent. This is considered a revenue center as well as cost center. While it is responsible for the sales of the product it manufactures, it cannot be considered a profit center because the corporate accounting department controls the majority of its operating budget. But it is also a cost center in effect, because it controls one of the costs to manufacturing which is office rent—a cost not necessarily deducted from the revenues, to make it a profit center. QUESTION3: The Frames ‘N More Corporation has three divisions: Frames Division, Glass Division, and Pictures Division. Frames Division produces frames that are needed by Pictures Division to manufacture the final product. The corporation has a negotiated transfer pricing policy. Frames Division’s unit costs and prices are as follows; Selling price to outside customers $12.00 Variable cost of production 7.00 Fixed cost of production 4.00 Market price of frames $10.00 A. What is Frames Division’s contribution margin for this product? Frames division generally has $5.00 contribution margin, or 41.67% for this product, as it sells $12.00 to outside customers. B. What amount would be considered the maximum price (ceiling) in this example and what price would be the minimum price (floor). The maximum price (ceiling) in this example is the market price of the frames, which is $10.00, if there is no idle capacity; and the minimum price (floor) in this example is the variable cost of $7.00. Any transfer price greater than this variable cost will increase the division’s profit if there is idle capacity. C. If Frames has idle capacity, what is the probable transfer price? EXPLAIN. The probable transfer price will be $7.00; market-based transfer pricing policy will result in dysfunctional behavior or actions taken in conflict with organizational goals. If the Frames division has idle capacity, it is implied that it would have zero contribution to the company’s operations if it is not to sell frames to external customers. In order not to forgo any contribution to the company, the variable cost would be a better basis for transfer pricing. This will be beneficial to the firm as a whole, as all the necessary additional costs that will be incurred in the production of the frames to be transferred. D. If Frames is currently operating at full capacity, what is the probable transfer price? EXPLAIN. The probable transfer price will be the market price—the other divisions will only accept any transfer price not more than the market price which is $10.00 as Pictures division could otherwise buy the service from outside sellers; at the same time, the Frames division cannot accept any transfer price less than the market price as it will reduce the cost. The $12.00 selling price is not appropriate because it will reduce Picture division’s profits, and will not be beneficial to the organization as a whole; in the same way that the $7.00 variable cost is not appropriate as it the Frames division will forgo the additional contribution it gets if it sells at the market price. QUESTION 4: Aunt Pitty’s Pies is a small bakery that sells its products to local restaurants and supermarkets. The bakery’s most recent income statement is as follows: Sales $78,000 Variable Costs 24,960 Contribution Margin $53,040 Fixed Costs 29,240 Net Income $23,800 A. What is Aunt Pitty’s contribution margin ratio? Aunt Pitty has a contribution margin ratio of 68% (contribution margin of $53,040 divided by sales of $78,000). B. What is Aunt Pitty’s breakeven level of sales revenues? The breakeven level of sales revenue of Aunt Pitty’s is $43,000. It is derived by dividing the fixed costs ($23,800) divided by the contribution margin ratio of 68%. C. What is Aunt Pitty’s margin of safety in the most recent year? Aunt Pitty’s margin of safety is computed by getting the difference between the planned sales and the breakeven sales, which is equal to $35,000. D. Assume that Aunt Pitty is considering investing in new machinery that will decrease variable costs per unit by 10%. In order to achieve the savings, the bakery’s fixed costs would increase by $6,360. What will happen to the breakeven level of sales revenues? You must give a specific numerical answer. (Note: the sales price will not change.) Incremental costs would be the fixed costs of $6,360; with the savings, variable costs per unit is decreased by 10%, making the contribution margin ratio per unit 10% more or 78% (68% + savings from reduction of variable cost of 10%). This gives a new contribution margin ratio of 78%; the new fixed costs will be $29,240 plus the additional $6360, or $35,600 in total. The new level of breakeven sales is $45,641.03—which is increased by $2,641.03 all in all. QUESTION 5: The Smooth Flight Airline Company is considering lowering fares in an attempt to fill unused seats on its regular flights from New York to Chicago. Current capacity on each flight is 250 passengers. At present, the company sells an average of 130 tickets at $330 per ticket, but estimates that an additional 100 tickets could be sold if it offered a stand-by ticket price of $140 on the day of the flight. Fixed costs per flight are $50,000 and variable costs per ticket are $25. A. Prepare a direct costing (variable) income statement to show the current profit or loss for each flight at the current level of 130 tickets sold per flight. Selling price 330 Sales in units 130 Sales revenues (330 x 130) 42900 Variable costs (25 x 130) 3250 Contribution margin 39650 Less: Fixed costs 50000 Net income (loss) -10350 Smooth Flight Air Company incurs a net loss of 10, 350 at the current level of 130 tickets it sells per flight. B. Prepare a direct costing (variable) income statement to show the change in profits if the proposed stand-by plan is put into effect. Additional TOTAL Selling price 330 140 Sales in units 130 100 Sales revenues 42900 14000 56900 Variable costs 3250 2500 5750 Contribution margin 39650 11500 51150 Less: Fixed costs -50000 Net income (loss) 1150 By selling the additional 100 tickets at $140/ticket, the company gains additional revenue of $14,000, and incremental variable costs of $2,500. Because the fixed costs do not change, Smooth Flight Air Company incurs a net income of $1,150 in this stand-by ticket plan. C. How many tickets must be sold at the $330 price to cover fixed costs? Approximately 164 tickets should be sold at this price level in order to cover the fixed costs. This is computed by dividing the fixed costs ($50,000) by the contribution margin of $305 (selling price less the variable cost, $330 less $25) which results in 163.94 tickets. D. How many tickets must be sold at the $140 price to cover fixed costs, assuming all tickets are at that price? Assuming all tickets are at the $140 price level, Smooth Flight Air Company should sell approximately 435 tickets in order to just recover the fixed costs. This is derived by dividing the fixed costs ($50,000) by the contribution margin of $115 (selling price less the variable cost, $140 less $25), which results in 434.78 tickets. E. Would you recommend that management adopt the stand-by ticket? WHY or WHY NOT? I would recommend that management adopts the ADDITIONAL stand-by ticket-selling plan in order to increase net income. Since the additional stand-by ticket will not incur additional fixed costs as long as the number of tickets is within the 250-seat capacity, any number of additional stand-by tickets will result in greater income to the company—the fixed costs will be spread, as well as recovered. However, it would be unwise for the company to adopt the $140 price level for all of its tickets, as this will require a breakeven level of sales in units of 435 tickets, which is beyond its capacity. Read More