MBA 6004 – MANAGEMENT AND FINANCE ACCOUNTING

MBA 6004 – MANAGEMENT AND FINANCE ACCOUNTING

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Introduction

The pages below contain a report that is written in the capacity of the management accountant of the case study organization. The overall aim of the report is to provide analysis related to a variety of issues to the organizational management and suggest recommendations to the company. In the present scenario, the case study organization is contemplating a strategic decision to develop a new plant and expand the overall production lines in the business.

In this regard, this report would carry out a series of calculations based on the given data and questions. The generated answers to these questions would assist in the development of the suitable response, advice, and suggestions to the company management. Mainly, break-even analysis of the current and the future cost and revenue information for the company would be carried out.

Q1

1. CM ratio and BEP (in seats)

CM ratio = (Bragg, 2024)

Contribution per seat = Selling price per seat – variable cost per seat

= $ 25 - $ 15

= $ 10

Thus, CM ratio = × 100 = 40%

BEP (in seats) = (Fatmawatie, 2021; Rizki & Sukoco, 2019)

Where, Fixed cost = $ 210,000

BEP (in seats) = = 21,000.

Thus, enterprise needs to sell 21,000 seats to break even.

2. Degree of operating leverage (DOL) at last year sales level

DOL = (Bragg, 2024a)

= = 3.33

Q2

Revised variable cost = $ 15 + $ 3 = $ 18

Thus, revised contribution per seat = $ 25 - $ 18 = $ 7

Revised CM ratio will be = = 28%.

BEP (in seats) = = 30,000.

Therefore, if the variable expense increases by $ 3 per seat, the company would have to sell 30,000 seats to break even i.e. 9,000 more than the previous level.

Q3

Desired net operating income = $ 90,000

Required sales to earn desired net income =

=

= 42,857.14 seats

The computations above suggest that the company need to sell at least 42,857 seats (approx.) to earn a NOI equal to $ 90,000.

Q4

As calculated in Q1 above, the CM ratio during previous year was 40%. In other words, contribution was 40% of the total sales made by the firm. In other words, the variable cost was 60% of the sales.

Therefore, if the same CM ratio is to be maintained in the current year, the revised variable cost must be 60% of the new selling price.

Revised variable cost = $ 18 per seat

So, new selling price would be = = $ 30.00

It is, therefore, estimated that the management must raise the selling price per seat to $ 30.00 to ensure that the variable costs are covered.

Q5

Variable expense per seat under new plant = $ 15.00 – 40% = $ 9.00.

Total fixed costs under new plant = $ 210,000 × 2 = $ 420,000.

New CM ratio =

= 64%

New BEP (in seats) =

= $ 26,250 seats

Q6

1. Sales to earn NOI of $ 90,000 under new plan

The use of formula for required sales for desired profit would be used here as well. The computations have been shown below -

=

= 31,875 seats

Thus, the organisation needs to sell 31,875 seats to ensure that the NOI after construction of new plant is $ 90,000.

2. Contribution format income statement

Particulars	Amount ($)
Sales	750,000
Less: variable costs	270,000
Contribution margin	480,000
Less: Fixed costs	420,000
NOI	60,000

DOL = (Bragg, 2024a)

= = 8 times

3. The results that have been presented above helps in concluding that the enterprise should not entertain the idea of construction of the plan further. The main reasons behind this suggestion have been outlined below –

• Going ahead with construction of new plant would mean that the overall NOI would reduce by 33.33%.

• Though fixed costs would drop by 40%, the new plant alternative would mean that the fixed costs would be doubled. This is highly risky as even if the organization does not sell a single seat, it would have to bear whole fixed cost of $ 420,000.

• The degree of operating leverage has also increased from 3.33 times to 8.00 times which shows that the proportion of fixed costs to total costs would increase significantly if the plant is built. This would lower firm’s profitability further.

