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Profit Calculations Under Various Alternatives

Pacific Telemet Ltd. manufactures a high end smart phone with dual sim cards that is popular with business executives who travel overseas frequently. Related financial data for this product for the last year is as follows:

Sales 12,000 units
Selling price $460 per unit
Variable manufacturing cost $184 per unit
Fixed manufacturing costs $360,000
Variable selling and administrative costs $36 per unit
Fixed selling and administrative costs $600,000.

The CEO is under pressure from the Board of Directors to increase the profitability of the phones and has asked executives from different departments for suggestions. Three managers have responded with the following ideas:

a) The production manager, David Groate, suggests making improvements to the quality of the product. These quality improvements would increase the variable costs by $36 per unit. This would be accompanied by a $60,000 national advertising campaign which he expects would boost sales volume by 30%.

b) The sales manager, Kirsten Arnold, believes that the product is unique, but not yet well known enough. Based on her market research, she feels that advertising should be increased by $120,000 and that the product would also be able to bear an increase in price of $60 with sales volume reduced by 12% from the current levels.

c) The marketing director, Jess Sutherland, wants to undertake a promotion campaign where a $40 rebate is offered to the first 2,500 phones sold. She expects that the rebate program would boost sales by an additional 2,000 units if spending on advertising was increased by $50,000. You have been asked by the CEO, Sherri Watkins, to comment on each of these three proposals before she presents them to the Board of Directors. Draft a report in response to this request. You are not asked to make one particular choice or recommendation, but rather to explore the potential strengths and weaknesses that includes discussion on the breakeven, potential profits and, where possible, the margin of safety related to each proposal. Keep in mind that the sales volumes should be treated as estimates only and your report should consider potential variations in actual sales and their effects. Give both qualitative and quantitative support to your comments.

You are the accountant for Go-Go-Grow Ltd, a children's electric toy car manufacturer that is located in Geelong and has customers in Australia and the USA. Their estimated current sales volume is 5,000 units per month and based on this level of production, the company has budgeted the following costs and prices per unit:

Manufacturing Costs per unit (Based on production of 5,000 units per month)
Direct Material Cost $150.00
Direct Labour Cost 75.00
Variable Factory Overhead 35.00
Fixed Factory Overhead 40.00
Total Manufacturing Cost 300.00
Selling & Administrative Costs
Variable Selling and Administrative Cost 35.00
Fixed Selling and Administrative Cost 25.00 60.00
Total Cost Per Unit 360.00
Selling Price Per Unit $720.00

Mantel Ltd is an overseas company that sells toy cars all over the world, with the majority of their market to wealthy new parents in China and India. They have approached Go-Go-Grow about obtaining a quote for a special one-off order as they would like to purchase 20,000 toy cars. As this will be a special order sale, there will be no costs incurred for variable selling and administrative costs and no additional fixed costs will be incurred. This order is because their existing supplier has suffered substantial earthquake damage to their premises, but the CEO of Mantel Ltd also hinted to your CEO that if they are satisfied with the product, this might not be the last deal between the two businesses.

Required:
1. Given this knowledge, what amount should Go-Go-Grow Ltd. bid for this contract in each of the following circumstances:
a) The Go-Go-Grow’s annual factory capacity is 90,000 units.
b) The Go-Go-Grow’s annual factory capacity is 75,000 units. (To fulfil the order, you may have to pull the product from your regular production).
2. Assuming that the annual factory capacity is 90,000 units, prepare a report for your CEO explaining your justification for the bid price that you came up with in 1 a).
Discuss the possible opportunities and potential disadvantages with accepting this contract with Mantel. Give both quantitative and qualitative support to your discussion

Describe your own background before you came to do your MBA at Southern Cross University. How has your earlier educational background influenced your understanding of this subject so far? When you complete ACC00724, which accounting tools in either Financial or Management accounting do you think will be most useful for your future career? Why?

Profit Calculations Under Various Alternatives

The data that is provided in these tables below relates to Pacific Telemat Ltd. whose principle business activity is to manufacture smart phones with dual sim cards. The following tables give us financial information of the company of the last year (Atkinson, 2012).

The profit calculations under various alternatives are shown in the table provided below:

Financial data from last year

Sales

       12,000

Selling price

            460

Variable manufacturing cost

            184

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

              36

Fixed selling and administrative costs

    6,00,000

Profit statement (under current circumstances)

Particulars

 Amount

Sales

  55,20,000

Less:

Variable manufacturing cost

  22,08,000

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

    4,32,000

Fixed selling and administrative costs

    6,00,000

Profit/Loss

  19,20,000

Alternative 1:

Proposal by David Groate

Sales

       15,600

Selling price

            460

Variable manufacturing cost

            220

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

              36

Fixed selling and administrative costs

    6,00,000

Advertisement charges

       60,000

Profit statement

Particulars

 Amount

Sales

  71,76,000

Less:

Variable manufacturing cost

  34,32,000

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

    5,61,600

Fixed selling and administrative costs

    6,00,000

Advertisement charges

       60,000

Profit/Loss

  21,62,400

In this alternative, the management of the company decided to spend $60000 on advertisement and also it estimated an increase of variable cost by $36 per unit. This resulted in overall extra profits of $242000.

