Decision-Making and Relevant Information - Assignment Example

Part A: Budgeting 1. Revenue budget Revenue budget for Standard trolleys Oct Nov Dec Total Units 27000 30000 30000   Selling Price per unit $84 $88 $88   Total sales for Standard trolleys(Total Units * Selling Price per unit) $2,268,000 $2,640,000 $2,640,000 $7,548,000 Revenue budget for Child trolleys Units 3200 3400 3400   Selling Price per unit $89 $92 $92   Total sales for Child trolleys (Total Units * Selling Price per unit) $284,800 $312,800 $312,800 $910,400 Total sales for all trolleys (Total sales for standard trolleys + Total sales for Child trolleys) $2,552,800 $2,952,800 $2,952,800 $8,458,400 2. Production budget in units Standard trolleys Sep Oct Nov Dec Jan Total (Oct - Dec) Budgeted units sold 27000 27000 30000 30000 24000 87000 Add budgeted ending finished goods inventory (trolleys) 34500 37500 36000 30000 30000 67500 Total requirements 61500 64500 66000 60000 54000 124500 Deduct beginning finished goods inventory (trolleys) 33750 34500 37500 36000 30000 70500 Budgeted production 27750 30000 28500 24000 24000 54000 Child trolleys         Budgeted unit sales 3200 3200 3400 3400 2800 10000 Add budgeted ending finished goods inventory (trolleys) 4050 4250 4100 3500 3500 11850 Total requirements 7250 7450 7500 6900 6300 21850 Deduct beginning finished gds inventory (trolleys) 4000 4050 4250 4100 3500 12400 Budgeted production 3250 3400 3250 2800 2800 9450 3. Direct material usage budget (both units to be used and the cost budget in dollars) Steel rod for: Oct Nov Dec Total Standard trolleys(Budgeted production * 24 * $1.60 per metre) $1,152,000 $1,094,400 $921,600 $3,168,000 Child trolleys(Budgeted production * 24 * $1.60 per metre) $76,160 $72,800 $62,720 $211,680 Plastic seat         Child trolleys(Budgeted production * Number of seats * $7 each) $23,800 $22,750 $19,600 $66,150 Wheels for:         Standard trolleys(Budgeted production * 4 * $2) $240,000 $228,000 $192,000 $660,000 Child trolleys(Budgeted production * 24 * $1.60 per metre) $27,200 $26,000 $22,400 $75,600 4. Direct material purchases budget in units and in dollars Steel rod for: Oct Nov Dec Total Standard trolleys(Budgeted purchases * 24 * $1.60 per metre) $1,209,600 $864,000 $691,200 $2,764,800 Child trolleys(Budgeted purchases * 24 * $1.60 per metre) $77,280 $59,360 $49,280 $185,920 Plastic seat Child trolleys(Budgeted purchases * Number of seats * $7 each) $24,150 $18,550 $15,400 $58,100 Wheels for: Standard trolleys(Budgeted purchases * 4 * $2) $252,000 $180,000 $144,000 $576,000 Child trolleys(Budgeted purchases * 24 * $1.60 per metre) $27,600 $21,200 $17,600 $66,400 Total $1,590,630 $1,143,110 $917,480 $3,651,220 5. Direct manufacturing labour hours and cost budget Standard trolleys Oct Nov Dec Total Units to be produced 30,000 28,500 24,000 82,500 Direct labour hours per trolley 0.250 0.250 0.250 Total direct labour hours (Total Units * labour hours per trolley) 7,500 7,125 6,000 20,625 manufacturing labour Cost per hour $14.50 $14.50 $15.08 Total Manufacturing Cost of direct labour 108,750 103,313 90,480 $302,543 Child trolleys Units to be produced 3400 3250 2800 9450 Direct labour hours per trolley 0.333 0.333 0.333 Total direct labour hours (Total Units * labour hours per trolley) 1133.333 1083.333 933.333 3150 manufacturing labour Cost per hour $4.50 $4.50 $5.10 Total Manufacturing Cost of direct labour $5,100.00 $4,875.00 $4,760.00 $14,735 6. Manufacturing overhead budget Oct Nov Dec Variable manufacturing overhead       Total direct labour hours 8,633 8,208 6,933 Budgeted direct manufacturing labour cost per hour (variable) $4.50 $4.50 $5.10 Total Variable manufacturing overhead $38,850 $36,938 $35,360 Fixed manufacturing overhead $14,000 $16,000 $16,000 Total manufacturing overhead 52,850 52,938 51,360 7. Opening and ending inventories budget for direct materials for three months ending 31 December 2012 $ Opening inventories budget for raw materials $9,656,390 Add: Direct material purchases budget in units and in dollars $3,651,220 Available direct raw materials $13,307,610 Less: Direct material usage budget (both units to be used and the cost budget in dollars) $75,600 Ending inventories budget for direct materials $13,232,010 8. Opening and ending inventories budget for finished goods for the three months ending 31 December 2012 $ Opening inventories budget for finished goods $10,844,960 Add: budgeted production in units and in dollars $2,859,030 Available finished goods $13,703,990 Less: budgeted sales (both units to be used and the cost budget in dollars) $8,458,400 Ending inventories budget for finished goods $5,245,590 9. Income Statement budget for the three months ending 31 December 2012   $ Budgeted sales 8,458,400 Less: cost of goods sold 75,600 Gross profit 8,382,800 Less: Labour expenses $317,278 Net income $ 8,065,523 Part B: Decision making and relevant information Relevant costs Relevant costs are appropriate costs for management decision making and they are therefore affected by the decision taken. This is because they are future costs and a decision is always about the future and it may not change what has already been done. According to Hilton (2004), the cost already incurred in the past is totally irrelevant to any decision making. Therefore, in deciding whether to accept or reject the order, the CEO should consider all the costs related to acquiring the equipment to make the brakes. He should also consider the costs of buying the brakes from a supplier for $6 per set and add the brakes to the trolleys. The CEO should only consider those costs that are in form of cash flows. It is normally assumed that decisions are taken in order to maximize the wealth of the shareholders or the value of the firm. Therefore, such decisions should change the net cash flows of the company. Those decisions that do not reflect additional cash flows may be ignored in decision making. Therefore, the CEO should not