Q7

The product margin for ‘protector’ and ‘booster’ seats have been calculated below –

Details	Protector Seats		Booster Seats
	unit ($)	Total ($)	unit ($)	Total ($)
Production and Sales	20000		80000
Sale Value	140.00	2800000.00	99.00	7920000.00
Less: Variable expenses
Direct Material	72.00	1440000.00	53.00	4240000.00
Direct Labour	24.00	480000.00	12.00	960000.00
Direct Manufacturing overhead *	16.50	660000.00	16.50	1320000.00
Total Variable cost	112.50	2580000.00	81.50	6520000.00
Contribution Margin	27.50	220000.00	17.50	1400000.00

Therefore, the respective margin under the traditional costing method for protector and booster is $ 220,000 and $ 1,400,000.

*The calculation with respect to direct manufacturing overhead has been shown below –

Hourly manufacturing overhead rate = $ 1980000/ 120000 = $ 16.5 per hour

Direct labour hours for –

Booster = 80,000 × 1 = 80,000 DLH

Protector = 20,000 × 2 = 40,000 DLH

Thus, the charged MOH to the different seats would be –

Booster = 80,000 DLH × 16.5 per hour = $ 1,320,000

Protector = 40,000 DLH × 16.5 per hour = $ 660,000

Q8

The calculation of the product margins for both types of seats has been shown below –

Details	Protector Seats		Booster Seats
	unit ($)	Total ($)	unit ($)	Total ($)
Production and Sales	20000		80000
Sale Value	140.00	2800000	99.00	7920000
Less: Variable expenses
Direct Material	72.00	1440000	53.00	4240000
Direct Labour	24.00	480000	12.00	960000
Direct Manufacturing overhead (WN)	44.62	892400	12.36	988600
Total Variable cost	140.62	2812400	77.36	6188600
Contribution Margin	-0.62	-12400	21.64	1731400

The note for distribution of overhead has been shown below –

Activity	Basis of apportionment	Total cost ($)	Protector ($)	Booster ($)
Supporting direct labour	40000/80000	783600	261200	522400
Batch setup	200/100	495000	330000	165000
Product sustaining	Equal	602400	301200	301200

Q9

A qualitative comparative account of the manner in which cost has been assigned under the two methods has been explained show and explained below –

Details	Protector ($)	Booster ($)	Difference ($)
Traditional costing method	660000	1320000	660000
Activity based costing method	892400	988600	96200
Difference ($)	232400	-331400

The summary table above that has been presented above shows the total amount of cost assigned to the booster and protector items for the company. As can be clearly seen in the table above the total amount that has been allocated to booster items is more in case of both the methods. More apparently, amount allocated to booster seats is $ 660,000 more in comparison to the protector seats. In addition to this, the excess amount that has been charged under the ABC method to the booster seats is $ 96,200.

The table above also provides information about the manner in which the overheads have been allocated to the two seats under the different products. The amount that has been presented in the above table shows that activity based costing method would clearly benefit the overall cost for the booster seats. For instance, the excess cost allocation under ABC for the protector seats would be as high as $ 232,400 while for the booster seats the total overhead would get reduced by $ 331,400.

The classification below further classifies the main points of differences between the traditional method and the ABC method –

Traditional costing	ABC costing
One of the highlighting features of this method is that costs related to material and labour is apportioned directly to the final products. In other words, it can also be said that these costs are allocated on the basis of the volume based driver (Wall Street Mojo, 2024). The other overheads such as those associated to production are charged to the final units based on the labour hours. Thus, there is only one rate that is used for overhead allocation in this method.	The process of overhead allocation, however, is highly different than the traditional one. The mechanism of overhead apportionment initiates with the identification of the all major activities associated to production in an enterprise. Subsequently, the manufacturing overheads are allocated to the final product (Wall Street Mojo, 2024).. This is made on the basis of the ascertainment of a suitable driver based on which the overhead allocation is made. The overall drivers that each of the activity in the business consumes are used for allocation of overheads.
It is also important to differentiate the two methods on the basis of the manner in which the costs and overhead that are not related to production are treated. The traditional costing method is the one that completely ignores these costs. In simple words, there is no allocation of the non-manufacturing cost under the traditional method (Wall Street Mojo, 2024). It is one of the main reasons this method is considered to be less accurate in comparison to the ABC method.	The treatment of the costs not associated directly to production, however, is different under the ABC costing method. This is the method that ensures that all the costs whether associated to production or not get reflected in the books of accounts of the business enterprise as a whole.
As has been explained above as well, the traditional costing approach only makes use of single driver and rate for the allocation of the overheads to the final units.	The situation in the case of ABC costing method is different as this is the method that ensures that all the costs are allocated based on suitable and relevant drivers. This is the method that makes sure that both volumes related and non volume cost drivers are used to apportion the overheads.

