(REF TO EXCEL DOCUMENT ATTACHED FOR COMPUTATION)
In order to ensure maximum returns to a company, a management accountant must ensure that goods are produced at the lowest cost possible so as to increase the margin of profit attributable to each product.Companys are however faced with the problem of deciding what particular products can be profitably produced in house, and those that should be sourced from outside suppliers given the given cost requirements of each product.
In deciding the proper mix of the products that should either be produced or sourced from outside suppliers, a management accountant has to determine the contribution margin of each product using the contribution statement. This is a tool used to determine the contribution of each particular product. Contribution is arrived at by deducting the variable costs from the selling price. In case of products that are to be bought from outside suppliers, a marginal cost statement is prepared which enable the management accountant to identify the marginal costs applicable to these particular products since such products are not available for sale (Drury, 2012). The contribution margin of each product per unit of the limiting factor is then determined.
A decision on what is to be produced and what is to be bought is reached through ranking all the products depending on the contribution margin per hour for goods to be produced and the cost saving per hour in the case of goods available from outside supplies as outlined in the attached document.
In deciding whether to buy or produce product Y and Z, We compare the marginal cost and buying price, in this case, both product are to be produced( Atrill & McLaney,2009). But we have a limiting factor which is the special machine hours; therefore we have to choose between producing W& X, We also have to consider the cost savings resulting from buying product Y and Z or producing them against the contributions of Wand X. For instance, X has the highest contribution of all. Between W and Z, producing W we get a contribution of 110 per hour but cost savings of producing of Z is 150 per hour, we had rather produce Z than buy it if there is a cost saving of 150 per hour than produce W and get a contribution of 110 per hour.
Using these accounting tools, one is therefore able to determine best products mix that maximizes profitability to the company. In some cases however, a company may decide to produce a product that is not profitable but that which may have other value to the company besides profitability.
For instance, a company may decide to produce a commodity that is a crowd puller for the company’s goods regardless of the profit considerations. This is a product that draws people to the company’s other profitable product and thus cannot be discontinued even if its not profitable.
In making the above decision, a number of assumptions have to be made. These include:
It’s assumed that there is only one objectively identifiable limiting factor. This may not practically be true since in real life situations, a company is always confronted with other issues that need to be taken into consideration when deciding what products to produce such as maximization of returns and reduction of risks
There is also the unrealistic assumption that prices will remain constant in the relevant time horizon. Accountants agree that this may not be feasible since product prices are determined by the forces of demand and supply and also by the prices of other products in the markets among other determinants.
There is also an assumption that everything that is produced will find its way to the market and will be sold. Sometimes, products are never sold and may be damaged or simply become obsolete. This therefore renders this assumption unrealistic (Lucas & Rafferty, 2008)
Variable costs are also assumed to be constant in the relevant period. This may not be true since most of the variable costs are likely to change very frequently.
Solving the problem of special machine hours
Since the special machine is only available for 6,000 hours, the cost accountant must make the maximum use of the available hours to attain the best results. This will involve producing the products that have the highest contribution per hour of the limiting factor. This is because; machine hours being the limiting factor cannot be increased and can only be profitably utilized.
References
Atrill, P. & McLaney, E., 2009 Management accounting for decision makers. 6th ed. Harlow, England: Financial Times/Prentice Hall.
Lucas, M. & Rafferty., J. 2008‘Cost analysis for pricing: exploring the gap between theory and practice’, The British Accounting Review, 40 (2), pp. 148–160, Elsevier SD Freedom Collection [Online]. DOI: 10.1016/j.bar.2007.11.002 (Accessed 30 June 2009).
Drury C., 2012.Management and Cost Accounting .8th Edition. Cengage Learning
