Question
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
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?
3. If budgeted sales cannot be achieved, should B be discontinued?
4. Does the charging of fixed costs to products help support the decisions in the case?
5. Can you help the sales manager consider his pricing policy?
6In what circumstance would you accept the new product business?
7. Assuming that the market is flexible, how might the labour shortage affect decisions
concerning product mix?
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