Alternative 2:

Proposal by Kristen Arnold

Sales

       10,560

Selling price

            520

Variable manufacturing cost

            184

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

              36

Fixed selling and administrative costs

    6,00,000

Advertisement charges

    1,20,000

Profit statement

Particulars

 Amount

Sales

  54,91,200

Less:

Variable manufacturing cost

  19,43,040

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

    3,80,160

Fixed selling and administrative costs

    6,00,000

Advertisement charges

    1,20,000

Profit/Loss

  20,88,000

In this alternative the volume of sales decreased by 12% and also there was an increase in advertisement expense by $120000 still the company managed to earn $168000 more than what it usually earns under normal circumstances (Berry, 2009.

Alternative 3:

Proposal by Jess Sutherland

Sales

       14,000

Selling price

            460

Variable manufacturing cost

            184

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

              36

Fixed selling and administrative costs

    6,00,000

Rebate

    1,00,000

Advertisement charges

       50,000

Profit statement

Particulars

 Amount

Sales

  64,40,000

Less:

Variable manufacturing cost

  25,76,000

Fixed manufacturing costs

    3,60,000

Variable selling and administrative costs

    5,04,000

Fixed selling and administrative costs

    6,00,000

Rebate

    1,00,000

Advertisement charges

       50,000

Profit/Loss

  22,50,000

Under this alternative, the managing director is offering to provide a rebate of $40 for the first 2500 phones that would be sold (Boyd, 2013). He also expects that the sales volume will increase by 2000 units which would increase the revenue by $50000.  In comparison to the normal circumstances, the company would be able to earn extra profits of  $330000.

It has been found on observation that the company is able to earn extra profits under all alternatives in comparison to the normal circumstances. A company has to look upon qualitative as well as quantitative factors before choosing any of the alternatives that is stated above (Horngren, 2012) . If the company has to take a decision based on quantitative factors then it would look upon the profits earned. The qualitative factors may include the quality of the product and not compromise with quality in order to reduce the price. It is important for the company to promote the product properly so that there is an increase in the sales volume which would help in earning higher profits (Holtzman, 2013).

  1. A company can accept a special order if it has spare capacity left after fulfilling the current demand of production.  In the given case, the total annual production capacity is 90000 units and the after fulfilling the current demand the spare capacity is equal to 30000 units.  However, the acceptance of special offer would require a capacity of 20000 units only. So the special order can be accepted (Noreen, 2015).

The table provided below shows the calculation of bid price:

Cost statement - special order

Direct Material Cost

  30,00,000

Direct Labor Cost

  15,00,000

Variable Factory Overhead

    7,00,000

Fixed Factory Overhead

    8,00,000

Total Manufacturing Cost

         60,00,000

Units

              20,000

Bid Price per unit

300 

In this case, the annual production capacity of the company is 75000 units.  The production at the current stage is 60000 units and the spare capacity is only 15000 units.

The company is left with only two choices either to reject the special order completely or to cut down the current production (Seal, 2012). If the company decides to cut down the current production then it would have to bear the loss of $1800000.  

Alternative 1: Proposal by David Groate

The bid price under this situation is shown in the table below:

Cost statement - special order

Direct Material Cost

  30,00,000

Direct Labor Cost

  15,00,000

Variable Factory Overhead

    7,00,000

Fixed Factory Overhead

    8,00,000

Total Manufacturing Cost

         60,00,000

Loss of profits from existing demand (5000*360)

         18,00,000

Total Cost

         78,00,000

Units

              20,000

Bid Price per unit

                   390

The above calculation shows that the company can accept the special offer only when it charges $390 per unit or above from each customer.

The annual capacity of production for the company was 90000 units and the spare capacity was of 30000 units. The capacity required to accept the special order was 20000 only. Since, the capacity was left spare after fulfilling the current demand the company must accept the special offer. The acceptance of this special order would help the company to increase its volume of sales which would help in earning higher profits (Siciliano, 2015). The company will not have to incur any sort of extra costs if it produces goods for this special order. It should also take into consideration the profit margin and production cost. The bid price which is calculated $300 per unit is the minimum price that has to be charged to the customers. The company should always consider the product quality and never compromise with it just to reduce the expense because it can hurt the customer base of the company in the long run.

I pursued commerce as my subject in my higher education. In the fields of commerce, we are taught about commercial applications and accountancy.

It has taught me that how a company Is formed and various activities are carried out. There are day to day transactions in the company which are recorded. It is known that the company’s are formed to earn higher profits which will be possible when there is higher cash generation and lower expenses. So, the management of the company has a major role in taking such decisions which might affect the company.

According to me, management accounting is the most useful for my future career because it deals with the decision making process that occurs within the organization. A wrong decision taken up by the management can affect the entire company along with the stakeholders. So, it is important to have basic knowledge of tools of management accounting so that the management is able to take all its decisions efficiently and on reasonable basis.

References:

Atkinson, A. A. (2012). Management accounting. Upper Saddle River, N.J.: Paerson.

Berry, L. E. (2009). Management accounting demystified. New York: McGraw-Hill.

Boyd, W. K. (2013). Cost Accounting For Dummies. Hoboken: Wiley.

Holtzman, M. (2013). Managerial Accounting For Dummies. Hoboken, NJ: Wiley.

Horngren, C. (2012). Cost accounting. Upper Saddle River, N.J.: Pearson/Prentice Hall.

Noreen, E. (2015). The theory of constraints and its implications for management accounting. Great Barrington, MA: North River Press.

Seal, W. (2012). Management accounting. Maidenhead: McGraw-Hill Higher Education.

Siciliano, G. (2015). Finance for Nonfinancial Managers. New York: McGraw-Hill.

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