Project 3: Costing and Cost Allocations
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Scenario
In your last business report, you recommended a strategic decision about the revenue target to make LGI competitive. In Project 3, you will help LGI’s leadership move the company forward on a path toward a sustainable future. The company needs to restore the confidence of shareholders and other stakeholders by maintaining a satisfactory level of operating performance.
LGI, like all companies, needs robust earnings before interest, taxes, depreciation, and amortization (EBITDA). In other words, earnings must be sufficient to cover LGI’s investing activities, debt service, and taxes—with a healthy profit left for reinvestment and distributions to stockholders
Your Project 3 business report will focus on strengthening EBITDA. To do this, you will analyze LGI’s cost structure and determine how to increase productivity. These tasks are prerequisites for identifying a future investment (Project 4) and how to finance it (Project 5).
Competencies
Your work will be evaluated using the competencies listed below.
· 3.1: Identify numerical or mathematical information that is relevant in a problem or situation.
· 3.2: Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
· 3.3: Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
· 10.3: Determine optimal financial decisions in pursuit of an organization’s goals.
· 10.5: Develop operating forecasts and budgets and apply managerial accounting techniques to support strategic decisions.
Project 3: Costing and Cost Allocations
Step 1: Prepare for the Project
For the next two weeks, you will focus on the specific actions LGI can take to strengthen its EBITDA. You will analyze cost-volume-profit, pricing decisions, and activity-based costing.
Log into O’Reilly by following these instructions
before accessing the chapters and completing the required reading.
Required Reading
Davis, C. E. & Davis, E. (2011).
Managerial Accounting
. Wiley.
Chapter 3: Cost-Volume-Profit Analysis and Pricing Decisions
· Section 3.1 to 3.3
Chapter 7: Activity-Based Costing and Activity-Based Management
· Sections 7.1–7.2
Recommended Reading
Chapter 2: Cost Behavior and Cost Estimation
· Sections 2.1–2.3
Project 3: Costing and Cost Allocations
Step 2: Review and Practice
Using the
Project 3 Review and Practice Guide
, review EBITDA and cost structures to set LGI on the path toward a sustainable future. Then apply what you have learned by completing the exercises and problems referenced in the Project 3 Review and Practice Guide.
You must review the guide and do the practice exercises and problems so that you
· are prepared to have informed discussions with your team about LGI’s income statement,
· understand what the cost data reveal about operational efficiency, and
· can use this information to make recommendations for improvements.
Complete this review and practice by the end of Week 5.
Review and Practice
You must complete the review and practice content to participate in the discussion in Step 3.
Project 3 Review and Practice Guide
Project 3: Costing and Cost Allocations
Step 3: Participate in the Required Project 3 Discussion
SolStock / E+ / Getty Images
You have finished reviewing the material and performing the exercises, but you have some questions. Participate in the Project 3 class discussion. Respond to the two questions below by posting in the discussion; then, respond to two of your classmates’ discussion posts by the end of the week.
Discussion
Answer the following questions:
1. Discuss the concepts that were most challenging for you in the readings and review material. How did the practice exercises help clarify these?
2. What did you learn that will help you analyze LGI’s cost structure to increase its productivity and put the company on a path to a sustainable future?
Before you participate in the discussion activity see
MBA discussion guidelines
.
Project 3: Costing and Cost Allocations
Step 4: Complete the Analysis Calculation for Project 3
Your team has provided you with an Excel workbook containing LGI’s financials. You will use the workbook to
· Determine how LGI can strengthen EBITDA
· Discover ways for LGI to increase productivity
· Perform cost calculations in the worksheets
Complete the analysis calculation for the project:
· Download the
Project 3 Excel Workbook
, click the Instructions tab, and read the instructions.
· Calculate and evaluate costs using the worksheets.
· If you would like instructor feedback on this step, follow the instructions in the box below to submit your Excel file to the Assignments folder as a milestone by the end of Week 5. This is optional. If you choose to submit the milestone, you will receive instructor feedback you may use to make corrections before submitting your final Project 3. To distinguish the milestone submission from the file you will submit in Step 5, label your file as follows: P3_milestone_lastname_Calculation_date
Take Action
Submit your assignment to your instructor for review and feedback.
Follow these steps to access the assignment:
· Click My Tools in the top navigation bar.