Q10

The cash collection for the period April to June and in total has been shown in the table below –

Details	April	May	June
Collected Cash
March Sales	120000	16000	-
April Sales	90000	180000	24000
May Sales	-	120000	240000
June Sales	-	-	75000
Total	210000	316000	339000

Q11

The below table presents the cash budget for the quarterly period April to June –

Details	April	May	June	Total
Cash Receipts
Loan from bank	30000	-	-	30000
Collection from accounts receivable	210000	316000	339000	865000
Total Cash Receipts	240000	316000	339000	895000
Cash Payments
Purchase of raw material	140000	210000	160000	510000
Payroll	20000	20000	18000	58000
Lease payments	22000	22000	22000	66000
Advertising	60000	60000	50000	170000
Purchase of equipment	-	-	65000	65000
Principal amount repaid	-	-	30000	30000
Interest amount repaid	-	-	1200	1200
Total Cash Payments	242000	312000	346200	900200
Net Cash Generated	-2000	4000	-7200	-5200
Cash balance - Opening	24000	22000	26000	24000
Cash balance - Closing	22000	26000	18800	18800

Q12

As has been depicted in the above quarterly cash budget, the repayment of the loan taken from bank commences from the month of June which is the last month of the quarter. The resulting effect of this decision by the company management is that the organization will be left with the following final closing balance at the end of each month –

April – $ 24,000

May – $ 22,000

June - $ 26,000

It is; therefore, clear that the organisation will be able to have a minimum cash balance of $ 20,000 at the commencement of each month during the quarter. Therefore, there will be no difficulty to the company to repay the loan in the planned manner.

Q13

The calculation of the required variances for the June month has been shown below –

1. Material price and quantity variances

Price

= (Standard price – Actual price) × Actual quantity

= (5.00 – 4.95) × 60,000

= 3,000 (Favourable)

Quantity

= (Standard quantity – Actual quantity) × Actual price (Lasker, 2022)

= (45,000 – 49,200) × $ 5

= 21,000 (Adverse)

Note –

Standard quantity (for actual output) = 15000 × 3 kg/seat = 45,000

2. Labour rate and efficiency variance

Rate

= (Standard Rate – Actual Rate) × Actual Hours (Chron, 2020)

= (16 – 17) × 11,800

= 11,800 (Adverse)

Efficiency

= (Standard Hours – Actual Hours) × Standard Rate

= (12,000 – 11,800) × 16

= 3,200 (Favourable)

3. Variable overhead spending and efficiency variances

Spending (Goedl, 2020)

= (Standard Rate – Actual Rate) × Actual Hours

= (3.00 – 3.10) × 5,900

= 590 (Adverse)

Efficiency

= (Standard Hours – Actual Hours) × Standard Rate

= (6,000 – 5,900) × $ 3

= 300 (Favourable)

Note –

Actual Rate = $ 18,290/ $ 5,900 = $ 3.10

Q14

The below table represents the summary table for the different types of the variances that have been computed for the month of June -

Details	Individual ($)	Total ($)
Material Variance
Price	3000
Quantity	-21000
Net		-18000
Labour variance
Rate	-11800
Efficiency	3200
Total		-8600
Variable overhead variance
Spending	-590
Efficiency	300
Net		-290
Net variance (June)		-26890

As can be seen on the above summary statement the final variance has been calculated to be $ 26,890 (Adverse). This shows that actual costs incurred by the company were $ 26,890 higher than expected. Consequently, the organization is unable to accomplish the target profit of $ 6,000. If the adverse variance would have been limited up to just $ 6,000 - $ 26,890 = - $ 20,890 then the profit in sight of the enterprise could have been accomplished.

