Accounting Management - LifeSung Corporation - Case Study Example

LifeSung Corporation Name: Institution: Table of Contents 1.0 Introduction 3 2.0 Main Issues 3 2.1 Unspecified Sales Target 3 2.2 Indecision as to whether to drop Plasma B or Not 4 2.3 Microcontroller Department Issue 4 3.0 Original product cost and Activity based Cost 4 4.0 Cost-Volume-Profit analysis for multiple products 5 4.1 Advanced 5 4.2 Boosted 6 4.3 Custom 6 5.0 Assumption made when using CVP analysis 8 5.1 Constant Sales Price 9 5.2 A constant Sales mix 9 5.3 Total Fixed Costs are Constant 9 5.4 Everything produced is sold 9 5.4 Constant Variable Costs 10 6.0 Determination on Whether Plasma B should be closed or not 10 6.1 Breakeven Point 10 6.2 Analysis 13 7.0 Microcontroller Department 13 7.1 Strategic Factors 14 7.2 Technically Incapable 15 References 16 LifeSung Corporation 1.0 Introduction This report analyses the discussion from a departmental managers meeting that I attended of the LifeSung Corporation. The meeting involved four main personalities, James Cook who is the Sales Director, Gemma Watts, the Finance Manager, Thomas Chen from the Plasma Department and Alex Hu, head of the Microcontroller Department. Each and every department has a problem that is unique to it and accounting theory can be used to solve the deadlock that exists in the meeting. 2.0 Main Issues From the discussion, there were vivid issues that needed quick action so as to ensure the smooth running of the company. 2.1 Unspecified Sales Target One of the main issues was that there was no clear target for the sales department on the standard of sales that they were to achieve. This required that the sales department be given a proper target for them to achieve so the James Cook could influence the same spirit to his sales team. The finance manager tries to solve this by informing the sales manager that they will be advised on the amount of revenue that the company wants to be generated. It worth noting that specific meeting, no exact values were determined. 2.2 Indecision as to whether to drop Plasma B or Not The other main Issue that was raised in the discussion was whether to retain or to drop retain Plasma B which was not performing well compared to Plasma A. From the Gemma’s report, it was identified that Plasma was dragging down the performance of the entire department and this what brought about the dispute as to whether to drop it or to still stay with it. Only a proper accounting procedure and use of accounting tools and theories will help determine whether to retain or to do away with the plasma department. This will be achieved using techniques such as Cost-Volume –Profit Analysis or the Capital Budgeting techniques such as Net Present Value method. 2.3 Microcontroller Department Issue The Microcontroller Department had an even pressing issue that needed immediate attention on deciding whether to buy a new machine or not to buy the new machine. The other option of not buying the machine involves outsourcing the production of controller 457. This has a long run effect of employing more people from the department in case the machine is bought. 3.0 Original product cost and Activity based Cost From the analysis the selling price of the Advanced, Boosted and Custom were found to be 222, 540 and 732 dollars respectively, whereas the costs were to be 185,450 and 610 respectively. The sales mix also were organized in the same manner in the ratio of 60% to 30% to 10%. Monthly fixed costs amounted to 65,000 dollars. Head of the sales department later stated that the sales Department had to attain 2.8 million from the sales in the coming year. The Number of Units for each Advanced, Boosted and Custom So as to identify the number of units that are to be sold for each specific band, Cost Volume- Profit Analysis must be used. 4.0 Cost-Volume-Profit analysis for multiple products This method of Cost Volume analysis for many products was brought about since many organizations do sell a combination of different services and products. However this analysis will enable us determine the number of units for each brand. Calculations In this case we have been given the value of target sales, 2,800,000. The value was not specified as to whether it was before tax or after tax. This value is the net profit after tax since the company’s previous quarterly financial report has a value of 1.065million and it is likely that the company is targeting more money since it is still growing. 4.1 Advanced The advanced product, has a sales mix of 60% and Cost of 185 dollars. From the analysis, the cost is 12 month multiplied by 65,000, the average monthly cost. 12 * 65,000 = 780,000 Profit = Total Revenue - Total cost. Total revenue = 2,800,000 Total Cost = 780,000 2,800,000 – 780,000 = 2,020,000 Tax = 30% 30% 0f 2,020,000 = 606,000 2,020,000 – 606,000 = 1,414,000 Advance = 60 / 100 * 1,414,000 = 848,400 Number of units = 848,400 / 222.0 = 3,821.62 3,821.62 units 4.2 Boosted 30/100 * 1,414,000 = 424,200 dollars Boosted occupied 424,200 of the total sales. To identify the number of units of Boosted that were sold to achieve the total sales, we divide the sales (424,200 dollars) by the selling price which is 540 dollars. 424,200 / 540 = 785.56 This therefore brings the total units for the Booted at 785.56 4.3 Custom This is the final number of units to be determined and the same procedure is used in this scenario. The percentage in sales mix is 10 % and the selling price is 732 dollars which is the highest price. From this it can be identified this was the least number of units that was sold, considering the selling price and the percentage in the market. To determine the share in the market, we get the 10 percent of the total 2,020,000. 