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Introduction to Management Accounting

Free essay example:

Sikander Mahmood        Introduction to Management Accountant         Martin Roberts

16001382        

Introduction to Management Accounting

Volsev Company LTD

1)        

Break Even=

Fixed Costs

Contribution Per Unit

Fixed Costs are £262,800.

To work out contribution I need to divide sales unit by contribution, however before that I need to work out sales units. To work this out I need to divide sales, which is £2,000,000 by how much they sell each unit for which is £10.

Sales Units

2,000,000

=

200000

10

In order to get contribution per unit I now need to divide contribution by sales units. Contribution is £360,000 and sales units are 200,000.

Contribution Per Unit

360,000

=

1.8

200,000

Now I have worked out contribution per unit, I will divide it by fixed costs to give the number of units needed to be sold to break even.

Break Even=

262,800

=

146000

1.8

To work out margin of safety I need to get subtract the break even units, 146000, from the sales units, 200,000, and then divide them by sales units, 200,000. If I then want to work out the percentage I just simply multiply it by 100.

Margin of Safety

          (200,000-146,000)           54,000

=

0.27

x100=

27%

200,000

This is the original margin of safety, now I need to work out the revised break even point if the Volsev Company LTD decided to spend £72,000 on an advertising campaign. Advertising costs are fixed costs because it does not change with output. Therefore I will add £72,000 to the fixed costs of £262,800. £72,000 + £262800 = £334,800.

To get the revised break even point I need to divide the new fixed costs of £334,800 by the contribution per unit which I have already worked out to be 1.8.

Revised Break Even=

334,800

=

186000

1.8

I will now work out the new revised margin of safety like I did for the original margin of safety.

Revised Margin of Safety

(200,000-186,000)        14,000

=

0.07

x100=

7%

200,000

2)

I think the special advertising campaign is worthwhile; however the margin of safety seems to have decreased by 20%. The margin of safety shows how many sales could decrease before the firm starts to make a loss. Even though margin of safety has gone down there is an increase in the number of units sold. Before the advertising campaign the units were 146,000 and after the advertising campaign the units were 186,000. This is a difference of 40,000 units. If you multiply it by £10, which is the unit price, the increase in sale is £400,000, therefore making it favourable.

3)

The sales manager believes that the sales will fall by 15%. Sales are £2,000,000.

15% of £2,000,000 is £300,000 (£2,000,000/100 x 15=300,000).

£2,000,000 - £300,000 =£1,700,000

There is also a 10% reduction in the purchase price of cost of goods sold. The cost of          goods sold is £1,340,000. 10% of £1,340,000 is £134,000 (1340,000/100 x 10=134,000)

£1,340,000-£134,000= £1,206,000

From the cost of goods sold I need to subtract another 15% because the sales volume will also fall. So I use the already reduced cost of goods sold, £1,206,000 and subtract another 15% from there. 15% of £1,206,000 is £180,900 (1,206,000/100 x 15=180,900).

£1,206,000-£180,900=£1,025,000.

Operating costs are £300,000, 15% needs to be reduced from operating cost. 15% of 300,000 is 45,000 (300,000/100 x 15= 45,000) £300,000-£45,000 = £255,000.

Administration costs have also risen by £20,000; because administration costs are fixed costs, I will add it to the fixed cost of £262,800. £262,800+£20,000 = £282,800.

£

£

Sale

1,700,000

Variable Cost:

Cost of Good Sold

1,025,100

Other Operating Cost

255,000

1,280,100

Contribution

419,900

Fixed Costs

282,800

Net Profit

137,100

Sales have decreased by £300,00 and operating costs has also decreased. Net Profit has increase from £97,200 to £137,100.

4)

Firstly there is a 15% reduction in sales of each product.

Product 1

Product 2

Product 3

Formula

Original Sales

1,000,000

600,000

400,000

Reduction of 15%

-15%

-15%

-15%

Value of 15%

150,000

90,000

60,000

Original Sales/100x15

New Sales

850,000

510,000

340,000

Original Sales -Value of 15%

Then I need to reduce 10% in the purchase price of cost of goods sold and then a further 15% change in the output.

Product 1

Product 2

Product 3

Formula

Cost of Goods Sold

600,000

420,000

320,000

 Cost of Goods Sold/100x10

Reduction of 10%

10%

10%

10%

Value of 10%

60,000

42,000

32,000

Cost of Goods Sold/100x10

New  Cost of Good Sold

540,000

378,000

288,000

Cost of Goods-Value of 10%

Further 15% Reduction

15%

15%

15%

Value of 15%

81,000

56,700

43,200

New Cost of Goods Sold/100x15

Final Cost of Goods Sold

459,000

321,300

244,800

New Cost of Goods-Value of 15%

I also need to take a 15% of Other Operating Costs because of the change in output.

Product 1

Product 2

Product 3

Formula

Other Operating Costs

150,000

90,000

60,000

Reduction of 15%

15%

15%

15%

Value of 15%

22,500

13,500

9,000

Other Operating Costs/100x15

New Other Operating Costs

127,500

76,500

51,000

Other Operating Costs-Value of 15%

Administration costs are added to Fixed Costs. Fixed Costs are £262,800 and Administration costs are £20,000. £262,800 + £20,000= £282,800

Product 1

Product 2

Product 3

Total

Sales

850,000

510,000

340,000

1,700,000

Variable Costs:

Cost of Goods Sold

459,000

321,300

244,800

1,025,100

Other Operating Costs

123,500

76,500

51,000

251,000

Total Variable Cost

586,500

397,800

295,800

1,280,100

Contribution (sales-total variable cost

263,500

112,200

44,200

419,900

Fixed Costs

282,800

Net Profit

137,100

By looking at the figures from an alternative supplier I am able to see that the contribution for each product has increased. Product 1 has increase by 5.4% (263,500/250,000x100=105.4-100=5.4%) Product 2 increased by 24.7% (112,200/90,000x100=124.7-100=24.7), and Product 3 Increased by 121% (44200/20,000x100=221-100=121).

