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Contingency Theory Of Management Accounting

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Question:

Discuss about the Contingency Theory of Management Accounting.
 
 

Answer:

Introduction:

If the company accepts the offer for additional 20,000 units, the loss per unit will be $ 0.08. The company at present sells the product at $ 2.20 units. Therefore, the total profit of the company will be $ 530,364.37 if the orders for additional 20000 units are accepted as compared to the previous profit of $ 532,000. Therefore, the profit will be decreased by $ 1,635.63 and the offer shall not be accepted.

The accounting staff shall evaluate the order proposal and shall be justified the fact whether to reject or accept the offer. Factors to be considered are as follows –

  • Acceptance of special order – one-time special order generally includes large quality products at specific rate. Before accepting the proposal the associated incremental revenue with special order shall be analysed. The incremental cost must be lower than the incremental revenue (Otley 2016). As the fixed cost is already taken into consideration for previous production, the variable cost is just to be considered for arriving at the profit.
  • Idle capacity – fro justifying the special order, the company must have the additional capacity for fulfilling the order. For avoiding the disruption of the regular production the company must have excess capacity with regard to the equipment and personnel under the production line. If the company is already operating in full capacity, it will not be in a position to accept new order.
  • Pricing of special order – as the special order is the one-time order, it indicates the pricing decision over the short-term period. The minimum possible price at which the order can be accepted shall be evaluated. While the idle capacity is there and the sales levels are low, the order can be accepted for new orders (Messner 2016).

Manufacturing of special coffee cup

Particulars

Per unit cost

Total cost

Direct material

 $               0.60

 $    240,000.00

Direct labour

 $               0.20

 $      80,000.00

Variable overhead

 $               0.10

 $      40,000.00

Fixed overhead

 $               0.15

 $      60,000.00

Total cost

 $               1.05

 $    420,000.00

Selling price

 $               1.20

 $    480,000.00

Profit

 $               0.15

 $      60,000.00

From the above calculation, it is revealed that the profit per unit for coffee cup will be $ 0.15, whereas, the profit per unit for canisters is $ 0.70. Therefore, Playdough Company shall not purchase the canisters from Canisters Company and start manufacturing the coffee cups as it will reduce their profit level.

 

Factors to be considered while deciding between purchase and manufacture

The purchase or manufacture decision is choosing among the manufacturing the product under in-house production or purchasing the product from outside supplier. The most crucial factors to be considered are the quantitative analysis like associated cost for production or the capacity of the company to produce at the required level.

  • Purchase versus manufacture cost – under the manufacture cost the expenses like maintenance cost; material cost, labour cost and overhead costs shall be considered. Further, storage requirements and additional space of storage shall be considered. On the contrary, for purchasing the expenses related to price of the product, importing fees, shipping cost, sales tax charges shall be considered. Apart from this, the expenses with regard to storage of purchased product, labour cost associated with product receiving labour shall also be considered (Bianchi et al. 2016).
  • Quality of product – if the manufactured product is of better quality as compared to the purchased product, then the product must be produced in-hose. However, if the company is not specialist in the product type, then the speciality supplier shall be selected for purchasing the product.
  • Quantity – the volume of the product required by the company has an influence on the decision of the company. If the company requires very small quantity of product, then it will not be feasible to produce the product. However, if the required quality is large then it may be cost- effective for in-house production for the product (Rodrigues, Leichsenring and Winkelmann 2014).
 

Reference

Bianchi, A., Barnett, J., Dempsey, W., Giachinta, M., Hugenberg, M. and Talley, A., 2016. Applying Value-Focused Thinking to a Make Versus Buy Decision. Industrial and Systems Engineering Review, 4(2), pp.171-177.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7), pp.414-428.

Messner, M., 2016. Does industry matter? How industry context shapes management accounting practice. Management Accounting Research, 31, pp.103-111.

Otley, D., 2016. The contingency theory of management accounting and control: 1980–2014. Management accounting research, 31, pp.45-62.

Rodrigues, R., Leichsenring, K. and Winkelmann, J., 2014. The ‘Make or Buy’Decision in Long-term Care: Lessons for Policy. Report commissioned by the Swedish Ministry of Health and Social Affairs.

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