10/100 * 1,414,000 = 141,400 To get the number of units that was sold, the value 141,400 is divided by the selling price 732.00. 141,400 / 732 = 193.17 = 193.17 Units. The total number of units is the sum of all the units and in this case it is 3,821.62 + 785.56 + 193.17. When the value is rounded off to the nearest thousand it becomes 4,800 units. Importance of Tax in the Calculation of the Number of Units Tax plays an important role in the financial statements and getting to know the revenue that a company has accumulated be it for a quarter analysis, midyear analysis or the End year analysis. Tax is perceived as a cost to the business and is therefore deducted from the gross profit so as to be able to get the net profit. Income in which the tax has not been deducted is always refered to as Earnings before Interest and taxes famously refered to EBIT. In this case it was vital to identify with the taxation value so as to understand whether to summit or to deduct to enable us determine the exact value or the number of units that were sold by the sales department. From the calculations above it is vivid that the tax implications are factored in the calculation of the units to be sold so as to achieve the target revenue that the Finance Department has set out for the sales department. So as to get the number of units one as to subtract the total cost and the income taxes which is 30% of the pre-tax income. After making all the deductions including the tax our value became 1,414,000, hence the value that was to be used in all other calculations. The Formula the is used in such scenario includes; After tax profit = Pre – Tax profit – Taxes Taxes = Tax rate * Pre-tax Profit We substitute the figure back to the main equation and this becomes =Pre-tax profit – [tax rate * pre-tax profit] After tax profit = Pre-tax profit * (1- tax rate) 5.0 Assumption made when using CVP analysis When carrying out a Cost- Volume- Profit Analysis, it is important to understand that there are certain assumption that work along with it. These assumptions are what makes the concept of Cost-Volume Analysis to hold1. The assumption only make the work easier and are at times refered to as linearizing assumptions and are mainly applicable at the elementary analysis of profits and costs. In the advanced treatment of Cost-Volume Profit Analysis, the revenues and costs are considered as non-linear and the analysis is perceived to be more complicated2. 5.1 Constant Sales Price This is one of the main assumptions that are used in the calculation of CVP analysis. Under this assumption, the sales price is presumed to be always constant in all situations. This is done so as to ensure consistency in the calculation3. 5.2 A constant Sales mix Under this assumption, the sales mix is perceived to constant for a long period of time when involved in the calculation when in actual sense we know that the sales mix cannot be constant for even a whole financial year4. 5.3 Total Fixed Costs are Constant The other assumption that holds in the CVP analysis is the fact that the total fixed costs are always constant even across departments in the institution. This is vividly evident in this specific question where the fixed costs are perceived to be constant across Plasma A and Plasma B. 5.4 Everything produced is sold When using the CVP analysis, it is perceived that everything that is produced by the company is wholly sold during the stipulated financial period which is not always the case in the real life scenario. 5.4 Constant Variable Costs Cost- Volume-Profit Analysis perceives the variable costs of any institution using this method to be constant a fact that is not even from the very definition of the term variable costs. 6.0 Determination on Whether Plasma B should be closed or not Before arriving to the decision as to whether to Plasma B should remain operational or be closed, it is important that the Accounting tools of decision making are used in determine the whether to retain it or not. 6.1 Breakeven Point The Break Even Point refers to the point where the total revenues of a company are equal to the costs incurred by the company in the production process. This is the point where there is neither profit nor is there any loss incurred by the business. In this scenario, the net profit is equal to zero. Using this knowledge to analyse Plasma B, it is Right to infer that Plasma B has no Breakeven point neither does it make profits since the net income is not zero but -200,000 dollars. Break Even Formulas There are certain formulas that are used in determining the units of the breakeven point. Break-even point = Fixed costs / Unit Contribution margin Break-even point (sales in dollars) = Fixed costs / Unit contribution margin ratio These formulas can be used as checks and balances on the stated financial statements So as to calculate it, we must first identify the contribution margin. Contribution margin = Total Fixed Costs / Sales. Total Fixed Costs (for plasma B) = Summation of Fixed wages + Fixed overhead Total Fixed Costs = 84,000 + 164,000 = 248,000 Sales = 1,250,000 Contribution margin = 248,000 / 1,250,000 = 0.2 = 0.2 * 100% = 20% The value of the contribution margin = Sales – Variable Cost Sales = 1,250,000; Variable cost = 310,000 +124,000 = 434,000 Contribution margin = 1,250,000 – 434,000 = 816,000 Breakeven point = Fixed Cost / Contribution Margin