Management Accounting of the Ozmedic Company - Essay Example

Management accounting Introduction The Ozmedic Company manufactures medical instruments such as penlights, stethoscopes, blood pressure monitors, thermometers and other measuring instruments which it supplies to private clinics and hospitals. The company sells the disposable thermometers to hospitals using a network of independent sales agents that are located in Australia. In addition to disposable thermometers manufactured by Ozmedic, the sales agents also sell a variety of products to hospitals. Increasing pressure from these independent sales agents regarding the adjustment of the commission rate coupled with vital issues required by the management before making various decisions necessitated a close and thorough analysis of Ozmedic. The report begins by presenting a budgeted income statement when the commission is increased and when the firm hires is own salespeople. The breakeven point and the level of indifference between the two options are then computed. The report then proceeds by recommending the best option between increasing the sales commission and hiring own sales people. It will be illustrated that it is better to hire own salespeople than increase the commission to 20 percent. Further, the report presents the launch date for the BPM-201 as well as factors that should be considered when deciding on launch date. In addition, the report will investigate if accepting the local government offer is viable for the firm. The report then establishes the maximum price to be paid for the outside supplier of Penlight Division for Instrulite. It then concludes by explaining other factors to be considered when deciding whether to outsource apart from the price of the product. Analysis Budgeted income statement OZMEDIC CORPORATION Budgeted Income Statement (20% sales commission) Sales 30,000,000 Variable cost: Cost of goods sold 17,400,000 Commission 6,000,000 Total variable cost 23,400,000 Contribution 6,600,000 Foxed cost: Cost of goods sold 2,800,000 Advertising expense 800,000 Administrative expense 3,200,000 Total fixed cost 6,800,000 Net operating income (200,000) OZMEDIC CORPORATION Budgeted Income Statement (hiring own salespeople) Sales 30,000,000 Variable cost: Cost of goods sold 17,400,000 Commission 3,000,000 Total variable cost 20,400,000 Contribution 9,600,000 Foxed cost: Cost of goods sold 2,800,000 Advertising expense 1,300,000 Administrative expense 3,200,000 Payroll cost $700,000  Travel and entertainment expenses $400,000  Salaries of sales manager and support staff $200,000  Total fixed cost 8,600,000 Net operating income 1,000,000 Breakeven point Referring to the contribution margin ratio from appendix 1, the breakeven point in sales dollars for the two options is computed using the formula below as follows: Break Even Point (sales dollars) = total Fixed cost /contribution margin ratio Breakeven point (20% commission) = 6,800,000/0.22= AUD $30,909,091 BEV (hiring own salespeople = 8,600,000/0.32= AUD $26,875,000 Level of indifference between the above two options Level of indifference between the two options refers to the sales volume at which the net income of the two options would be the same. From the appendix 2, the level of indifference would be AUD $18,000,000. From this volume of sales, the Ozmedic’s management would be indifferent of the option to choose because both results to a loss of AUD $2,840,000. Even though, this volume of sales would result to the same figure, it is not viable because the business would incur a loss regardless of the option adopted. The firm’s management should increase its promotional efforts so that a more viable level is achieved. Recommendation of the preferred option Permanent organizations like Ozmedic would like to maximize their profits by reducing transaction costs. Given any level of sales, reduced expenses results to high profits. The best option that would help the company maximize its profit is, therefore, hiring their salespeople. Accepting the increase to the sales commission would prevent the company from making money because they will incur a net operating loss of AUD $200,000, however, hiring their own salesperson’s results to a net profit of AUD $1,000,000. Additionally, the option of hiring own salespeople has a low breakeven point which is better because it means that the business has to sell fewer quantity of products before it starts making profit (Simmons, Anthony and Richard 2011, 51). The