Question
Dear Everyone, I would like to ask for your help in stating 3 recommendations including 2 advantages/pros and 2disadvantages/cons to this case. I. Synthesis/Background of
Dear Everyone, I would like to ask for your help in stating 3 recommendations including 2 advantages/pros and 2disadvantages/cons to this case.
I. Synthesis/Background of the Case
John Abbott was hired as staff accountant six months ago by Duo-Products Corporation. He reports to the controller, Wess Davidson and he performs routine type of analytical work.
Duo-Products Corporation is a manufacturing company that has three products.
French is a business school graduate and is considered by his peers to be quite capable and conscientious. He was well aware of his capabilities and took advantage of every opportunity that arose to try to educate those around him.
French was invited by Davidson to the managers meeting and asked the latter to present his break-even analysis that Duo company has not been making use of in its past planning procedures. He presented his break-even analysis chart as follows:
Plant Capacity | 2 million units per year |
Past years level of operation | 1.5 million units |
Average unit selling price | $7.2 |
Total fixed costs | $2,970,000 |
Average unit variable cost | $4.5 |
Unit contribution margin to fixed costs | $2.7 |
Required number of units and sales to break-even | 1,100,000 units $7,920,000 |
French based the break-even analysis on the product cost analysis of the normal year as Exhibit 3 in the case that is presented as follows:
| Aggregate | "A" | "B" | "C" |
Sales at full capacity (units) | 2,000,000 |
|
|
|
Sales Volume (units) | 1,500,000 | 600,000 | 400,000 | 500,000 |
Unit Sales Price | $ 7.20 | $ 10 | $ 9 | $ 2.40 |
Total Sales Revenue | 10,800,000 | 6,000,000 | 3,600,000 | 1,200,000 |
Variable Cost per unit | 4.50 | 7.5 | 3.75 | 1.5 |
Total Variable Costs | 6,750,000 | 4,500,000 | 1,500,000 | 750,000 |
Fixed Costs | 2,970,000 | 960,000 | 1,560,000 | 450,000 |
Profit | 1,080,000 | 540,000 | 540,000 | 0 |
Ratios: |
|
|
|
|
Variable cost to sales | 0.625 | 0.75 | 0.42 | 0.625 |
Unit contribution to sales | 0.375 | 0.25 | 0.58 | 0.375 |
Utilization of capacity | 75% | 30% | 20% | 25% |
During the meeting, participants pointed out several limitations of the break-even analysis of French due to its failure to consider unit sales increase, use of individual product line analysis, change in product mix, price increase in C line products, manufacturing cost increase, taxes, dividends, union demand and product emphasis. The managers intervention provided new sets of information that needs to be considered as indicated in the following table:
Participants of Managers Meeting | New information provided |
John Cooper Production Control | 20% increase in unit sales 90% push in capacity Ray Bradshaw Assistant Sales Manager A line is losing. Only 2/3 will hold B is constant C line increase by .25 million |
Fred Williams Manufacturing | Increase in fixed cost to $60,000/month |
Arnie Winetki General Sales Manager | half a million unit on C for next year is on the basis of doubling the price with no change in cost Raise price for two reasons: 1) current price is inconsistent and out-of-line with the company reputation for quality, 2) no increase will result in 500,000 units of unmet demands |
Anne Fraser Admin. Asst. to President | On Net Profit: Half of last years profit went to taxes, $300,000 as dividends 50% increase in dividend for anniversary year and $150,000 retained earnings or $600,000 after tax-profit On union demands (Fixed costs): Meet the union demand of 10% increase across the board without eroding bonus dividend and net profit On product emphasis: Since A line is weak, grab the big demand for C by shifting some of the assets from A to C. |
Once this set information is considered, change in the method of analysis and break-even levels has to be modified. This also requires shift in the assumptions from which the analysis was based.
II. Statement of the Problem
Management accounting aims to provide relevant, timely and accurate information for decision makers. Holding in mind this goal and the current needs and problems of the management team of Duo-Products Corporation, we state the statement of the problem of this case as follows:
How can John Abbott improve his break-even analysis in relation to management issues and concerns?
III. Statement of the Objectives
In providing answers to the case problem, this analysis will pursue the following objectives:
Identify the assumptions that limit Frenchs break-even analysis
Integrate relevant management issues and problems in the analysis
Determine the optimal balance and level of operations that maximize the value of the company
IV. Point of View
The case analysis adopts the point of view of John Abbott manager Wess Davidson.
V. Conceptual Framework and Areas of Consideration
Assumptions of the Analysis
Judgements are oftentimes based on assumptions. Frenchs break-even analysis was made based on his assessment of the limited information that was available to him within the time limit of his work. This concern to specify assumption was raised by Frenchs senior manager and is specified in the following question in the case that we adopt to guide our analysis: What are the assumptions implicit in John Abbotts determination of his companys break-even point?
The following assumptions are implicit in John Abbotts determination:
There is a single breakeven point for the whole company by taking the average of the 3 products
The sales mix will not be modified by the management team
Total revenue and total expenses behave in a linear manner within a relevant range
There are no changes and issues in business processes and operations (through lack of information on management problems, issues and concerns)
The increase in the capacity will be allocated to product C which was due to increase production.
