Management Accounting: Justin PLC - Research Paper Example

JUSTIN PLC (a) Budgeted Profit ment for July 2007: Details Alice 100 Alice 300 Alice 700 Demand in Units 4000 8000 7000 Selling Price 200 240280 Sales Value 800,000 1,920,000 1,960,000 Variable Expenses: Material Cost 480,000 1,040,000 1,050,000 Direct Labour 24,000 62,400 78,400 Other Variable Overheads 24,000 67,200 89,600 Total Variable Expenses 528,000 1,169,600 1,218,000 Contribution 272,000 750,400 742,000 Direct Fixed Overheads 145,000 150,000 150,000 Other Fixed General Overheads 134,400 278,400 243,600 Total Fixed Expenses 279,400 428,400 393,600 Net Profit/Loss (7400) 322,000 348,400 Net Profit for July 2007: Net Loss from Alice 100 (7400) Net Profit from Alice 300 322,000 Net Profit from Alice 700 348,400 Net Profit for July 2007 663,000 Workings: Material Cost = No of Units X Material Cost per Product Unit Direct Labour Cost = No of Units X Labour Hours per Unit X Labour Hour Rate Other Variable Expenses = No of Units X Variable Overhead Rate/Labour Hour General Fixed Overheads: General Fixed Overheads per Machine Hour = Budgeted Total Fixed General Overhead Budgeted Machine Hours = 6,464,000 273,500 = 24/Machine Hour General Fixed Overhead per product = No of Units X Machine Hour per unit X 24 (b) Stopping the Manufacture of Alice 100: Based on the Budgeted profit statement for July 2007, the Managing Director's decision to stop the production of the product Alice 100 is correct as it is expected to make a net loss as per the budgeted statement. The Impact of Stopping the Product Alice 100 will be as below: Details Alice 300 Alice 700 Demand in Units 8000 7000 Selling Price 240 280 Sales Value 1,920,000 1,960,000 Variable Expenses: Material Cost 1,040,000 1,050,000 Direct Labour 62,400 78,400 Other Variable Overheads 67,200 89,600 Total Variable Expenses 1,169,600 1,218,000 Contribution 750,400 742,000 Direct Fixed Overheads 150,000 150,000 Other Fixed General Overheads 278,400 243,600 Total Fixed Expenses 428,400 393,600 Net Profit/Loss 322,000 348,400 Net Profit for July 2007: Net Profit from Alice 300 322,000 Net Profit from Alice 700 348,400 Net Profit for July 2007 670,400 (c) Labour Hours: Labour Hours Required: For Alice 300 8000 units @ 0.60 hours/unit = 4,800 Hours For Alice 700 7000 units @ o,80 hours/unit = 5,600 Hours Total Labour Hours Required = 10,400 Hours Labour Hours Available: Total Working Days for July 2007 = 22 days Total Number of employees = 80 No of working Hours per day = 8 Total number of working hours available = 22 X 80 X 8 = 14,080 Hours As against the required labour hours of 10,400, the company can afford 14,080 labour hours. Hence the labour hours are not a limiting factor. Note: The requirement of the labour hours has been worked based on the assumption that the product Alice 100 is removed from the product line. (d) Optimal Product Mix for July 2007: Considering the limited availability of the component R 5674 the optimal product mix can be illustrated as below: Option I Details Alice 300 Alice 700 Demand in Units 8000 7200 Selling Price 240 280 Sales Value 1,920,000 2,016,000 Variable Expenses: Material Cost 1,040,000 1,080,000 Direct Labour 62,400 80,640 Other Variable Overheads 67,200 92,160 Total Variable Expenses 1,169,600 1,252,800 Contribution 750,400 763,200 Direct Fixed Overheads 150,000 150,000 Other Fixed General Overheads 278,400 250,560 Total Fixed Expenses 428,400 400,560 Net Profit/Loss 322,000 362,640 Net Profit in the Revised Optimal Product Mix: Net Profit from Alice 300 322,000 Net Profit from Alice 700 362,640 Net Profit for July 2007 684,640 The above working is done on the assumption that product Alice 100 is stopped and no component of R 5674 will be used for its production. The distribution of the components over the two products Alice 300 and Alice 700 is arrived as below: Total Available Components: 60,000 Normal Budgeted Requirement: For Product Alice 300 8000 units X 3 components = 24,000 For Product Alice 700 7000 units X 5 components = 35,000 Total Normal Requirement = 59,000 Balance to be allotted 60,000 - 59,000 = 1,000 The Balance of 1000 components is allotted to Alice 700 on the basis of contribution margin per unit, since Alice 700 gives the maximum contribution as shown below: Contribution of Product Alice 300 = 750,400 No of units = 8,000 Contribution per unit = 93.80 Contribution of Product Alice 700 = 742,000 No of units = 7,000 Contribution per unit = 106.00 Option II If the remaining 1000 units are allotted to product Alice 300 it can produce additionally 333.33 units (rounded off to 330 units) the profits will be as shown below: Details Alice 300 Alice 700 Demand in Units 8330 7000 Selling Price 240 280 Sales Value 1,999,200 1,960,000 Variable Expenses: Material Cost 1,082,900 1,050,000 Direct Labour 64,974 78,400 Other Variable Overheads 69,972 89,600 Total Variable Expenses 1,217,846 1,218,000 Contribution 781,354 742,000 Direct Fixed Overheads 150,000 150,000 Other Fixed General Overheads 289,884 243,600 Total Fixed Expenses 439,884 393,600 Net Profit/Loss 341,470 348,400 Net Profit in the Alternative Optimal Product Mix: Net Profit from Alice 300 341,470 Net Profit from Alice 700 348,400 Net Profit for July 2007 689,870 Option III Alternatively if the remaining 1000 units are allotted