· Click Assignments.
· Select the relevant assignment.
· You should use the comments your instructor made about your optional milestone submission to revise your calculations as needed. Next, proceed to Step 5, where you will answer questions about your analysis, make recommendations for the client, and compile and submit your final report.
Project 3: Costing and Cost Allocations
Step 5: Prepare the Analysis Report for Project 3
Chalirmpoj Pimpisarn / iStock/Getty Images Plus / Getty Images
You have developed an in-depth understanding of LGI’s operating efficiency related to costing and the impact on EBITDA. You feel confident that your target revenue combined with a better mix of fixed and variable costs will positively boost LGI’s productivity, providing the company with a competitive edge. LGI will finally be on a path toward a sustainable future. Answer the questions in the
Project 3 Questions – Report Template
document. Prepare your analysis report including recommendations for how the company can improve its financial situation.
Complete the analysis report for the project:
· Download the Project 3 Questions – Report Template
· Read the instructions.
· Answer all the questions.
· Include your recommendations.
· Submit the analysis report (Word document) and analysis calculation (Excel file) to the Assignments folder as your final deliverable at the end of Week 6. Label your files as follows:
· P3_Final_lastname_Report_date x
· P3_Final_lastname_Calculation_date.xlsx
Check Your Evaluation Criteria
Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work. A good practice would be to use each competency as a self-check to confirm you have incorporated all of them. To view the complete grading rubric, click My Tools, select Assignments from the drop-down menu, and then click the project title.
· 3.1: Identify numerical or mathematical information that is relevant in a problem or situation.
· 3.2: Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
· 3.3: Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
· 10.3: Determine optimal financial decisions in pursuit of an organization’s goals.
· 10.5: Develop operating forecasts and budgets and apply managerial accounting techniques to support strategic decisions.
3
COST-VOLUME-PROFIT ANALYSIS AND PRICING DECISIONS
After studying this chapter, you should be able to meet the following learning objectives (LO)
.
1. Calculate the breakeven point in units and sales dollars. (Unit 3.1)
2. C
alculate the level of activity required to meet a target income. (Unit 3.2)
3. Determine the effects of changes in sales price, cost, and volume on operating income. (Unit 3.2)
4. D
efine operating leverage and explain the risks associated with the tradeoff between variable and fixed costs. (Unit 3.2)
5. C
alculate the multiproduct breakeven point and level of activity required to meet a target income. (Unit 3.3)
6. D
efine markup and explain cost-plus pricing. (Unit 3.4)
7
. Explain target costing and calculate a target cost. (Unit 3.4)
The Pitch
Martin Keck, vice president for sales at Universal Sports Exchange, was talking with his sales team at the monthly sales meeting. “As you know, the company missed its sales target last year. We were expecting to sell 10% more jerseys than we did. And we all saw the effect that the lower sales level had on our bottom line. When we miss our sales targets, it affects what everyone else in the company can accomplish because they count on us to generate revenue.”
Sarah Yardley, one of the company’s top salespeople, had been listening intently as Martin discussed the concept of cost behavior. “I think I understand all this talk about cost behavior,” she said, “but I’m still not sure how it plays into my decisions.”
“Sarah,” Martin replied, “we have to use our knowledge of cost behaviors to predict what effect our decisions will have on the bottom line. We know when it is advantageous to, say, initiate a new advertising campaign instead of reducing prices, but to persuade the president and the CFO, we need to have more convincing data, and that includes the financial impact of our decisions. In fact, I’ll be meeting with the president and CFO next week to discuss the relative merits of a $50,000 advertising campaign and a 10% reduction in sales price. You can be sure that I’ll know the financial impact of each alternative before I walk into the meeting.”
Decisions like this one come up frequently in business. Managers of a start-up company want to know how much they will have to sell before they generate a profit. Managers of a company that has been in business for years want to know whether they should pass their increased costs on to customers in the form of a price increase. And in a highly competitive industry, managers of another company want to know what will happen to income if they meet a competitor’s lower price or offer a coupon to increase sales volume. Knowing how these changes will affect a company’s income will help managers to decide which alternatives to implement.
UNIT 3.1 Breakeven Analysis
GUIDED UNIT PREPARATION
Answering the following questions while you read this unit will guide your understanding of the key concepts found in the unit. The questions are linked to the learning objectives presented at the beginning of the chapter.