Looking at these figures I would say from a financial perspective that the deal should be agreed for all 3 products because of the increased contribution rate. Product 3 has the highest rate of increase in contribution and by switching to this supplier and this could be beneficial to the company as they could try to sell more of product 3. However the only downside is that because the quality has decreased the sales volume will decrease by 15%, this could lead to loss of market share to rivals who may gain an advantage. This could affect the long term future of the company.

5)

There are many issues Volsev Company LTD should consider before reaching a decision on the scenarios in Q3 &Q4. It is impossible to quantify all aspects of business decisions. These aspects are better known as qualitative issues.

Volsev Company LTD should make sure the new supplier has the capacity to deliver supplies needed and make sure they can deliver on time. If the new supplier can not deliver and make sure stock is ready to go out to Volsev Company LTD. By not delivering on time Volsev Company LTD has the problem because they will be increasing customer waiting time. Loss of customer good will while waiting for a product/service is an example of a qualitative issue, and if the business can not keep up with customer demand it faces losing market share to it rivals. Not only do they face losing market share it could also lead to new companies coming in the market and challenging Volsev Company LTD for market share.

In Q3, it states that the quality will be lower; this could lead to another qualitative issue because it could lead to a decline in employee’s morale. The reason for this is because the new material is cheaper in quality it could also be more problematic. Cheaper quality may also mean that customers refuse to buy from the company and buy from a company that offer more quality in their product/service.

6)

Absorption costing is a method in management accounting which is used to assign costs to products. Absorption costing is the process which charges fixed as well as variable overheads to cost units. Absorption costing in addition to assigning direct costs, also assign all or a proportion of production overhead costs by means of a number of absorption rates.

Absorption costing takes in to account the fixed and variable costs while calculating the unit cost of an item.

If product cost are to be calculated, direct labour, directs materials and indirect expenses need to be included in the calculation. Allocating cost should be considered while calculation the product cost. This is basically allocating a cost centre overhead on that particular cost centre. After allocating the cost centres, which have been apportioned, you have to then apportion the cost centres by the size of the floor area.

Another aspect that needs to be considered is finding a way in which specific units are to be used to absorb the production overhead after it has been allocated and apportioned. The allocated overheads are broken down and then allocated on pro rata basis.

To work out the fixed costs, an overhead absorption rate needs to be calculated. To work out the absorption rate, the ideal thing to use would be direct labour hours, or machine hours if the product is machine intensive. The reason for using labour hours/machine hours is because it gives a more precise figure. This is because it takes into account the time taken to produce a unit.

Absorption costing is suitable to calculate product costs because the selling price of the unit product is set high enough to recuperate all costs that had occurred in the production of the product. If the product is not sold at the selling price, which have been set, then absorption costing will allow the selling price to be reduced. However it is only reduced so that the company can recover all their costs, which occurred in the manufacturing of the unit product.

For example, a company which manufactures furniture, it main production item is tables, the table is one of the cost centres. First of all costs which are directly traceable to the production of the table is allocated to the cost centre. This includes machinery which is dedicated to the production of tables. Secondly, the calculation of service centres like the human resources department are taken in to account. These costs are apportioned to various cost centres like the production of tables. Then the apportioned costs are absorbed into the production of each table. This then ensures that all costs are recovered.

7)

Absorption costing in management accounting can lead to managers taking incorrect decisions about the business which can be potentially dangerous to the running of the business. Managers can make decisions which are expensive or time consuming to the business.

Absorption costing can be problematic because all the methods are arbitrary; this means that these methods are subjective. No method digging up fixed costs is satisfactory. Absorption costing can also lead to managers taking up incorrect and potentially risky decisions because absorption costing is only correct at the level of activity at which it was calculated at. Absorption costing can lead to managers making decisions on under or over absorption of overheads. Absorption costing is known to be very complex, time consuming and expensive. The problem with that is if the process is time consuming managers will not b able to make quick decisions and therefore the role of the manager is very inefficient, it could also lead to managers making incorrect decisions because they do not have enough time to make a calculated decision. Absorption costing is said to be very expensive, this makes it inefficient. Absorption costing is also very complex, this makes it very hard for managers to understand the absorption costing, due to this factor, managers may not completely understand the costing system and the decision they make might not be correct for the business. Absorption costing can be lead to managers taking incorrect decisions, because absorption costing gives managers the incentive to overproduce. Absorption costing can be potentially misleading guide to the profitability of the firm’s products, if the profitability of the products are misleading, the manager may take a decision which has come through misleading information, and this makes the decision of the managers incorrect. The capacity levels chosen for overhead absorption rates are based on historical data and data which are questionable. If absorption costing data is questionable this means that the data is open to debate. If the data is debatable it may mean that if any decision was made by looking at that data the decision may not be correct and could be a risky threat to the business.

In absorption costing the main objective of managers is to increase profits, this may lead to ignoring factors such as qualitative issues. The decisions they make can lead to loss in employee morale and loss of customer goodwill

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