Costing and Budgeting - Report Example

Management Accounting – Costing and Budgeting Task a. i. Full cost of each of the products: The full costs of each of the products are computed bycomputing the sum of the total variable costs incurred for each product range and the apportioned fixed overhead of £700,000. Product Range Basic Mid Top Total Variable Cost £12,000,000 £3,200,000 £3,000,000 Apportioned Fixed Overheads £700,000 £700,000 £700,000 Total Costs £12,700,000 £3,900,000 £3,700,000 Hence, the full costs of, Basic = £ 12,700,000 Mid = £ 3,900,000 Top = £ 3,700,000 ii. Total Unit Cost of each of the products: The total unit cost of each of the products is computed by dividing the total cost by the number of items for each product range. Product Range Basic Mid Top Total Costs £12,700,000 £3,900,000 £3,700,000 Production Volume (Items) 200,000 40,000 25,000 Basic Range: Unit Cost = £ 12,700,000 / 200,000 = £ 63.50 Mid Range: Unit Cost = £ 3,900,000 / 40,000 = £ 97.50 Top Range: Unit Cost = £ 3,700,000 / 25,000 = £ 148 iii. Selling Price of the three products: The selling price of the three products is computed using the unit cost and the profit margin for the three products. Product Range Basic Mid Top Unit Cost £63.50 £97.50 £148.00 Profit Margin 10% 15% 20% Basic Range: Selling Price = £ 63.50 + 10% of £ 63.50 = £ 63.50 + £ 6.35 = £ 69.85 Mid Range: Selling Price = £ 97.50 + 15% of £ 97.50 = £ 97.50 + £ 14.625 = £ 112.13 Top Range: Selling Price = £ 148 + 20% of £ 148 = £ 148 + £ 29.6 = £ 177.60 b. Expected Annual Profit: The annual profit can be estimated by computing the total revenue and the total costs for the three product ranges. The revenue for each of the product ranges is computed as the selling price times the total number of items sold. The profit is then the difference between the total revenue and the total costs (Samuels et al, 2000). Product Range Basic Mid Top Selling Price £69.85 £112.13 £177.60 Production Volume (Items) 200,000 40,000 25,000 Revenue £13,970,000 £4,485,000 £4,440,000 Total Revenue     £22,895,000 Full Costs £12,700,000 £3,900,000 £3,700,000 Total Cost     £20,300,000         Profit £1,270,000 £585,000 £740,000 Total Profit     £2,595,000 Hence the expected annual profit for the first year is £ 2,595,000. c. Revised Unit Cost: As per the marketing director’s model, the fixed overheads are apportioned to the three product ranges based on the cost drivers. The ratios for apportioning the cost to each of the three product ranges will be derived from the cost driver. The product of this ratio and the cost of the particular fixed overhead will provide the cost to be apportioned to the product type (Burke and Wilks, 2007). The fixed overheads are computed as shown below. 1. Technical Staff Salaries (£ 240,000) - Direct Labour Cost: Technical Staff Salaries Basic Mid Top Direct Labour £7,000,000 £1,600,000 £1,500,000 Total     £10,100,000 Ratio (Cost / Total) 0.6931 0.1584 0.1485 Salaries £166,337 £38,020 £35,644 2. Customer Service Costs (£ 500,000) – Number of Customers: Customer Service Costs Basic Mid Top Number of Customers 500,000 300,000 200,000 Total     1,000,000 Ratio (Cost / Total) 0.5000 0.3000 0.2000 Customer Service Costs £250,000 £150,000 £100,000 3. Heat, Light and Cleaning (£ 100,000) – Area: Heat, Light and Cleaning Basic Mid Top Area 50% 30% 20% Total     100% Ratio (Cost / Total) 0.5000 0.3000 0.2000 Heat, Light and Cleaning £50,000 £30,000 £20,000 4. Store Running Costs (£ 120,000) – Direct Material Costs: Store Running Costs Basic Mid Top Direct Material Costs £4,000,000 £1,200,000 £1,000,000 Total     £6,200,000 Ratio (Cost / Total) 0.6452 0.1935 0.1613 Store Running Costs £77,419 £23,226 £19,355 5. Depreciation of Equipment (£ 40,000) – Equipment Value: Depreciation of Equipment Basic Mid Top Equipment Value £100,000 £150,000 £250,000 Total     £500,000 Ratio (Cost / Total) 0.2000 0.3000 0.5000 Depreciation of Equipment £8,000 £12,000 £20,000 6. Factory Rent and Business Rates (£ 200,000) – Area: Factory rent and business rates Basic Mid Top Area 50% 30% 20% Total     100% Ratio (Cost / Total) 0.5000 0.3000 0.2000 Factory rent and business rates £100,000 £60,000 £40,000 7. General Administration (£ 400,000) – Sales Value: General Administration Basic Mid Top Sales Value £13,970,000 £4,485,000 £4,440,000 Total     £22,895,000 Ratio (Cost / Total) 0.6102 0.1959 0.1939 Administration Costs £244,071 £78,358 £77,572 8. Vehicle Running Costs (£ 40,000) – Total Variable Cost: Vehicle and Others Basic Mid Top Total Variable Costs £12,000,000 £3,200,000 £3,000,000 Total     £18,200,000 Ratio (Cost / Total) 0.6593 0.1758 0.1648 Vehicle Running Costs £26,374 £7,033 £6,593 9. Other Operating Costs (£ 460,000) – Total Variable Costs: Other Operating Costs Basic Mid Top Total Variable Costs £12,000,000 £3,200,000 £3,000,000 Total     £18,200,000 Ratio (Cost / Total) 0.6593 0.1758 0.1648 Other Operating Costs £303,297 £80,879 £75,824 Total Fixed Costs: Basic = £1,225,497 Mid = £ 479,515 Top = £ 394,988 Based on these costs, the unit cost per unit can be computed as shown below. Product Range Basic Mid Top Total Variable Cost £12,000,000 £3,200,000 £3,000,000 Apportioned Fixed Overheads £1,225,497 £479,515 £394,988 Total Costs £13,225,497 £3,679,515 £3,394,988 Production Volume (Items) 200,000 40,000 25,000 Unit Cost £66.13 £91.99 £135.80 d. Expected Annual Profit at the new Selling Prices: The expected annual profit is computed using the revised selling prices of £ 70, £ 100 and £ 150 for the basic, mid and top ranges respectively. Product Range Basic Mid Top Selling Price £70.00 £100.00 £150.00 Production Volume (Items) 200,000 40,000 25,000 Revenue £14,000,000 £4,000,000 £3,750,000 Total Revenue     £21,750,000 Full Costs £13,225,497 £3,679,515 £3,394,988 Total Cost     £20,300,000         Profit £774,503 £320,485 £355,012 Total Profit     £1,450,000 Hence the expected annual profit is £ 1,450,000. e. Profit Mark-up: The profit mark-up is computed using the following formula. Profit Mark-up (%) = [(Selling Price – Unit Cost) / Unit Cost] * 100 Product Range Basic Mid Top Unit Cost £66.13 £91.99 £135.80 Selling Price £70.00 £100.00 £150.00 Profit Mark-up 5.86% 8.71% 10.46% f. Briefly comment on the financial implications of the two different costing methodologies for Holding Ltd. The cost for each of the three product ranges were computed by the method proposed by the production director as well as the marketing Director. According to the production director, the fixed overheads were equally apportioned among the three product ranges. This method does not apportion the fixed overheads accurately, as the three product ranges might consume different ratios of the fixed overheads (Weston and Copeland, 1988). The marketing director has proposed a completely different method, which apportions the fixed overhead cost pools based on certain cost drivers. Thus the method takes the type of activities into account and apportions the various fixed overheads to the three product ranges. Hence the total costs computed are more accurate and in turn, the unit costs are also more accurate. The table below indicates the different unit costs computed by the two methods. Product Range Basic Mid Top Production Dir. £63.50 £97.50 £148.00 Marketing Dir. £66.13 £91.99 £135.80 The costs indicate that the basic range has been estimated at a much lower value whereas the mid and top ranges have been overestimated. The difference is very significant for the mid and top ranges, indicating that the production of a unit basic product is costlier than expected. As far as the selling prices are concerned, the marketing director’s proposal is more valid, as the selling prices are based on the demand in the market and the prices that the customers are willing to pay for the same. The profit margins on the products are comparatively lesser, as it is evident from the table below. Product Range Basic Mid Top Production Dir. 10% 15% 20% Marketing Dir. 5.86% 8.71% 10.46% As the profit margins are lesser, the total profit computed as £ 1,450,000 is also much lesser when compared to the expected annual profit of £ 2,595,000, when the products are priced using the first method. It is imperative to note that all the products produced can only be sold at the lower prices, as specified by the marketing director. Pricing them at high levels, Holding Ltd will run into the risk of all the products not being sold. Hence it can be concluded that the second method proposed by the marketing director will suit best for Holding Ltd in terms of the pricing, risks involved and the annual income. Task 2: a. Break Even Analysis: Total Fixed Costs = £ 80,000 Average Spend per Visit = £ 10 Variable Cost per Visit = £ 3 Contribution per Visit = £10 - £3 = £ 7 Break Even Visits = Total Fixed Costs / Contribution per Vist = £ 80,000 / £ 7 per visit = 11,429 visits Hence 11,429 employee visits are required to break even. b. Write a short statement which discusses the operational viability of the operation of the planned cafeteria in terms of its capacity to deliver the required service to employees. The cafeteria has been planned to operate for 4 hours per day and it is estimated that it will be able to accommodate up to 8 diners within an hour. Assuming that the cafeteria is always at its full capacity, the number of employee visits can be computed as follows. Cafeteria opening hours in a year = 4 * 6 * 48 = 1,152 hours No. of diners in a year (max. Capacity) = 1,152 * 8 visits = 9,216 visits It is evident from a) that the number of visits required to break even is 11,429. However the maximum number of employee visits that can be accommodated in a year is just 9,216. Hence the cafeteria will not be able to break even, even if it operates at it maximum capacity throughout the year. Hence the cafeteria will not be able to provide the services to the employees in the long term due to lack of financial justification. c. What, if any, actions might you recommend in the light of your findings under b. It is evident from b) that the planning for the cafeteria requires a number of changes in order to be financially justifiable and be able to at least break even with the fixed expenses incurred every year. 1. Opening Hours: The first issue to be addressed is the number of opening hours. As per the plan, the cafeteria is to be open only for 4 hours a day. The opening hours have to be extended to at least 6 hours. The number of items in the cafeteria can also be increased. 