Intermediate: Calculation of break-even points and limiting factor decision-making You are employed as an accounting technician by
Question:
Intermediate: Calculation of break-even points and limiting factor decision-making You are employed as an accounting technician by Smith, Williams and Jones, a small firm of accoun¬ tants and registered auditors. One of your clients is Winter pic, a large department store. Judith Howarth, the purchasing director for Winter pic, has gained considerable knowledge about bedding and soft furnishings and is considering acquiring her own business.
She has recently written to you requesting a meeting to discuss the possible purchase of Brita Beds Ltd. Brita Beds has one outlet in Mytown, a small town 100 miles from where Judith works. Enclosed with her letter was Brita Beds’ latest profit and loss account. This is reproduced below.
Also included in the letter was the following information:
1 Brita Beds sells three types of bed.
models A to C inclusive.
2 Selling prices are determined by adding 30%
to the cost of beds. 3 Sales assistants receive a commission of 10% of the selling price for each bed sold. 4 The beds are delivered in consignments of 10 beds at a cost of 400 per delivery. This expense is shown as 'Transport' in the profit and loss account. All other expenses are annual amounts. 6 The mix of models sold is likely to remain constant irrespective of overall sales volume.
Task 1 In preparation for your meeting with Judith Howarth, you are asked to calculate:
(a) the minimum number of beds to be sold if Brita Beds is to avoid making a loss;
(b) the minimum turnover required if Brita Beds it to avoid making a loss.
At the meeting, Judith Howarth provides you with further information:
1 The purchase price of the business is £300000.
2 Judith has savings of £300 000 currently earn¬ ing 5% interest per annum, which she can use to aquire Beta Beds.
3 Her current salary is £36 550.
To reduce costs, Judith suggests that she should take over the role of manager as the current one is about to retire. However, she does not want to take a reduction in income. Judith also tells you that she has been carrying out some market research. The results of this are as follows:
1 The number of households in Mytown is currently 44 880 2 Brita Beds Ltd is the only outlet selling beds in Mytown.
3 According to a recent survey, 10% of house¬ holds change their beds every 9 years, 60% every 10 years and 30% every 11 years.
4 The survey also suggested that there is an average of 2.1 beds per household.
Task 2 Write a letter to Judith Howarth. Your letter should:
(a) identify the profit required to compensate for the loss of salary and interest;
(b) show the number of beds to be sold to achieve that profit;
(c) calculate the likely maximum number of beds that Brita Beds would sell in a year;
(d) use your answers in
(a) to
(c) to justify whether or not Judith Howarth should purchase the company and become its manager;
(e) give two possible reasons why your estimate of the maximum annual sales volume may prove inaccurate.
On receiving your letter, Judith Howarth decides she would prefer to remain as the purchasing director for Winter pic rather than acquire Brita Beds Ltd. Shortly afterwards, you receive a tele¬ phone call from her. Judith explains that Winter pic is redeveloping its premises and that she is concerned about the appropriate sales policy for Winter’s bed department while the redevelopment takes place. Although she has a statement of unit profitability, this had been prepared before the start of the redevelopment and had assumed that there would be in excess of 800 square metres of storage space available to the bed department. Storage space is critical as customers demand immediate delivery and are not prepared to wait until the new stock arrives.
The next day, Judith Howarth sends you a letter containing a copy of the original statement of profitability. This is reproduced below:
In her letter she asks for your help in preparing a marketing plan which will maximize the profit¬ ability of Winter’s bed department while the re¬ development takes place. To help you, she has provided you with the following additional infor¬ mation:
1 Currently storage space available totals 300 square metres.
2 Staff costs represent the salaries of the sales staff in the bed department. Their total cost of £3780 per month is apportioned to units on the basis of planned turnover.
3 Departmental fixed overhead of £2000 per month is directly attributable to the depart¬ ment and is apportioned on the number of beds planned to be sold.
4 General fixed overheads of £2520 are also apportioned on the number of beds planned to be sold. The directors of Winter pic believe this to be a fair apportionment of the store’s central fixed overheads.
5 The cost of carriage inwards and the cost of beds vary directly with the number of beds purchased.
Task 3
(a) Prepare a recommended monthly sales sched¬ ule in units which will maximize the profit¬ ability of Winter pic’s bed department.
(b) Calculate the profit that will be reported per month if your recommendation is implemen¬ ted.LO1
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