consider whether the decision enhances the image of the Steelworks Ltd in deciding whether to accept or reject the order. This is because such a decision does not cause cash flows to the firm. The relevant costs will be only those costs that are incremental, that is, there should be an increase in the total amount incurred if the decision is undertaken. Customizing the child trolleys by adding a set of brakes to the trolley will call for incremental cost of buying the brakes from a supplier for $6 per set and adding the brakes to the trolleys. Supposing the trolleys are manufactured in November and: If the firm buy the brakes from a supplier Incremental cost = 10,000 * $6 = $60,000 Total cost = cost of manufacturing 10,000 child trolleys + incremental cost of brakes = (10,000 * $37.4) + (10,000 * 0.333 * $4.50) + $60,000 = $449,000 Revenue = 10,000 * $90 = $900,000 Profit = $900,000 - $449,000 = $451,000 If the firm buys equipment: Incremental cost = $30,000 Total cost = cost of manufacturing 10,000 child trolleys + incremental cost of brakes = (10,000 * $37.4) + (10,000 * 0.333 * $4.50) + $30,000 = $419,000 Profit = $900,000 - $419,000 = $481,000 If order is rejected: Cost = direct raw materials cost + direct labour cost = (4,000 * $37.40) + (4,000 * 0.333 * $4.50) = $155,594 Revenue = 4,000 * $92 = $368,000 Profit = $368,000 - $155,594 = $212,406 This means the CEO has to consider this additional cost in order to find ways of minimizing it and ensure that the firm will not incur extra costs for which returns are low. The CEO of Steelworks Ltd should consider whether to accept or reject the order if only there is a limiting factor. This is a scarce resource on which the decision should be made. This is important consideration since Steelworks Ltd has a constraint on the direct manufacturing labour hours. This means the production of the customized child trolleys is subject to availability of direct manufacturing labour hours hence the firm is limited from attaining the maximum possible production. Other financial issues and costs It has been argued that the goal of a financial management is to earn the highest possible profit for the firm. This argument has some serious drawbacks to profit maximization as the primary goal of the firm. Such drawbacks may include; The level of risk – the change in profit may represent a change in risk. For a conservative firm, for instance, that earn $1.50 per share may be a less desirable investment if its earnings per share increases to say $2.00 but the risk inherent in the operation increases even more. Timing of benefit – if during two consecutive period the total earning per share is $5.00 but on alternative A the earnings per share is $3.00 and $2.00 for period 1 and period 2 respectively but for alternative B the earnings per share is $2.00 and $3.00 for period 1 and period 2 respectively, then the profit maximization principle fails to consider the timing of benefit. Alternative A is more superior to an investor since he can reinvest the money and earn more in the following period. Accurately measuring the profit – the goal of maximizing profit suffers from the almost impossible task of accurately measuring the key variable (profit) due to inflation and international currency transaction that tend to complicate the issue (Fess and Warren, 2004). The CEO of Steelworks Ltd should attempt to maximize the wealth of the firm’s shareholders through achieving possible values for the firm. The aim of the management of a company is to maximize the wealth of the shareholders. The CEO should also consider the accuracy of the estimates of the costs, that is, whether the variable cost per unit will remain constant during the manufacturing period. Other non-financial issues Though profit is important, the key issue is how to use them in setting the goals of the business. The ultimate measure of performance is not what the business earns, but how the earnings are valued by the owner. When analyzing the business enterprise, investors will consider the risk inherent in the business’s operation, the time pattern over which the earning increases or decreases, the quality and reliability of reported earning among other factors. If a decision maintains or decreases the overall wealth of the owner, it is acceptable from a financial view point. Before a decision is made to on whether to accept or reject the order the CEO needs to satisfy himself that the matter to be ruled on represent a significant problem and that the decision will not impose cost on the many for which the benefits are few (Horngren & Harrison, 2009). If the decision passes that first test then a second test may subsequently be useful. Even if absolute magnitude cannot be attached to cost and benefits, a comparison between alternatives may yet be possible and useful. Decision on whether to accept or reject the order is cost effective only if the perceived profit of accepting that order exceeds the anticipated cost for customizing the child trolleys. The other non-financial factors to consider include; I. The availability of direct raw materials for the manufacture of the additional trolleys II. The quality of the brakes made by buying the equipment to make the brakes and add the brakes to the trolleys themselves compared to the quality of the brakes bought from a supplier and added to the trolleys. III. The impact of the employees of the firm and the trade union reactions to the decision made by the CEO to buy the brakes from external supplier instead of buying the equipment to make the brakes and add the brakes to the trolleys themselves. References Horngren, C. T., & Harrison, W. T. 2009. Accounting (7th ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Fess, E. and Warren, C., 2004. Accounting principles. Canada: Southwestern Company. Hilton, R. W., 2004. Managerial Accounting: Creating Value in a Dynamic Business Environment. New Delhi: McGraw-Hill Publisher. Read More