New Equipment and Contribution Format Income Statement
1. (a) Morton Company's contribution format income statement for last month is given below:
The industry in which Morton Company operates is quite sensitive to cyclical movements in the economy. Thus, profits vary considerably from year to year according to general economic conditions. The company has a large amount of unused capacity and is studying ways of improving profits. Required:
i) New equipment has come onto the market that would allow Morton Company to automate a portion of its operations. Variable expenses would be reduced by $9 per unit. However, fixed expenses would increase to a total of $225,000 each month. Prepare two contribution format income statements, one showing present operations and one showing how operations would appear if the new equipment is purchased. Comment on key changes. (3 + 3 = 6 marks)
ii) Refer Refer to the income statements in (i). For the present operations and the proposed new operations compute and explain
(a) the degree of operating leverage, (3 marks)
(b) the break-even point in dollar sales, and (3 marks)
(c) the margin of safety in dollars and the margin of safety percentage. (3 marks) (3 + 3 + 3 = 9 marks)
iii. Refer to the original data. Rather than purchase new equipment, the marketing manager argues that the company's marketing strategy should be changed. Rather than pay sales commissions, which are currently included in variable expenses, the company would pay salespersons fixed salaries and would invest heavily in advertising. The marketing manager claims this new approach would increase unit sales by 30% without any change in selling price; the company's new monthly fixed expenses would be$180,000; and its net operating income would increase by 20%.
(a) Compute the company's break-even point in dollar sales under the new marketing strategy. (8 marks)
(b) Do you agree with the marketing manager's proposal? Why? (2 marks) (8+ 2 = 10 marks)
(b ) Critically evaluate the proposition that "low operating leverage attributable to highly automated phanna manufacturing companies has made them loss making businesses during the current pandemic".
Illustrate your answer with practical observations and data. (25 marks)
(a) Critically evaluate the propositions that "Price over short term must cover relevant cost. Price over financial year must cover full cost (direct cost plus share of indirect cost)".
Where feasible, support your arguments with practical observations and / or numerical examples. (25 marks)
(b) Critically evaluate the proposition that "Lifecycle costing is a better alternative to target costing". Where feasible, support your arguments with practical observations and / or numerical examples