What can I say as a statement of total contribution and total profit for the original budget and for each of the four proposals put forward by the managers? (with the calculations for each component) and I also have to give a clear direction as to which course should be followed by management?

Component A Component B Component C Total

Sales: 100,000 units at 18 1,800,000

80,000units at 30 2,400,000

120,000 units at 12 1,440,0005,640,000

Materials 360,000480,000576,0001,416,000

Labour 840,000960,000900,0002,700,000

Overheads 270,000432,000396,0001,098,000

1,470,0001,872,0001,872,0005,214,000

Proft/(Loss) 330,000528,000(432,000) 426,000

Context:

Management are not satisfied with these projected figures for two reasons: they were aiming for a targeted total profit of at least 480k to meet the company's required return on capital of 18%; and they are unhappy about the further deterioration of Component C, their oldest product, which on has already suffered a marginal loss during the current year and is projected to become highly unprofitable next year.

There have been diverse reactions to this situation from the company's management team, as explained below.

Simon Bonello, the recently appointed Chief Financial Officer (CFO) who prepared the budget, argued that the best course of action would be to stop manufacturing Component C. He stated the following: "In view of the disappointing figures portrayed by this budget, I have carried out some calculations to help us in our discussion during this meeting. If we discontinue the production of Component C, we can save the fixed labour costs attributable to this component of 108k. However, we will incur redundancy costs of around 60k."

The Chief Operations Officer (COO), Ivan Zerafa, who has been with the company since its inception, was infuriated. He said, "The company has been producing Component C since we started two decades ago and demand for this component is still steady. And don't forget that some of the people involved in the production of C have been with the company a long time. Can I at least be given a few days to identify possible cost savings on the production line?" Simon Bonello (CFO) replied, "Last year, when I joined the company, I offered to sit down with you to go through your costs, but as soon as I mentioned the possibility of exploring the merits of Activity Based Costing (ABC), you said that it's nonsense and a waste of time. Now you can't blame me for this mess!"

The Marketing Manager, Sera Sammut, intervened, stating, "Guys, let's try to calm down and discuss this rationally! What if we lower the price of Component C by 1.20 per unit? My calculations show that this would increase demand for C by circa 25%. If Ivan can somehow save 1.20 per unit in variable production costs (for Component C), why don't we try this strategy?"

At this point, Kate Mallia, the Chief Executive Officer (CEO) spoke up. "I'd like to compare the results of going with Simon's proposal versus Sera's. Ivan, I'd like you to take a couple of days to think on how you might re-organise production in order to see some improvements, and then you can liaise with Simon for him to translate your plans into numbers. And Simon, would you please make some calculations to see what an overall 10% increase in sales and activity would do, holding prices and everything else constant?"

The management team meeting came to an end, agreeing to proceed as directed by the CEO.

The following day, the COO held a meeting with the CFO. Ivan Zerafa explained that, after looking into things, he believes that labour supervision on Component C could be reduced, which would result in a decrease in labour fixed costs by 90k. However, variable overhead would go up by 10%. The COO also suggested that C could be replaced by a cheaper component which would result in savings of 0.90 per unit.

Before proceeding with the budget revision, Simon took note of the information set out below, which he had used in preparing the original budget: All material costs are fully variable

The fixed element of labour cost for Components A, B and C is 120k, 192k and 108k respectively

The overheads comprise both variable and fixed elements.

The fixed element has been absorbed at the rate of 6 per machine hour.

The machine time per unit for each component is as follows: Component A - 15 minutes; Component B - 30 minutes and Component C - 15 minutes.

 

Answer rating: 100% (QA)

To analyze the total contribution and total profit for the original budget and each proposal we need to calculate the values for each component Lets g... View the full answer