Management Accounting
Step 1:
Question 1:
The total variable cost for the company comprises of manufacturing costs and sales and administrative cost. Accounting both, the total variable costs for the firm was calculated at $10 per unit
Question 2:
The total production costs for any organization is bifurcated as fixed costs and variable costs. Important to note, while the variable costs and output carry a direct and proportional relationship, fixed cost is not related to output level and remains constant throughout. In other words, while the variable costs increase in proportion to the increase in output level, fixed cost does not change and remains constant. Example of fixed costs are, building rent, lightning charges, while cost of raw material and hourly wages represents variable costs.
Question 3:
-Contribution Margin: Sales- Variable Costs
= 20-(8+2)
= $10/unit
-Contribution Margin: (Sales-Variable Cost)/Sales
= (20-10)/20
= 50%
-Break-Even(In units): Fixed Costs/(Sales- Variable Cost)
= 90000/(20-10)
= 9000 units
-Break-Even(In Dollars): Fixed Costs/Contribution Margin Ratio
= 90000/0.50
= $180000
Question 4:
= (90000+(20000*10))/20000
= $14.5 per unit
Question 5:
Average cost represents the cost attributed to a unit of product produced by the entity. Important to note, every manufacturing entity, thrives to generate lower average cost as the same is a potent source of competitive advantage.
Average costs shares a unique relationship with fixed cost as well as variable costs. As for fixed cost, as the company increase its production, average fixed costs keep on diminishing, however, it never reaches zero as the fixed cost will always prevail no matter what is the production level of the company. It is considerable that the reason for declining average fixed costs is the allocation of constant fixed costs over the increasing number of production units.
On the other hand, the average variable costs is responsive to the law of variable proportion and thus attains the U-shape. In other words, as the company adds more labor to the production arena, initially, the average costs decreases. However, as the company keep on adding more and more labor keeping other factors constant while keeping other factors of production at the constant level, the optimal ratio between the fixed factors and variable factors get disturbed and the average variable costs start increasing.
Question 6: Prepare a pro-forma income statement AND a CVP graph for the Company under the current production level. What is the current operating profit?
In the above two graphs, X-axis represents revenue figures, while the Y-axis represents expenses.
Step 2:
The Company’s sales manager just received a large order from a new customer for 10,000 units at a price of $15 each, $5 less than the standard selling price. The new customer promised to place the same ordered quantity every year if he was satisfied with the quality of the product. Remember that the price offered equates the Company’s current average cost per unit. Through a little investigating, you determined that you’ll need to spend another $50,000 to purchase an equipment (a fixed cost capital expenditure) to enable you to produce the additional 10,000 units at the same current variable cost of $10 each. The equipment has a five year useful life. If placed in service in the current year, full year depreciation will be charged to income in the current year.
Question 7:
Incremental revenue encompasses the additional revenue generated by the company on account of any change in the production process or on account of receiving new order. On the other hand, incremental costs is the additional cost attributed to the change in the production process.
In the given scenario, the incremental revenue is related to additional sales from the new customers and accounts for $150000 every year. On the other hand, the incremental costs is related to the increase in the variable cost associated with the production of 15000 units ordered by new customer and a capital investment of $50000 for the purchase of new equipment
Question 8:
Yes, definitely. If the company accepts the new order, out of the total selling price of $15/unit, $10 will be absorbed by variable overheads. Therefore, the remaining $5 will have to be used for breakeven on fixed costs.
Question 9:
Income Statement without new order:
Income Statement without new order:
Question 10:
Yes, the company should accept the new project because even though it might breakeven in terms of new order, however, since it is able to keep its variable costs at the similar level and also because it is able to allocate the existing fixed costs to more units, the company is able to generate an additional profit of $40000 compared to the original scenario. Hence, it should accept the new order.
Question 11:
Current year contribution margin income statement:
Forecasted contribution margin income statement(Next six years):
Question 12:
Original Scenario:
CVP graph including the new order:
In the above two graphs, X-axis represents revenue figures, while the Y-axis represents expenses. As we may witness, the firm will achieve break-even point when revenue figures are equal to total costs. Therafter, any sales volume will add to profit level of the company. The relationship between break-even point, fixed costs, revenue and variable cost is established through following expression:
Break-even point: Total fixed costs/(Sales-Variable Costs)
Question 13:
Referring to the current year income statement, we can see hat even if the company accepts the new order, the profit figure of $150000 is still relatively lower than the target level of $220000. Therefore, the CEO should consider the following recommendation that will increase the profit levels of the company:
i)Higher sales volume/Additional Production
The company has recently spent $50000 for purchase of a machinery to facilitate additional product and to keep the variable cost at $10/unit. It is considerable that even if the company increase the production level further, the machine will help in keeping the variable cost at the current level, and accordingly, the company can increase the contribution margin through increased sales volume. Another point to be considered here is that by increasing its production level, the company will also be able to allocate the fixed costs to additional units, and this will also enhance the profitability of the company.
ii)Employee Training
Apart from focusing on generating additional sales volume, the company can also consider investment in training its employees and increasing their productivity, which eventually lower down the per unit variable costs of the company. Some of the methods through which the company can consider the employee training are:
Hiring outside professionals to educate the employees within the factory premises
Forming employee batches and sending them outside for simulation training on new equipments
An appropriate training program will allow the employees to produce the product at a lower variable cost, and this will result in increased profits figures for the company.
References
Bejada, C. (2012). The Costs of Production. In C. B. all, Economic Principles (pp. 83-105). Mcgraw Hill.
Cost Volume Profit Analysis. (n.d.). Retrieved February 26, 2016, from http://accountingexplained.com/managerial/cvp-analysis/