1. What does it mean to break even? LO 1
2. If a product’s variable cost per unit increases while the selling price and fixed costs remain constant, what will happen to the breakeven point? LO 1
3. How do you calculate the breakeven point in units? In dollars? LO 1
4. What actions can a company take to reduce its breakeven point? LO 1
5. What is the margin of safety? How is it calculated? LO 1
A common question for managers, particularly of start-up ventures, is, “How long will it take us to earn a profit?” Stated another way, what these managers are really asking is, “When will we break even?” Knowing the breakeven point helps managers evaluate the desirability and profitability of various business opportunities.
1
The Breakeven Point
As managers evaluate business opportunities, they examine many factors, including profitability. But before a business can generate a profit, it must generate sufficient revenue to cover all of its expenses. In other words, the business must reach its breakeven point. At the breakeven point, sales revenue is exactly equal to total expenses, and there is no profit or loss. There is only one level of sales at which this relationship is true. Thus, the breakeven point can be calculated using the profit equation. To find the breakeven point, set the standard profit equation equal to zero, let x equal the number of units needed to break even, and then solve for x, as shown in the following equation.
As
Exhibit 3-1
shows, Universal Sports Exchange, one of C&C Sports’ customers, reported operating income of $42,000 for fiscal year 2010. Using the information in Universal’s income statement, let’s calculate Universal’s breakeven point in jerseys using the profit equation above.
EXHIBIT 3-1 Universal Sports Exchange’s contribution format income statement.
In Step (1) we put everything into “constant” form—sales price per unit, variable cost per unit, and total fixed expenses. We set the number of jerseys equal to x because that is what we want to know—the number of jerseys that must be sold to break even. Step (2) shows that we could have started the calculation with the $4 contribution margin per unit, skipping Step (1). Step (3) reveals an essential relationship: At the breakeven point, the total contribution margin equals total fixed expenses. In Step (4), we solved the breakeven question: 42,000 jerseys must be sold to break even.
We can use our definition of the contribution margin as a shortcut to finding the breakeven point. Since the contribution margin is the amount that is available to cover fixed expenses and provide a profit ($0 in the breakeven case), we can use the following formula to calculate the breakeven point in units:
Notice that this formula is just a restatement of the mathematical operations made between Steps (3) and (4).
Sometimes it is useful to know the breakeven point in terms of sales dollars rather than units. If we know the breakeven point in units, we can simply multiply it by the sales price per unit: $20 × 42,000 = $840,000. Alternatively, we could use the contribution margin ratio and the profit relationships examined above, as in the following formula:
Reality Check—Who really uses breakeven analysis?
For the gallery to break even, only 400 people a day needed to view the exhibit.
Retail establishments and manufacturers have an obvious interest in breakeven analysis. But do organizations such as art galleries ever use the concept? Consider the Bellagio Gallery of Fine Art, housed in the Bellagio Casino in Las Vegas. With no permanent collection, the gallery must borrow works from museums and private collections. On January 30, 2004, Bellagio opened a show of 21 Monets on loan from the Museum of Fine Arts in Boston. Marc Glimcher, the man behind the show, guaranteed the museum at least $1 million for the loaned paintings. He estimated that for the gallery to break even, only 400 people a day, paying between $12 and $15 each, needed to view the exhibit. Since shows of works by Andy Warhol and Faberge had drawn over 150,000 visitors, this level of attendance did not appear to be out of reach.
When the exhibit closed on May 30, 2005 after a 16-month run, 450,000 people had visited the show. The average 1,000 visitors each day far exceeded the projected breakeven attendance. The show generated approximately $6 million in ticket sales, with more than $1 million going back to Boston’s Museum of Fine Arts. Following the show’s success, the gallery staged another show of Impressionist paintings from the museum, and other museums are expressing interest in showing their works at the Bellagio.