2. Maximum Diners: Though it is not possible to have the maximum number of customers all the time, the cafeteria should be planned to accommodate more number of people. This will enable the cafeteria to operate effectively at times of higher demands. 3. Reduction of Costs: It is evident from the projected fixed costs that the highest expenses are incurred in terms of the resources including the Chef and the kitchen staff. Holding Ltd should reduce these costs by reducing the number of kitchen staff. This can be accomplished by efficiently planning the operations, forecasting the demand and recruiting part time staff as per the demand. The other alternative to Holding Ltd is to provide a contract to a private supplier. This will make it possible for the company to provide the service and also make a profit by outsourcing the service. Task 3: a. Actual Cash Flow Statement: The actual cash flow statement is prepared using the given information on cash income and expenses. 1. Cash in Bank: The cash in bank at the start of the year is £ 125,000. 2. Sales: All the sales had been on credit to the customers and the time given to settle the accounts is 2 months. Hence, exactly 10 months worth of annual sales has been settled in the year. From the Actual Profit and Loss Statement, total sale for the year is obtained as £ 23,000,000. Assuming that the sales every month was consistent throughout the year, 1 Month Sales = £ 23,000,000 / 12 = £ 1,916,667 10 Month Sales = £ 1,916,667 * 10 = £ 19,166,670 Hence the total cash received for sales is £ 19,166,670. 3. Heat Light and Cleaning: Credit is given for 1 month. Hence 11 months worth of costs has been paid. Actual expenses on Heat Light and Cleaning (from the actual Profit and Loss statement) is £ 102,000. Assuming the expenses to be consistent every month, 11 Months Cost = (£ 102,000 / 12) * 11 = £ 93,500 Hence the cash paid for Heat Light and Cleaning is £ 93,500. 4. Store Running Costs: The store running expenses are also given a credit term of 1 month. The total expense on the store running costs is £ 124,800 (taken from the actual Profit and Loss statement). 11 Months Cost = (£ 124,800 / 12) * 11 = £ 114,400 Hence the cash paid for running the store amounts to £ 114,400. 5. Direct Materials: For the purchase of direct materials as well, 1 month credit term is given. The profit and loss statement indicates that direct materials worth £ 6,200,000 have been purchased. 11 Months Cost = (£ 6,200,000 / 12) * 11 = £ 5,683,333 Hence the total cash paid for the purchase of direct materials is £ 5,683,333. The other costs have been paid in full. The actual cash flow statement is shown below. Cash Flow Statement (£) Cash and Bank at start of year 125,000 Cash from Debtors for Sales 19,166,670   19,291,670     Cash paid to:   Technical Staff Salaries 247,200 Customer Service Costs 618,000 Heat Light and Cleaning 93,500 Store Running Costs 114,400 Factory rent and business rates 208,000 General administration 408,000 Vehicle running costs 39,200 Other Operating costs 464,600 Direct Materials for the Year 5,683,333 Direct Labour for the Year 10,100,000 Variable Overheads for the Year 1,900,000 Total Cash Out 19,876,233     Cash and Bank in hand / overdrawn (-) (584,563) Hence, by the end of the first year, the cash flow statement indicates that Holding Ltd has a net amount of £ 584,563 overdrawn from the bank. b. Comment briefly on the profitability and cash position of Holding Ltd as at the end of its first year of operation. What, if any, cash strategies might the directors of Holding Ltd have followed during the year to improve the cash position of the business. It is evident from the actual profit and loss statement that the company has earned a significant income of £ 2,548,200 in the first year. Holding Ltd is strong in terms of the efficiency of operations and also generating sales. However, the cash flow statement indicates that the liquidity position is very weak, as the net cash at the end of the year remains at a negative figure of £ 584,563 overdrawn from the bank. The company requires a more flexible schedule for cash income and payments. The credit terms given to the customers need not be fixed at 2 months; instead a variable credit terms can be defined based on the customer type and relationship with the company. High value and trust worthy customers can be given a 2 months credit terms. Most of the expenses are settled in the same month; Holding Ltd can negotiate with the suppliers for a more lenient payment period. This will enable the company to strengthen its liquidity position (Samuels et al, 2000). Bibliography Burke, L. and Wilks, C., 2007, Management Accounting – Decision Management, 4th edn, CIMA Publishing Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., 2000, Management of Company Finance, 6th edn, Thomson Learning, London Weston, J. F. and Copeland, T. E., 1988, Managerial Finance, 2nd edn., Cassell Educational Ltd, London Read More