to product Alice 100 the factory can produce 500 units of this product. In that situation the budgeted profitability would be like: Details Alice 100 Alice 300 Alice 700 Demand in Units 500 8000 7000 Selling Price 200 240 280 Sales Value 100,000 1,920,000 1,960,000 Variable Expenses: Material Cost 60,000 1,040,000 1,050,000 Direct Labour 3,000 62,400 78,400 Other Variable Overheads 3,000 67,200 89,600 Total Variable Expenses 66,000 1,169,600 1,218,000 Contribution 34,000 750,400 742,000 Direct Fixed Overheads 145,000 150,000 150,000 Other Fixed General Overheads 16,800 278,400 243,600 Total Fixed Expenses 161,800 428,400 393,600 Net Profit/Loss (127,800) 322,000 348,400 Net Profit for July 2007: Net Loss from Alice 100 (127,800) Net Profit from Alice 300 322,000 Net Profit from Alice 700 348,400 Net Profit for July 2007 542,600 Solution: Considering the three options option II is ideally the optimal product mix. Although the product Alice 700 provides higher contribution per unit, the profitability statement workings prove that the remaining units are to be allotted to product Alice 300 due to higher profit. This is due to the reason that Alice 300 is making the maximum number of products out of the critical component of R 5674 and results in more profitability. Hence producing 8330 units of Alice 300 and 7000 units of Alice 700 is the optimal product mix. The additional contribution both the products give as a result of allotting the balance 1000 units is shown below: Alice 300 330 additional units X 93.80 = 30,954 Alice 700 200 additional units X 106.00 = 21,200 (e) Development of Alternative Source for Component R 5674: In view of the shortage of the component R 5674 and inability of the manufacturer to produce and supply the component, there is the potential danger of the company's production being affected for want of this particular component in the line. As it appears that the current supplier would be able to resume his production and supply us the required quantity it is advisable that the company identify a prospective manufacturer who can meet the production needs of the company. However the following criteria should be kept in mind while selecting the new supplier: Quality: It is of utmost importance that the new supplier excels in the quality of the product so that there will be no potential damage to the quality of the company's final products. Reliability: Next to quality, the supplier should be extremely reliable in terms of timely delivery. Being an essential component for the manufacture of the company's products the reliability of the supplier for timely deliveries should be thoroughly verified with the record of performance with any other manufacturer with whom the supplier has business relationship. Price: Last but not the least the supplier selected should be able to meet the company's price standards, which is also an essential pre requisite. It is recommended that the selection for an alternative supplier may be undertaken as a permanent measure instead of as a stop gap arrangement, as it is always advisable to have alternative sources of supply. This issue should be addressed rather urgently as the production can pull on with the available components to meet the demands for months just before Christmas. There will be shortage of components for production during July 2007. If the company starts to develop the alternative supplier right away there will be sufficient time for trial runs and approvals. A periodic review of progress being made in this respect would avoid all potential bottlenecks in production at times of high demand. (f) Contribution to Overheads and Profits: Under Marginal Costing the contribution is arrived at by subtracting the total variable overheads from the sales revenue. In cases where there are different product lines and the fixed overheads cannot be precisely apportioned over the production units the contribution from the respective units towards profits and fixed expenses become a good measure for taking decisions about the optimal product mix and also to decide on the continuance of any product line. The management by reviewing the contribution margin from the different products would be able to arrive at the individual profitability of the products and decide on them. Relevant Cost: Relevant Costs are the costs that change with respect to the particular business decision taken by the management. When the future costs are considered, if in any way the future costs are going to be incurred irrespective of the change in the decision, then such future costs become irrelevant. On the other hand if the incurring of the future costs have some bearing on the decision, the future costs become relevant. Thus future costs may or may not be relevant while the sunk costs already incurred are irrelevant. "Including sunk costs in a decision can lead to a poor choice. However, including future irrelevant costs generally will not lead to a poor choice; it will only complicate the analysis."