Sources: Fred A. Bernstein, “A Loan That Keeps on Paying,” The New York Times, March 30, 2005; Kristen Peterson, “Casino Handed Artistic Legacy,” Las Vegas Sun, February 8, 2008,
http://www.lasvegassun.com/news/2008/feb/08/casino-handed-artistic-legacy/
(accessed March 5, 2008); Steve Friess and Peter Plagens, “Show Me the Monet,” Newsweek, January 26, 2004, 60; Ken White, “Making an Impression, Las Vegas Review-Journal Neon, June 10, 2005,
http://www.reviewjournal.com/lvrj_home/2005/Jun-10-Fri-2005/weekly/2000819.html
(accessed March 5, 2008).
Breakeven Graphs
While calculating a breakeven point is useful, managers are also interested in the profits generated at other sales levels. A breakeven graph illustrates this relationship between sales revenue and expenses, allowing managers to view a range of results at a single glance.
Exhibit 3-2
shows Universal’s breakeven graph based on the company’s sales and expense information. Notice that the total sales revenue line intersects the y-axis at $0 and has a slope of $20: for every jersey sold, Universal takes in $20 of revenue. The fixed expense line intersects the y-axis at $168,000 and remains constant across all sales volumes. Even if no jerseys were sold, the company would incur fixed expenses of $168,000. The total cost line represents the sum of fixed and variable expenses, so it intersects the y-axis at $168,000 and increases at a rate (slope) of $16 per jersey. The point at which the total sales revenue line and the total expense line intersect is the breakeven point. Any level of sales to the left of the breakeven point represents an operating loss. Any level of sales to the right of the breakeven point represents operating income.
EXHIBIT 3-2 Breakeven graph for Universal Sports Exchange.
One of the activities managers like to engage in is called “what-if” analysis, or sensitivity analysis. “What if I could reduce fixed expenses—how would profits change?” Before we get into this type of analysis, let’s use Universal’s breakeven graph to think conceptually about these questions. What if fixed expenses decrease—how would the graph change? The fixed expense line would shift downward, as would the total expense line. The revenue line would remain unchanged, so the breakeven point would shift to the left, indicating that fewer jerseys would need to be sold to break even. And since neither sales nor variable costs changes, the contribution margin doesn’t change either. The end result: when expenses go down, operating profit goes up.
Think About It 3.1
Fill in the rest of the table
Margin of Safety
A company’s margin of safety is the difference between current sales and breakeven sales. It represents the volume of sales that can be lost before the company begins to lose money and can be measured in units or sales dollars.
Let’s calculate Universal’s margin of safety. From
Exhibit 3-1
we can calculate Universal’s current unit sales: $1,050,000 ÷ $20 sales price per jersey = 52,500 jerseys sold.
Universal is in good shape—it would have to lose 20% ($210,000 4 $1,050,000) of its sales before it started losing money.
UNIT 3.1 REVIEW
KEY TERMS
Breakeven point p. 82
Breakeven graph p. 84
Margin of safety p. 86
SELF STUDY QUESTIONS
1. LO 1 At the breakeven point, sales revenue and total contribution margin are equal. True or False?
2. LO 1 Reese Manufacturing has a current breakeven point of 475,642 units. To reduce the breakeven point, Reese Manufacturing should
2. reduce the contribution margin.
2. increase fixed expenses.
2. reduce the sales price per unit.
2. increase the contribution margin.
1. LO 1 Jordan Graft Images sells framed prints of various college landmarks. Jordan purchases the prints from his supplier for $30 and sells them through his website for $65. Jordan’s fixed expenses are $89,250. What is Jordan’s breakeven point in units?
3. 940
3. 1,373
3. 2,550
3. 2,975
1. LO 1 Deaton, Inc., sells computer backpacks. The company purchases the backpacks from its supplier for $15 and sells them to office supply stores for $2
5. D
eaton’s fixed expenses are $100,000. What is Deaton’s breakeven point in sales dollars?
4. $100,000
4. $166,667
4. $175,000
4. $250,000
1. LO 1 Conrad Steel sells bridge supports. Currently, the company’s sales revenue is $5,000,000. If Conrad’s controller has calculated the company’s breakeven point to be $3,975,000, what is the company’s margin of safety?
5. $1,025,000
5. $2,950,000
5. $3,975,000
5. $5,000,000
UNIT 3.1 PRACTICE EXERCISE
Use this income statement to answer the questions that follow.
