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Solution “price decrement” is to decrease the price of a yellow ginger to £7.00, which is estimated to raise their sales by 35%.
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Solution “sale reduction” is to manufacture only 5000uints of yellow ginger, produce 800 units of red cinnamon and 500units blue-black pepper.
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Solution “ discard” is to abandon the product, which might make losses in the future.
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Solution “advertisement and promotion” is to reduce price and create product awareness. If ICBIP invested £45 per annum in advertisement and with the fixed cost of £30 then sale is expected to be: 10000units @7.00
(A) With so many solutions in hand, manager has asked you to calculate and suggest which solution is best for him and how it can effect the company? (50 marks)
Workers are paid £2 per hour and fixed costs are allocated to products according to the labour hours. ICBIP has contracted “Unlimited potatoes” to supply potatoes for red cinnamon, blue black pepper and yellow ginger for at least one year under terms and conditions. Unfortunately, Unlimited potatoes have given an urgent notice to ICBIP that it will shut down next year as they are making loss and can now provide only 40000kg of potatoes for one year. Besides this, ICIBIP has to produce 5000 blue black pepper for their wholesaler “Water Land” to keep good relations because they had supplied fewer crisps, which did not meet their agreement.
(B) Calculate and compare the two ways of utilizing the supply of 40000kg of potatoes and 5000 blue black peppers. (50 marks)
Answers
(1)
Price decrement
Contribution of products:……………………………………………………..(i)
Contribution= selling price – variable cost.
Contribution gained of yellow ginger (YG): 8000*0.35(35%)= 2800unit
- Therefore from eq. (i) (2800*4.2) 11760
Decrease contribution from reduced selling price:
- Selling price (9-7=2)
- (8000-2800=5200) & (5200*2) (10400)
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Total difference 1360
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Sale reduction
Lost contribution from 3000 units of (YG): {3000*4.2} (12600)
Extra contribution from Red cinnamon: {800*4.45} 3560
Extra contribution from (BBG): {500*4.75} 2375
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Total reduction in contribution: 6665 ------------
Discard
Fixed cost:
- Therefore total fixed asset volume: £ 48450
Profit of ICIBP
Contribution: 93250
(-) Fixed costs: 48450
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Profit: 44800
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Advertisement and promotion
- NP = Px – (a + bx)……………………………………………………….(ii)
- Expected sales – breakeven sales
-------------------------------------------- …………………………………(iii)
Expected sales
Situation before the advertisement and promotion
Breakeven point
Form eq. (ii)
45 + 4.80x = 9x-0
45 = 4.2x
x = 10.714285
Total sales of yellow ginger sold: 10.714285 *9 = 96.428565units
Margin of safety
Percentage margin of safety = 8000 - 96.428565
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{From eq. (iii)} 8000
= 7903.5715
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8000
= 98.794643%
Situation might be after the advertisement and promotion
Breakeven point
Form eq. (ii)
75 + 4.8 x = 7x
75 = 2.2x
X = 34.09
Therefore total sales 238.6363
Margin of safety
{From eq. (iii)}
Percentage margin of safety = 10000 – 238.6363
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10000
= 97.61364%
On the basis of the calculation decrease in price will give net gain of £1360, which is a good profit margin. On the other hand, reduction of sales solution displays the decrease in contribution of £6665 which quite high and company may face more losses. Moreover the overall profit of ICIBP from the normal activity without any solutions suggested is £44800. Last solution of spending advertisement the total sales of company will be 238.6363 and before it was 96.428565 but margin of safety is quite high in both the cases. In conclusion it’s better to eliminate solution of sale reduction, as company will loose out £6665. It is not advisable to discard yellow ginger, as in usual business practice it is earning the sales of £44800. Furthermore spending on advertisement and promotion doesn’t show enough profits for the company and hardly makes any impact. Hence solution price decrement is better solution than others as there is increase in net gain of £1360 and Beckham can ignore other solution he came up with.
(2)
From equation (i)
Availability of the potatoes = 40000 – (5000*5.6)
= 12000
- Get the most out of red cinnamon = 15400*2.022 = 31149.998
- Manufacture blue black pepper deal = 8149*1.397 =11384.15
- Manufacture remaining blue black pepper = 5000*3.4 = 17000*1.397 =23749
Total contribution: £66283.148
Suggestion
- Exploit production of yellow ginger as sales were going down = 6000*0.75= 4500
- Produce blue black pepper agreement = 5000*1.397 = £6985
- Use remaining to produce red cinnamon = 29000*2.022 =£58638
Total contribution =£ 70123
Probably this suggestion is better and will turn out beneficial for the company as the contribution difference is {70123 – 66283.148 = £3839.852}. In this they maximize their production and supply 5000 their blue black pepper to their agreement.
Commentary
CVP in accounting is exceptionally essential because it answers all the questions relating to profits, selling price sales, labour etc. Hence I decided to put several issues into my problems that are pragmatic and companies actually face in reality for Eg. A crisps company called “Piknik” had comparable problems addressed in the question. Moreover I thought that reduction in price is a general issue, which all firms deal with, or review to keep up with the rivalry. Companies try to form strategies or solutions to cope with price of competitors and engage themselves in price war and hence I decided to place in my question. In addition, I also determined to divide the problem into two parts in which one deals to test the application, the decision making of the student and other deals with the knowledge of CVP. What’s more, I have laid down the figures like existing sales, selling price, variable cost contribution, expected sales etc. This has been the most difficult part because most of the time I over estimated the figures and all answers were going haywire. When putting in the figures for each of the categories I had to make sure that the answers don’t come out vague. For the first part students were required to calculate the impacts of all the solution, which is straightforward. I came up the many solutions but preferred four of them for the first part of the problem. I have given students four different ideas totally different from each other. I thought that these four questions would bring in deep analytical skills of the students. Their decision on the basis of their calculations is a vital factor in this judgment of the answers. “Discard” solution might be a bit confusing for students as they might think how go about solving the problem. It gets tricky actually because students are required to calculate normally how ICBIP operates by allocating its labour hours and find the profit. There after students have to compare with other solutions to see whether this is appropriate solution or business should carry on the way it is. In advertisement and promotion solution students are required to calculate and compare the breakeven and margin of safety for both before and after invest in advertisement to decide option is the best for manager. For the second part students had to suggest which would be profitable use of limited supply. This part is difficult then the first one, key to this question was to find contribution per kg and then finding the demand. The logic behind the second half is that with limited supply contribution can be maximized through per unit of limitations. The most important when solving the sum is that students have to assume that 1kg of potatoes is required to make one packet of crisp. With this students will not be able to solve the problem. Also after finding out two ways of calculating the use of potatoes a good student would compare his/her answers and comment on it.
Managerial Accounting and Finance
Module no.: BS2512
Student no.: 0226318
Tutor: Barry Morse
Word count: 1601
Date: 1/12/03
