Orrs Products Short-Term Decision Making

Orrs Products operates in a competitive market with about seven other firms and they have an

average market share. There is spare capacity in the industry generally and Orrs are under

capacity by about one-third (10,000 units). There are three recognised types of product with

different cost characteristics, made in separate production departments. The labour is capable of

being switched from one product to another, so it is possible to change product mix to some

extent. It would not be possible to switch total production, however, without major capital

investment.

There are also constraints on flexibility of product mix caused by the market. Customers

normally like to take a combination of all three types, but it is possible to influence the mix to

some extent by the emphasis of the sales force and by promotional activity. Normally, the

effectiveness of such emphasis is equal in sales value terms, for all three products.

During the present year the company moved below breakeven for the first time, and the

management resolved to produce a plan to move them into profit. They analysed the cost

position and found that B seemed to be the main problem. It is making a loss which is more

than the total company loss, so the other two products are making a profit. They prepared a

sales budget which is shown in Appendix 1.

The sales manager was not optimistic about the chances of getting any increases in price. We

always lose out on volume, he said, 5% price increase always causes 5% loss of volume, so

we are no better off. However, he was optimistic about the chances of getting extra business

from a new lower price product type (which could be produced in any of the three

departments), and asked the management accountant for some costing. The new product may

attract some new clients, but would also be of interest to existing customers.

One further problem expected towards the end of next year was a labour shortage due to

another factory opening up in the vicinity. The management accountant had mentioned to the

managing director that, when this arose, there might have to be a re-think about product mix.

Appendix 2 shows the costing of the new product; Appendix 3, this years profit and loss

statement. The split between fixed and variable costs is admittedly not perfect, but is felt to be

a reasonable reflection of the way costs will behave in the next year.

Detailed cost projections for next year have not yet been made, but inflation is expected to be

fairly low and the management accountant is suggesting that, at this stage, budget calculations

should assume present costs and prices.

Appendix 1

Product this year

A B C Total Sales

Units 7,843 6.061 6,464 =20,368

Price 146, 130 , 115

Sales Value (nearest

000) 1,145 ,788 ,743 , 2,676

Sales Budget

next year

Units 8,000 7,500 6,500 =22,000

Price 146, 130, 115 -

Sales Value (nearest

000)

1,168, 975 ,747= 2,890

Appendix 2

New Product

Expected Unit Sales 3,000

Expected price 100 each

000

Sales Value 300

Material Costs (142)

Labour Costs (55)

Other Variable costs (43)

Total variable costs (240)

Department Fixed* (40)

Total Costs (280)

*This is an allocation of existing costs on an average per unit basis. No extra departmental fixed

Appendix 3

Profit or loss account this year (000)

Product A Product B Product C Total

Sales Value 1,145 788, 743 =2,676

Variable Costs

Materials (467) (381) (260) (1,108)

Labour (182) (84) (120) (386)

Energy (36) (27) (34) (97)

Repairs & Maintenance (12) (28) (14) (54)

Distribution (64) (50) (47) (161)

Consumables (9) (7) (7) (23)

Total Variables (770) (577) (482) (1,829)

CONTRIBUTION 375 211 261 847

Contribution/Sales ratio (32.7%) (26.8%) (35.1%) (31.6%)

Departmental Fixed Costs

Indirect labour (19) (16) (17) (52)

Depreciation (36) (34) (31) (101)

Management (14) (12) (12) (38)

Others (6) (4) (4) (14)

Total Dept. Fixed (75) (66) (64) (205)

Apportioned Fixed Costs

Production (71) (54) (53) (178)

Administration (56) (40) (38) (134)

Selling (59) (34) (45) (138)

Marketing (36) (29) (30) (95)

Research & Dev (30) (27) (21) (78)

Others (12) (10) (9) (31)

Total App. Fixed (264) (194) (196) (654)

Total Fixed Costs (339) (260) (260) (859)

Questions: Orrs Products Short-Term Decision Making

1. What will be the approximate financial effect of the budget if achieved (exclude the new

product)?

2. Do you agree on financial grounds, with the policy of pushing product B in next years

budget?