Question 4 Strategic Management Accounting Case Study(25 marks)

This question builds on prior studies of Cost Volume Profit (CVP) analysis and relates to learning material and objectives from Online Topics 1 and 2. For assistance on this question you are advised to undertake the case study from Mars Petcare which is provided online (with solution) in Topic 2 as the Reflection Task.

Star Wars Themed 'Darth Vader' Electric Tooth Brushes

STRATEGIC MARKET ANALYSIS

You have been asked to join the Strategic Management Committee of Empire Australasia Ltd as the management accounting representative. The main task of the Committee is to carry out ongoing reviews of the profitability and viability of various product lines across all of the divisions of the Empire Group.

Despite the rapid increase in sales of Star Wars themed merchandise, one of the products under review is the Darth Vader toothbrush. The Empire Group is not the only company licenced to manufacture and market Star Wars franchised products in Australasia. The Darth Vader electric toothbrush manufactured by the Empire Group is sold through major department stores and supermarket chains in Australia and New Zealand and has been the clear market leader in its category since the product was introduced to Australian markets more than 10 years ago. Regional competitor Death Star Manufacturing has been producing a cheaper version of a Darth Vader toothbrush which has eaten into the market share of the Empire product.

The major competitor is Death Star Manufacturing which product retails at a lower price than the Empire Group product. Market research indicates that although the Empire Group Darth Vader toothbrush is recognised as being a superior product, the lower price is a significant factor in why consumers are switching to the Death Star Manufacturing toothbrush. Whilst the overall market for Star Wars themed merchandise has continued to grow steadily, in the last two years Empire Group's sales have fallen from 75% of the total market to only 40% of the market. During the same period, major competitor Death Star Manufacturing has increased its sales of electronic toothbrushes from 10% to 40% of the market. Unit sales of all brands of Darth Vader toothbrushes in the Australia and New Zealand market for 2021 stood at 4 million units.

Whilst the Empire Group's Darth Vader electronic toothbrush is still profitable the Strategic Committee is concerned about the products overall profitability given the downward trend in sales. The Empire Group has a base expected return on investment of 20% (calculated as Gross profit divided by Total Assets). Product lines which do not meet this Return on Total Assets (ROTA) benchmark may be discontinued.

As the Management Accounting representative you have provided the Strategic Management Committee with the following breakdown of revenues and costs for the Darth Vader Toothbrush product line for the just completed 2021 calendar year:

Darth Vader Electronic Toothbrush

Darth Vader Toothbrush Factory Total Assets

$20m

Total Sales (Volume)

1.6m

Regular Retail Price (per unit) (price sold in store)

$19.95

Gross Sales Value (per unit) (Price received by Empire Group)

$12.50

Prime Costs

$4.80

Manufacturing Costs

$4.25

Logistic Costs

$1.00

Total Costs (per unit)

$10.05

Gross Profit (per unit)

$2.45

Total Gross Profit

$3,920,000

ROTA

19.6%

The Return on Total Assets (ROTA) for the Darth Vader Electronic Toothbrush for the 2021 year was 19.6%. This is below the required ROTA of the Empire Group which is 20%. If the product continues to trade at current levels it will be deemed as unviable and discontinued.

The Australasian Marketing Division of the Empire Group believes that Research and Development (R&D) advances from within the world-wide Empire Group could improve the Darth Vader product and its sales and profitability outlook. Developments in digital electronics means that the company will have the capacity to include a feature where the Darth Vader Toothbrush will be able to digitally record a name and then include it in a replayed sound bite every time the toothbrush is activated. It is planned that the toothbrush will play an adaption of a famous Darth Vader catch-phrase by saying "Luke, I am your toothbrush" every time it starts up. Purchasers will have the option of recording a different name to replace Luke if they wish. Initial engineering indicates that by making savings in packaging and other materials the prime cost and manufactured cost of the toothbrush will not change from its current $10.05 per unit.

The Marketing Division have carried out some initial market research and believe that this added feature will make a big difference to consumers and will potentially increase unit sales by 50% in the first year. To achieve the increase Marketing advises that it is imperative that the product improvement is advertised effectively and have suggested that a marketing rebate of $1.00 per unit be paid to retailers which must be spent by the retailers on direct advertising.

The Chair of the Strategic Management Committee has reviewed the marketing proposal and advised that even after allowing for the 50% sales increase, the increase in costs represented by the extra $1 marketing rebate means that the products ROTA will fall to 17.4% which is well below the required rate of 20%. The CEO argues that if this remains the case, the previously successful Darth Vader Electronic Toothbrush product line may have to be discontinued.

You are aware that following the recent drop in sales the Darth Vader Electronic Toothbrush factory is operating at only 50% of its practical manufacturing capacity. You are also aware that whilst the Darth Vader Electronic Toothbrush product's Prime Costs are 100% Variable, other Manufacturing Costs and Logistic Costs are made up of 90% Fixed costs and 10% Variable costs.

You ask if you can be given time to prepare a report for the Strategic Management Committee on the Management Accounting cost and profit implications of the changes proposed by Marketing and R&D based on the budgeted costs and increases in sales and production.

Required:

i.Using Excel prepare a 'before and after' budget comparative analysis of the revenues and costs of the Darth Vader Electric Toothbrush product line. The analysis should incorporate the 50% predicted sales increase and the added $1 per unit Marketing Rebate. Ensure you include in your analysis any impact of the budgeted production increase on other per unit manufacturing and logistics costs.(10 marks)

ii. It can be assumed that 90% Fixed 10% Variable cost break-down between variable and fixed costs will hold consistently across the industry (including for competitor Death Star Manufacturing). Assume that 60% of the predicted Darth Vader Electric Toothbrush unit sales increase will be made at the expense of the unit sales of their main competitor Death Star Manufacturing (meaning Death Star Manufacturing unit sales will fall). Assume that Darth Vader Electric Toothbrush and Death Star Manufacturing have identical manufacturing and logistics cost structures at the commencement of the 2022 calendar year.Allowing for the change in sales volumes use Excel to calculate the expected impact of the drop in sales on the per unit product costs of Death Star Manufacturing.(5 marks)