Cost-Volume-Profit Analysis and Special Order Short-term decision making PART 1 Funai Corporation is a Japanese manufacturer of video cassette recorders (VCRs) and was established in 1987. There is now increased competition in its markets and the firm expects to find it difficult to make an acceptable profit next year. You have been appointed as a management accountant at the company, and have been given a copy of the draft budget for the next financial year. Draft Budget for 12 months to 30th September 2019 (m) (m) Sales revenue 960 Cost of sales Variable assembly materials 374.4 Variable labour 192 Factory overheads - variable 172.8 - fixed 43 (782.2) Gross profit 177.8 Selling overhead - commission (variable) 38.4 - fixed 108 Administration overhead - fixed 20 (166.4) Net profit 11.4 The following information is also supplied to you by the firms financial controller, John Smith: a) Planned sales for the draft budget in the year to 30th September 2019 are expected to be 25% less than the total of 3.2 million VCR units sold in the previous financial year. b) The firm operates a Just-in-time stock control system, which means that it holds no stocks of any kind. c) If more than 3 million VCR units are made and sold, the unit cost of material falls by 4 per unit. d) Sales commission is based on the number of units sold and not on turnover. 2 e) The draft budget assumes that the factory will only be working at two-thirds of maximum capacity. f) Sales above maximum capacity are not possible. Questions: 1) Calculate the Total contribution margin and contribution margin per unit, showing your working. [5 marks] 2) Calculate the Break-even-point (BEP) in units and BEP in sales revenues, showing your working. [3 marks] PART 2 John Smith explains that the Board is not happy with the profit projected in the draft budget, and that the sales director, Mary Ford, has produced three proposals to try and improve matters. Proposal A involves launching an aggressive marketing campaign: i. This would involve a single additional fixed cost of 14 million for advertising. ii. There would be a revised commission payment of 18 per unit sold. iii. Sales volume would be expected to increase by 10% above the level projected in the draft budget, with no charge in the unit selling price. Proposal B involves a 5% reduction in the unit selling price: i. This is estimated to bring the sales volume back to the level in the previous financial year. Proposal C involves a 10% reduction in the unit selling price: i. Fixed selling overhead would also be reduced by 45 million. ii. If proposal C is accepted, the sales director believes sales volume will be 3.8 million units. Questions: 3) For Proposal A, calculate: 3.1) the change in profit compared with the draft budget [4 marks] 3.2) the BEP point in units and sales revenues. [3 marks] 4) For Proposal B, calculate: 4.1) the change in profit compared with the draft budget [4 marks] 4.2) the BEP point in units and sales revenues. [3 marks] 5) For Proposal C, calculate: 5.1) the change in profit compared with the draft budget [4 marks] 5.2) the BEP point in units and sales revenues. [3 marks] 6) Based on your results for questions 3) to 5), recommend which proposal, if any, should be accepted on financial grounds, and explain your choice in detail. [5 marks] 3 7) Discuss three non-financial issues to be considered before a final decision is made. [6 marks] PART 3 John Smith now tells you that the firm is considering a new export order for three months with a proposed selling price of 3 million. He provides you with the following information. i. The order will require two types of material: - Material X is in regular use by the firm. The amount of stock now held, when originally purchased, cost 0.85 million, but its standard cost is 0.9 million. The amount in stock is sufficient for the order. The current market price of material X to be used in the order is 0.80 million. - Material Y is no longer used by the firm and cannot be used elsewhere if not used on the order. The amount in stock now held, originally purchased, cost 0.2 million although its current purchase price is 0.3 million. The amount of material Y in stock is only half the amount required on the order. If not used on the order, the amount currently in stock could be sold for 0.1 million. ii. Direct labour of 1 million will be charged to the order. This includes 0.2 million for idle capacity, as a result of insufficient orders to keep the workforce fully employed. The firm has a policy of no redundancies, and spreads the resulting cost of the time across all orders. iii. Variable factory overhead are expected to be 0.9 million. iv. Fixed factory overhead are apportioned against the order at a rate of 50% of variable factory overhead. v. No sales commission will be paid. Questions: 8) Perform a Contribution Margin Analysis based on opportunity costs and revenues [12 marks]. 9) Prepare a brief report showing whether or not the new export order should be accepted or rejected and explain your decision. [8 marks] 10) General question: To the extent that costs of activities are not, after all, direct costs, there is no reason to suppose that the allocation procedure by which they are determined is more accurate than any other. (Armstrong, 2002:107) Critically discuss the idea that ABC is a more accurate costing approach than traditional full (absorption) costing. Present in detail the differences between ABC and traditional full (absorption) costing, and the main advantages and limitations of ABC implementation. Also explain how the organisational context influences the implementation of ABC as well as its consequences.