profit, therefore, starts to increase dramatically once the breakeven point is crossed because variable costs are low. This option should, therefore, be adopted because it increases the net profit margin of the firm. Launch date Based on financial consideration only, the new machine should be released on December 1, 2014. Releasing the new machine on September 1, 2014 will not only kill the old model but will also result to an incremental operating loss of AUD $5 (appendix 3). The firm needs to delay the launch for the three months in order to move first the stockpile of the old model (BPM-100). Incremental revenues from the introduction of a new machine (BPM-201) are less than the incremental costs. The introduction should, therefore, be delayed to prevent the potential losses. Factors to consider when deciding on launch date Deciding on the launch date of the product is a hectic job particularly in the arena that is very competitive. Strategies should be well planned and necessary steps taken. An appropriate product launch date sets a precedent for future revenue streams (Power et al. 2006, 17). There are several factors that should, therefore, be considered when deciding on launch date: i) Level of Competition BPM should research on the competitive environment surrounding the new machine to be launched. Offering the two products together may create unnecessary competition that may affect the demand of one product resulting to losses. ii) The size of the target market The firm needs to determine if a potential customer base of the new product is large enough so that the sales target can be achieved. Offering two products concurrently may reduce the potential customer base for the old machine thus reducing profit. BPM should ensure that by the launch date there should be a market and a verified need for a new product (Needles, Marian and Susan 2011, 21). iii) Ongoing service commitment BPM should determine if a new product requires ongoing service commitment before launching it. It may be launched quickly and yet it requires heavy service that the upfront and ongoing streams of revenue cannot justify. This should be considered because it will specify the appropriate date that the revenues can justify the extra service work. iv) Customer preferences BPM should determine what the customer prefers. A product that the customers would appreciate or commit to should be launched with any hesitation. Such a product is likely to attract large customer base hence large streams of revenue capable of justifying the loss suffered from the killed old machine. Accepting or rejecting the local government offer The two alternatives are summarized as follows (refer to appendix 4) Alternative A. alternative B Per unit Total A B Regular customers 6.00 120,000 90,000 Local government Manufacturing cost 3.60 0 18,500 Fixed fee 1,000 Total relevant cost 120,000 109,000 Difference in favor of alternative A AUD $11,000 Adraina should reject the offer because accepting it results to a loss of AUD $11,100. Accepting the -off offer from the local government reduces the total revenue because the fixed fee paid is not able to justify the expended marketing cost. Since the total incremental cost is more than the price offered, the offer should not be accepted. Accepting the offer will not generate additional contribution but will results to a loss instead. The total offer price is lower than normal total price hence the incremental revenue from the offer is less than the incremental costs. Maximum price Manufacturing cost Direct materials AUD $1.00 Direct manufacturing labor 1.20 Variable manufacturing overhead cost 0.80 Fixed manufacturing overhead cost (0.5*0.5) 0.25 Marketing Variable (1-0.2)*105 1.20 Fixed 0.90 Margin 0.10 Total price AUD $5.45 The maximum price that should be paid for the outside supplier of Penlight Division for Instrulite is, therefore, AUD $5.45 because it justifies the relevant costs. The amount should be paid because it is less than their original selling price of AUD $6.00 hence cannot affect the operating income for Instrulite. When that amount is paid for Instrulite, the company will have an incremental revenue of AUD $(6.00-5.45) = AUD $0.55. Factors to consider when making decision to outsource Several factors need to be taken onto account when making the decision to outsource. These factors include: i) Quality. The company must have control over the quality of the product component. Firms tend to make the product in-house so that they can better