(Dennis Caplan) Thus the 'relevant costs' concept is being applied in a variety of situations including decisions that involve replacing equipment, making or buying a component, adding or dropping a product line, processing a joint product further and using a constrained resource. Any decision involving costs hinges on the proper identification and analysis of the costs that are relevant. "Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits are irrelevant and can and should be ignored" (Managerial Accounting) Opportunity Cost: Opportunity cost is the revenue foregone by selecting one alternative over the other. Opportunity cost represents the net revenue that could have been realized had the resource available been put to the next best use. Opportunity cost may thus be either the profit foregone by not taking the next best alternative or may represent the difference between the profit actually made by the decision taken and the profit foregone by not taking the nest best alternative. David R. Henderson defines opportunity cost as "When economists refer to the "opportunity cost" of a resource, they mean the value of the next-highest-valued alternative use of that resource." He further adds that the virtue of opportunity cost is to remind us that the cost of using a resource arises from the value of what it could be used for instead. The terms contribution, relevant cost and opportunity cost are related to one another and make a better support to the decision making process. Relevant costs are sometimes called incremental cost and actually include the opportunity cost. Opportunity costs are relevant cost that aids the management decisions by identifying the extent of revenue losses in alternative proposals. The contribution margin approach also has the same purpose of finding out the profitability of any product and objectively is related to opportunity cost. (g) Cost-Volume-Profit Relationship: Cost-Volume-Profit analysis or Break-Even analysis is used to compute the volume level at which total revenues are equal to total costs. When the total revenues and the total costs are equal the business is said to be 'breaking even'. "The analysis is based on a set of linear equations for a straight line and the separation of variable and fixed costs." (Enotes) The objective of cost-volume-profit relationship is to analyse the behaviour of total revenues, total costs, and operating income due to changes in the output level, selling price, variable costs per unit or fixed costs. The basic assumption behind this relationship is that either the variants for a single product situation is analysed or where multiple products are involved, the sales mix will remain constant even though there may be changes in the total number of units being sold. Similarly this concept assumes that there can be a comparison of accumulated costs and revenues irrespective of the time value of money. The major advantage of studying this relationship is that with the analysis, it is possible to examine the changes in operating income as a result of selling different quantities of one product or more number of units in a particular sales mix. It is precisely this aspect of cost-volume - profit relationship will become handy for deciding on a particular volume of business comprising of all the three products Alice 100,300 and 700. The management will be able to assess the extent of changes in the operating income when the volume of sales goes up by suitably modifying the variable and fixed cost components of the total cost. Calculation of Cost Volume Profit Ratio: The different parameters for arriving at the profit-volume ratio are calculated as below: Breakeven point in Units = Fixed Costs / Contribution per unit Break even point in Sales Revenue = Fixed Costs X Sales Price Unit /Contribution Per unit Profit Volume Ratio = Contribution per unit/Sales price per unit X 100 (Contribution to Sales Ratio) Margin of Safety = Existing or Expected sales - Break even sales / Existing or Expected sales X 100 Calculation of Cost-volume-Profit Ratio for Optimal Product Mix (Option II ) Details Alice 300 Alice 700 Demand in Units 8330 7000 Selling Price 240 280 Sales Value 1,999,200 1,960,000 Total Variable Expenses 1,217,846 1,218,000 Contribution 781,354 742,000 Contribution per unit 93.80 106.00 Total Fixed Expenses 439,884 393,600 Break Even Point in Units 4,690 3,714 Break Even Sales Value 1,125,600 1,039.920 Profit Volume Ratio 39.08% 37.86% Margin of Safety 43.70% 46.94% Calculation of Cost-Volume-Profit Ratio for Original Budgeted Sales for July 2007 (Excluding Product Alice 100) Details Alice 300 Alice 700 Demand in Units 8000 7000 Selling Price 240 280 Sales Value 1,920,000 1,960,000 Total Variable Expenses 1,169,600 1,218,000 Contribution 750,400 742,000 Contribution per unit 93.80 106.00 Total Fixed Expenses 428,400 393,600 Break Even Point in Units 4,568 3,714 Break Even Sales Value 1,096,320 1,039.920 Profit Volume Ratio 39.08% 37.86% Margin of Safety 42.90% 46.94% Reference: 1. David R. Henderson Opportunity Cost The Concise Encyclopedia of Economics http://www.econlib.org/LIBRARY/Enc/OpportunityCost.html 2. Dennis Caplan Management Accounting: Concepts and Techniques College of Business Oregon State University http://classes.bus.oregonstate.edu/ba422/Management%20Accounting%20Chapter%203.htm 3. Enotes.com Cost-Volume-Profit Analysis http://business.enotes.com/business-finance-encyclopedia/cost-volume-profit-analysis 4. Managerial Accounting Relevant Costs for Decision Making http://www.mhhe.com/business/accounting/garrison/Student/olc/garrison9emgracct_s/ch13s_cs.html Read More