Break Even Point= 248,000 / 816,000 = 0.3 Breakeven point = 0.3 From the analysis, the breakeven point is below 1 indicating the the Plasma B is not profitable. The CVP Analysis Formula PX = V +FC + Profit In this scenario, P is the unit price, v represents the variable costs, x shows the total number of units that have been produced and sold and FC represents the Fixed Costs From our calculations above we were (on the first question) we were able to obtain the total number of goods that were sold. The total number was 4800 units. The variable cost = 434,000; the fixed costs = 248,000 and the profit in Plasma B = - 200,000 P (4800) = 434,000 +248,000 – 200,000 P (4800) = 482,000 P = 482,000 / 4800 = 100.42 P= 100.42 Variable cost per unit = 434,000 / 4,800 The average variable cost = 90.42 The total fixed costs = 248,000 Average fixed costs per unit = 248,000 / 4800 = 51.67 Profit = P – fixed costs – variable costs 100.42 – 90.42 - 51.67 = -42.09 6.2 Analysis From the various analysis carried out it Plasma B has proven not to have any breakeven point. The initial calculation of determining the breakeven point showed that the value of the Breakeven point was below 1.0 and this can used to infer that the department didn’t break even5. Plasma B should be closed and since the company investing plenty of money but with no positive returns on its investment. It is therefore important that the company closes down Plasma B so as to enable the business save on other variable costs that are associated with Plasma B. Such funds can be invested in other areas of the business such as the new project that is planned by the Micro controller Department. The other investment is that the company can use the funds that as savings and also keep the business be liquid. 7.0 Microcontroller Department The Microcontroller Department is undecided as to whether start the production of controller 457 or to contract the APG Technology to carry out the production on its behalf. The department in charge is already running its machine at the full capacity. However the main contention lies on the in the cost of production in that the cost of production under the microcontroller department is 100.50 per unit and the cost of production under the APG Technology is 68.00 per unit. Under this analysis, the total cost of production for the department in the last quarter is 1,005,000 dollars. This production is for 10,000 units This means the cost of production for an individual unit is the Total cost / Number of Units 1,005,000 / 10,000 = 100.5 68.00 * 10,000 = 680,000 1,005,000 – 680,000 = 325,000 This situations are refered to as information for decisions and involve formulating decisions after considering relevant benefits and costs6. These choices involve making or buying a product. In these situations it is important to consider the avoidable costs versus the unavoidable costs. This means that there are costs that the business may choose to avoid for the greater benefit of the business and also save itself from the rigidities that are involved in its production and marketing. One of such choices is this, under this situation it is important that the company avoids the costs that are involved with the production of the production of controller 457. 7.1 Strategic Factors The other consideration should be the strategic issues. Examples of the strategic factors to be considered include, the quality of the product, ability of the supplier to keep confidential information, technical capabilities and labour relations. All these factors influence the decisions cumulatively 4. It is vivid that the Department’s variable and fixed costs are extremely high hence disadvantaging the Microcontroller Department. A keen analysis of the costs involved show that the variable overheads are 50% of the labour costs, the fixed overhead are 100 % of labour costs hence the total overhead costs are equal to 150% of the labour costs. 7.2 Technically Incapable The Department is technically incapable in the production of controller 457 since it is a new product and it will therefore take long before the department streamlines the production and therefore it is important that the company contracts APG to deal with its production. APG has several years’ experience in the production and hence able to significantly reduce its production costs7. However the company should not enter into the contract blindly but rather consider some of the regulations that are involved and should be able to trust the contracted company. Conclusion The report has analysed and identified the number of units that are required to be sold so as to meet the targets set by the Microcontroller Department, explained the importance of tax in the calculation of the number of units that are required to be sold so as to earn profit. The assumptions associated with Cost-Volume-Profits analysis are analysed in details. The report concluded that Plasma B should be done away with since it creates more burden to the company. The calculation and analyses identified that Plasma B didn’t break even. The Microcontroller Department should contract APG Company to carry out the production of the controller. From the analysis it was identified that the company and the Department lacked the capability to handle the production of controller 457. The factors that inhibit its production are discussed in detail in the report. References Caf10: , (Cafferky and Wentworth 2010), Aor10: , (Aora 2010), Shi00: , (Shim and Siegel 2000), Tho141: , (Thorne and Hilton 2014), Sha05: , (Shapiro 2005), Read More