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# Introduction to Management Accounting

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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.

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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