Q15

The below points outline the two most significant variances for the company. A discussion on the possible reasons behind the occurrence of these variances have been explained below –

Labour rate variance

The estimations suggest that the value of this variance during June is $ 11,800 (adverse). The organization spent $ 11,800 more than the expected amount due to variation in the rate at which labour was paid. This variance comes under the category of variances that a business does not have much control on. This is so because the rate at which an organization pays the labour is decided by the market forces (Dandago & Adah, 2013). Thus, there lies a strong possibility that the negative variance occurred due to inability of the manager to establish clear communication and strong negotiation with workers.

Material Quantity variance

The estimated variance of 21,000 (adverse) might have occurred due to use of inferior quality material in production. The produced units, therefore, were lesser than expected. To ensure that the organization meets the production target, the company had to ensure additional materials are employed.

Q16

As a part of the future expansion plan of the company, the management of point piper contemplated the development and construction of a new plant. The company intended to use two new production lines – Booster seats and Protector seats under the new plant. The available information concerning the variation in costs for company under the new plant suggested that while Point piper will be able to reduce its variable costs by 40%, the costs and expenses of fixed nature would be double if the said plant is constructed. The new VC per unit and fixed costs were assessed to be $ 9 and $ 420,000 respectively.

The main computations associated to Break even analysis related to the new plant was done with respect to the contribution margin for the company if the new plant is built. The company was currently operating at a level where the contribution was 40% of total revenue. However, the construction plan was expected to raise the margin to as high as 64%.

One major negative that was identified with respect to the plan under contemplation of the company was that it lowered the overall NOI of the company. An analysis and evaluation associated to the projected profitability of the project was also done based on estimated NOI from the new plan. The company currently sold 30,000 seats and used the same level as a measure of profitability in the coming year. The calculations revealed that the final NOI under the new plan for the enterprise would be $ 60,000. This was significantly lower than the existing ROI of $ 90,000. Also, as opposed to existing BEP of 21,000 seats, the company was expected to sell a minimum of 26,250 seats under this plan just to break even.

The above discussion highlights the positives and negatives of the construction of the new plant for the company. It is apparent that the negatives related to economic impact of this plan outweigh the benefits that the organization would be able to enjoy if the plant is constructed. Therefore, as far as the best interest of the company is concerned, the company should not entertain the thought of constructing the plant. If the same is done, the operating income of the business is expected to be impacted negatively and significantly. For instance, the pressure of fixed expense would be double that the company would have to bear even in the case when the company does not sell even a single seat in the coming period. It is therefore, suggested that the company should continue with the current plant and should attempt to develop strategies that assist the business control costs and raise profits in the coming period.

References

Bragg, S. (2024). Contribution margin ratio definition. [Online]. Accounting Tools. Available at: https://www.accountingtools.com/articles/contribution-margin-ratio. [Retrieved: 6th October 2024].

Bragg, S. (2024a), Operating leverage definition. [Online]. Accounting Tools. Available at: https://www.accountingtools.com/articles/operating-leverage. [Retrieved: 6th October 2024].

Chron. (2020). Comparison of Labor Price Variance vs. Labor Efficiency Variance. [Online]. Chron. Available at: https://smallbusiness.chron.com/comparison-labor-price-variance-vs-labor-efficiency-variance-39340.html. [Retrieved: 6th October 2024].

Dandago, K. I., & Adah, A. (2013). The Relevance of Variance Analysis in Managerial Cost Control. Journal of Finance and Investment Analysis, 2(1), 61-67.

Fatmawatie, N. (2021). Implementation of Break Event Point Analysis andMargin of Safety in Profit Planning. IDAROTUNA: Jurnal Adminstrative Science, 2(2), 132-146.

Goedl, P. (2020). Standard Costs and Variance Analysis. Principles of Managerial Accounting.

Lasker, R. (2022). How to Calculate Materials Quantity Variance. [Online]. The Ascent. Available at: https://www.fool.com/the-ascent/small-business/accounting/articles/materials-quantity-variance/. [Retrieved: 6^th October 2024].

Rizki, N. & Sukoco, A. (2019). Break even point analysis as a tool for profit and sales planning on Otak-Otak Bandeng Kang Wahab SME. In Journal of World Conference (JWC) (Vol. 1, No. 1, pp. 220-224).

Wall Street Mojo. (2024). Traditional Costing. [Online]. Wall Street Mojo. Available at: https://www.wallstreetmojo.com/traditional-costing/ [Retrieved: 5th October 2024].