Production of Product A is to be scaled down, but its level of fixed costs will remain unchanged
During managers meeting, new information came out reflecting the issues, concerns and problems management team are facing that unfortunately are not considered and integrated in Frenchs analysis and runs contrary to analysis held assumptions. As a result, the base year of Frenchs analysis is incomplete and limited, and new information must be integrated in the analysis (see
New information provided | Normal/Base Year | Projection/Changes |
John Cooper Production Control 20% increase in unit sales 90% push in capacity Ray Bradshaw Assistant Sales Manager A line is losing. Only 2/3 will hold B is constant C line increase by .25 million | 1,500,000 2,000,000 600,000 400,000 500,000 | 1,750,000 400,000 400,000 750,000 |
Fred Williams Manufacturing Increase in fixed cost to $60,000/month | 2,970,000 | 3,690,000 |
Arnie Winetki General Sales Manager half a million unit on C for next year is on the basis of doubling the price with no change in cost Raise price for two reasons: 1) current price is inconsistent and out-of-line with the company reputation for quality, 2) no increase will result in 500,000 units of unmet demands | 2.40 | 4.80 |
Anne Fraser Admin. Asst. to President On Net Profit: Half of last years profit went to taxes, $300,000 as dividends 50% increase in dividend for anniversary year and $150,000 retained earnings or $600,000 after tax-profit
On union demands (as fixed cost): Meet the union demand of 10% increase across the board without eroding bonus dividend and net profit
On product emphasis: Since A line is weak, grab the big demand for C by shifting some of the assets from A to C. | $1,080,000
2,970,000
A: 600,000 B: 400,000 C: 500,000 | > 1,305,000 3,690,000 + 10% in labor cost
400,000 400,000 950,000 |
Break-even Analysis and the New Information from Management Meeting
The second question (On the basis of Frenchs revised information, what does next year look like?) calls for the integration of the new information raised during management meeting. Taking note of the way this new information shaped the new assumptions for analysis, the following table of calculations will present the new break-even analysis for Duo-Products Corporation:
| Aggregate | "A" | "B" | "C" |
Sales at full capacity (units) | 2,000,000 |
|
|
|
Sales Volume (units) | 1,750,000 | 400,000 | 400,000 | 950,000 |
Unit Sales Price ($) | 6.95 | 10 | 9 | 4.8 |
Sales Revenue ($) | 12,160,000 | 4,000,000 | 3,600,000 | 4,560,000 |
Variable Cost per unit ($) | 3.385 | 7.5 | 3.75 | 1.5 |
Contribution margin per unit ($) | 3.56 | 2.5 | 5.25 | 3.3 |
Total Variable Costs ($) | 5,925,000 | 3,000,000 | 1,500,000 | 1,425,000 |
Fixed Costs ($) | 3,690,000 | 960,000 | 1,560,000 | 1,170,000 |
Profit ($) | 2,545,000 | 40,000 | 540,000 | 1,965,000 |
Ratios: |
|
|
|
|
Contribution to total sales | 1 | .33 | .30 | .37 |
Contribution margin ratio | .25 | .58 | .69 | |
Variable cost to sales | 0.4871906 | 0.75 | 0.416667 | 0.3125 |
Unit contribution to sales | 0.5128094 | 0.25 | 0.583333 | 0.6875 |
Utilization of capacity | .8750 | .20 | .20 | .4750 |
Break Even Point (units) | 1,035,686 | 384,000 | 297,143 | 354,545 |
Breakeven point in sales |
Breakeven point is the point where total revenue equals total cost, that is, a zero profit situation. There are several ways breakeven point is calculated, namely, breakeven points in units and breakeven point in the amount of sales. In using these methods, we assume that there are no common fixed expenses, all fixed costs are direct fixed expenses.
The breakeven point in units is calculated using the formula:
Breakeven number of units = Fixed costs / Contribution margin per unit or
= Fixed costs / Selling price Variable cost per unit
= 3,690,000 / 3.56 = 1,036, 516 units
For each product, same formula applies and each respective values are considered. Total of from individual product varies due to rounding applied.
Another breakeven point analysis method for companies with multiple product line is to use the contribution margin ratio (CMR) approach. This approach allows the company to estimate breakeven sales based on the estimate of the weighted average CMR for all its products.
The CMR is computed as follows: CMR = (unit price-unit variable cost)/price or
CMR = contribution margin/price
The weighted average CMR is computed in the following manner:
WA CMR = % of T Sales x CMR A + % of T Sales x CMR B + % of T Sales x CMR C
= .33 (.25) + .30 (.58) + .37 (.69)
= .08 + .174 + .255 = .48
The breakeven point is calculated using WA CMR as follows:
Breakeven point = Total fixed cost/WA CMR
= $3,690,000/.48
= $7,687,500
This means that for Duo-Production Company to break even, $7,687,500 of all three products must be sold proportionately. The break-even units and sales for each product is as follows:
Product | % of total sales | Aggregate break-even sales ($) | Product break-even sales ($) |
A | .33 | 7,687,500 | 2,536,875 |
B | .30 | 2,306,250 | |
C | .37 | 2,844,375 |
On the basis of Frenchs revised information, what does next year look like:
What is the break-even point?
What level of operations must be achieved to pay the extra dividend, ignoring union demands?
What level of operations must be achieved to meet the union demands, ignoring bonus dividends?
What level of operations must be achieved to meet both dividends and expected union requirements?
Can the break-even analysis help the company decide whether to alter the existing product emphasis? What can the company afford to invest for additional C capacity?
Calculate each of the three products break-even points using the data in Exhibit 3. Why is the sum of these three volumes not equal to the 1,100,000 units aggregate break-even volume?
Is this type of analysis of any value? For what can it be used?
VI. Alternative Courses of Action
VII. Recommendation and Implementation.
VIII. Learning Points
Breakeven point analysis provides a convenient and informative tool in performance evaluation and control. However, there are indirect cost or common fixed expenses that are arbitrarily allocated to a product such as interest expense, senior management salaries and compensation. This will not invalidate the analysis but less accurate.
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