Philly Ltd manufactures a portable high-definition music player(The ZX99)with high specifications at a lower price than its rivals. The company has progressed from producing music players that mainly played mp3s, because of the advent of smartphones which have made budget mp3 players obsolete.

During 2018, the company operated at full capacity of 250,000 units, selling its music player for 120. A new Managing Director (Vicky Anderson) has recently joined the company and has asked you to advise on the company's selling price policy. The sales price of 120 was previously viewed as satisfactory because the resulting demand enabled full capacity operation.

You have been asked to investigate the effect on costs and profit of an increase in the selling price.

Appendix 1shows costs and revenues of ZX99 last year (2018). The company isnow planning for 2019

Further information relating to 2019 can be found in the accounts of meetings between Vicky Anderson and other senior members of staff (see Appendices 2-4)

The company will start 2019 with 800,000 as its bank balance. Tax of 800,000 is expected to paid in Quarter 3, with dividends of 1,000,000 in Quarter 2 and 500,000 in Quarter 4.

Requirements

(a)Calculate the annual profit which is earned with the current selling price of 120 per unit for 2018(using only the data from Appendix 1)(5 marks)

(b)Assuming the same cost structure for 2019 (but subject to any possible amendments from the appendices), we need a schedule to show the annual profit which would be earned with each of the three alternative selling prices referred to by the Sales Director. Based on the figures calculated, recommend the selling price that should be charged for the high definition music player, to maximise Philly Ltd's profit. Calculate the breakeven point (units) and the margin of safety (%s) at this profit maximising level.(Ignore any potential bad debts and sales discounts, mentioned by the Sales Director, when calculating profit)(10 marks)

(c)Are there any other non-financial factors to be considered when making the decision regarding the selling price.(25 marks)

(d)Based on the profit maximising decision, prepare the production, material, labour and cash budgets (split into quarters)(20 marks)

(e)Reconcile the budgeted profitchosen in (b)with the actual results for 2019 by means of variance analysis(15 marks)

(f)Suggest possible reasons for the difference between actual and budgeted results making recommendations of possible action by Philly Ltd to help improve future performance.(25 marks)

Appendix 1

The following data relates to costs and revenues of the ZX99last year (2018)

Sales

120.00

Direct materials*

1 component pack @ 28.50

28.50

Direct labour

1.8 hours @ 13

23.40

Variable production overhead

1.8 hours @ 4

7.20

Sales commission

10% of sales price

12.00

Fixed production overheads

4,000,000

Fixed selling overheads

1,500,000

Fixed administrative overheads

1,000,000

All fixed overheads arise evenly throughout the year

*Each music player requires 1 set of components which are bought together from one supplier

Appendix 2

The following conversation took place between the Managing Director and the Sales Director:

Vicky Anderson: we have been able to sell 250,000 units per annum, which is full capacity, because of the fact that we sell a good value product but are we missing out by pricing the product too low?

Gladys Knight: Possibly. If we price the product at 120 in 2019, we expect to sell 250,000 units, as was the case last year. However, my team have done some work on this and have come up with the following estimates of sales volume based on 3 alternative sales prices:

Selling price

140

160

180

Annual sales volume (units)

200,000

160,000

110,000

Vicky Anderson: Ok, so pushing the price up will mean that we make more money per music player, but of course we will sell less of them. We need to find out whether a change in price will actually increase or decrease our expected profit.

Gladys Knight: Bear in mind that selling overheads would decrease by 100,000 per annum, if annual sales volume falls below 240,000 units as we will be able to reduce our part-time sales force. We still expect sales commission to be 10% of the sales price. All sales and admin costs are paid for in the quarter that they arise.

Our sales of 250,000 units last year were subject to a slight seasonal variation, with 25% of our sales falling in the 1^stquarter, 30% of our sales falling in the 2^ndquarter, 25% in the 3^rdquarter, with the remaining 20% in the final quarter. We expect the same seasonal variation to arise next year (2019).

Based on past experience, 60% of our sales are settled in the quarter of sale with 37% of sales settled in the following quarter. The remaining 3% of sales are expected to become uncollectible (bad debts). Those customers who settle in the quarter of sale are entitled to a 2% discount on the original selling price.

Appendix 3

The following conversation took place between the Managing Director and the Production Director:

Vicky Anderson: We are reviewing our pricing policy with a view to pushing price of our music player up so as to maximise the profit made from each unit.

Harry Casey: Well, the amount of units you plan to sell will obviously have an impact on the amount of units we plan to produce, and that in turn will impact on our production costs. If annual production falls below 200,000 units, we would need to hire less machinery and that will save us 200,000.

Furthermore, if annual production and sales falls below 200,000 units, this will reduce the bonus payments we have to pay our labour force. This will have the effect of reducing the average hourly rate we pay by 10% from last year's hourly rate.

We will aim to keep production levels very close to quarterly sales levels, subject to movements in opening and closing stock. We will start the year with 4,000 units of opening stock and we plan to have the same number of units as closing stock at the end of the year. For all other quarters, we aim to have closing stock of 10% of the following quarter's expected sales

All labour and overhead (e.g. rent) costs are paid for in the quarter they arise.

As you know, we will also be planning a major investment in machinery of 2 million (in addition to the fixed overhead expenditure) in the last quarter of the year, ready for use at the beginning of the following year

I'm glad that we are considering pushing the selling price of the music player up. The pressure we are under to keep production costs down influences the quality of staff that we can afford to employ. We have many inexperienced staff and that is causing errors to happen on the production line.

Appendix 4

The following conversation took place between the Managing director and the Purchasing Manager:

Vicky Anderson: we are considering pushing the price of the music player up as we feel our product is cheaper than similar products manufactured by our rivals. Inevitably, this will reduce the amount of units that we sell, but we hope that this reduction will be minimal.

Bernard Edwards: in that case, bear in mind that if production falls below 150,000 units, we will lose bulk discounts, meaning that our component costs will increase by 15% for all units produced in the year.

Vicky Anderson: on the subject of components. What is our policy regarding their purchase and payment?

Bernard Edwards: all components are paid for one quarter after we purchase them. The amount of components we have to pay for in the first quarter of 2019 were the components purchased in the previous quarter, which was 49,000 component packs.The aim is to keep opening stock of components at 2,000 packs every quarter.

The following conversation took place between the Managing Director and the Purchasing Manager at the end of the year, when analysing the difference between the budgeted and actual profit:

Vicky Anderson: I'm a little concerned with the amount of money we have spent on the components that we bought this year, in 2019. Are there any possible factors that contributed to this.

Bernard Edwards: well, bear in mind that when the budgets were set at the beginning of the year. The average price for those components was 28.50, but 2019 saw a general price rise for the components, meaning that the average price on the market was nearer 30. Also, don't forget the fact that we had to make an emergency purchase of components in the final quarter because of the number of components that had to be scrapped on the production line. You can't blame my department for that.

Appendix 5

Actual results for 2019

The actual results for the year were as follows:

Production & sales (units) : 172,500 units generating 27,600,000

Direct materials: 187,450 component packs costing 5,529,775

Direct labour: hours unknown (see note below) @ 10.50 per hour

Variable overhead: hours unknown (see note below) @ 4.1 per hour

Sales commission = 2,760,000

Fixed production overhead = 3,500,000

Fixed selling overhead = 1,900,000

Fixed admin overhead = 1,100,000

Your assistant has started to calculate some of the variances and has told you that there are no variances for sales commission, while the Labour Efficiency Variance is605,475 adverse. Unfortunately in making the calculations, your assistant has misplaced all the timesheets which recorded the actual labour hours.