control the quality. Those that have proprietary technology that requires to be also protected tend to make it within. If the outside supplier can make a product of better quality then, it should be outsourced. Further, the product can be outsourced in case the outside supplier specializes in this type of product because they will provide a high-quality product. ii) Reliability of the outside supplier The product can be outsourced in case the supplier is very reliable in supplying it. iii) Impact of the decision on customers. If the decision is going to affect customers in any way should not be accepted. iv) Convenience If the outside vendor can deliver the product in a short notice, then it is very convenient to outsource. However, the firm should not outsource if it is operating on high gear and hence is capable of meeting ongoing demand. The firm should select the option that is convenient. v) Quantity The volume of the demand of the product influences the decision whether to outsource or make. It is very cost-effective to outsource if the needed volume is large enough for the company to meet. It is also unwise to make a product if the demand is subtle. vi) Marketing Making the product within is always an important marketing strategy because the firm can offer added value and strong brand to customers. Further, it helps the firm to build lifelong (loyal) customers. A firm may choose to make the product in-house if there is a need to develop customer for life. vii) Expertise Availability of expertise influences a firm’s decision whether to outsource or make. Firms that lack in-house expertise tends to outsource unlike those that have (Weygandt, Kieso, and Paul 2010, 56). viii) Desire for multiple sourcing Firms that would like to obtain various components from various outside supplies tend to outsource. Conclusion In summation, the management should hire own salespeople because it results to a net operating income unlike increasing the commission that results to a net operating loss. The option of hiring own salespeople breakevens at AUD $26,875,000 while the option of 20 percent commission breakevens at a sales volume of AUD $30,909,091 which is higher than hiring own salespeople. The firm will be indifferent between the options at a sales volume of AUD $18,000,000. The new machine should be launched on December 1, 2014 to avoid the potential incremental loss. Adraina should reject the local government offer because it results to a loss of AUD $11,000. References Power, Mark John, Kevin C. Desouza, and Carlo Bonifazi. 2006. The outsourcing handbook how to implement a successful outsourcing process. London: Kogan Page. Warren, Carl S., James M. Reeve, and Jonathan E. Duchac. 2012. Accounting. Mason, OH: South-Western Cengage Learning. Needles, Belverd E., Marian Powers, and Susan V. Crosson. 2011. Principles of accounting. Mason, Ohio: Cengage Learning. Tyson, Eric. 2012. Personal finance for dummies. Hoboken, NJ: John Wiley & Sons. Owen, Glenn. 2011. Using Peachtree Complete 2010 for accounting / Glenn Owen. Mason, OH: South-Western. Schermerhorn, John R. 2010. Management. Hoboken, N.J.: Wiley. Weygandt, Jerry J., Donald E. Kieso, and Paul D. Kimmel. 2010. Managerial accounting: tools for business decision making. Hoboken, NJ: Wiley. Needles, Belverd E., Marian Powers, and Susan V. Crosson. 2014. Principles of accounting. Mason, OH: Cengage Learning. Jiambalvo, James. 2009. Managerial accounting. Hoboken, N.J.: Wiley. Simmons, Anthony, and Richard Hardy. 2011. Cambridge VCE accounting units 1 & 2. Cambridge: Cambridge University Press. Appendices 1. Contribution margin ratio= contribution/sales 20% sales commission= 6600000/30000000= 0.22 Hiring own salespeople= 9600000/30000000= 0.32 2. Net profit= sales*contribution margin-total fixed cost Net profit22%=net profit32% 0.22*sales-6,800,000= 0.32sales-8,600,000 0.32sales-0.22sales=8600000+6800000 0.1sales= AUD $1,800,000 Sales= 1,800,000/0.1 Sales= AUD $18,000,000 3. Selling price of BPM-201 195 Selling price of BPM-100 160 Incremental revenue 35 Less incremental cost (170-130) 40 Incremental operating income (AUD $5) 4. Manufacturing cost Direct materials $1.00 $ 1.00 Direct manufacturing labour 1.20 $1.20 Variable manufacturing overhead cost 0.80 $ 0.80 Fixed manufacturing overhead cost 0.50 $0.60 Total manufacturing cost AUD $3.50 3.60 Marketing cost Variable 1.50 Fixed 0.90 Total costs 6.00 3.50 Alternative A 6*20000= AUD $120,000 Alternative B 15000*6+5000*3.5+1000= AUD $108500 Read More