Required
1. What is the variable cost per unit?
2. What is the total fixed expense?
3. What is the contribution margin per unit?
4. What is the contribution margin ratio?
5. What is the breakeven point in units? In dollars?
6. What is the margin of safety in units? In dollars?
SELECTED UNIT 3.1 ANSWERS
Think About It 3.1
Self Study Questions
1. False
2. D
3. C
4. D
5. A
Unit 3.1 Practice Exercise
1. The two variable costs are cost of goods sold ($32 per unit) and shipping ($2 per unit), for a total variable cost per unit of $34.
2. The two fixed expenses are salaries ($800) and advertising ($400), for a total fixed expense of $1,200.
3. $50 − $34 = $16
4.
5.
(Notice that this amount also equals 75 units × $50.)
6. The margin of safety equals current sales minus breakeven sales. Before this calculation can be done in units, you must compute how many units the company is currently selling:
Margin of safety in units = 100 units − 75 units = 25 units
Margin of safety in dollars = $5,000 − $3,750 = $1,250 (Notice that this amount also equals 25 units × $50.)
UNIT 3.2 Cost-Volume-Profit Analysis
GUIDED UNIT PREPARATION
Answering the following questions while you read this unit will guide your understanding of the key concepts found in the unit. The questions are linked to the learning objectives presented at the beginning of the chapter.
1. How can managers use breakeven analysis to determine the level of sales needed to attain a specific level of income? LO 2
2. How can managers use CVP analysis to support their decision making? LO 3
3. What assumptions are made in CVP analysis? Do those assumptions invalidate the predictions managers make using CVP analysis? LO 3
4. Explain the concept of operating leverage. LO 4
Although managers often want to know how many units they need to sell to break even, they are more interested in finding out how they can generate a profit. Cost-volume-profit analysis, or CVP for short, helps managers assess the impact of various business decisions on company profits.
Target Operating Income
Managers frequently have an income target in mind when they plan business activities. They might want to know what it takes to make, say, $60,000 in operating income, or income before taxes. Calculating the level of sales required to meet that goal is easy if you know some basic information. You use the same profit equation you use to determine the breakeven point, but set profit equal to the target income. In Universal’s case, we would solve the problem as follows:
Recall from page 83 that Universal is already selling 52,500 jerseys. Although we can do the math to determine that the company will need to sell 4,500 additional jerseys to reach the target income of $60,000, managers must use their judgment in deciding if achieving this level of additional sales is likely.
With a simple adjustment, we can use our shortcut formulas from Unit 3.1 to answer the target income question:
Target Net Income
Suppose that instead of operating income, Universal’s managers want to know how many jerseys they must sell to make $42,000 in net income. Remember, net income is operating income less income taxes. Since the profit equation calculates operating income, we need to convert the desired net income to operating income. Universal’s income taxes are 30% of operating income. That means net income must be 70% of operating income. If we state this relationship mathematically, we can determine what operating income results in $42,000 net income:
Now we have the same operating income target—$60,000—as in the last section. From this point, we simply follow the steps described in that section to calculate the number of units needed to reach the target operating income.
From the preceding calculations, we can develop the following general formula for converting net income to operating income:
What-If Analysis
Managers often want to know what will happen to profit or other measures if costs or volume change. Recall that the profit equation includes sales revenue, variable expenses, and fixed expenses. If we know all but one of these variables, we can solve for the remaining unknown variable. Here are some questions that Universal’s managers might ask. As we answer these questions, refer back to
Exhibit 3-1
, which shows Universal’s contribution format income statement as of January 30, 2010. Remember that the company sold 52,500 jerseys that year.
What if C&C Sports were to raise the price of a baseball jersey by 5%?
The price Universal pays C&C Sports for each jersey is a variable cost, so we need to adjust the “constant” form of that cost, which is the $14.80 cost per jersey. A 5% increase from $14.80 would be $0.74, so the new cost of goods sold per jersey would be $14.80 + $0.74 = $15.54. The total variable cost per jersey would be $15.54 plus a $1.20 sales commission, or $16.74.
Since the variable cost per unit has gone up, the contribution margin per unit has gone down to $20 − 16.74 = $3.26. (We could just as easily reduce the original contribution margin per unit by the increase in variable costs: $4 − $0.74 = $3.26.) To calculate the new operating profit, we simply substitute this revised contribution margin into the profit formula:
If the cost of jerseys increases 5% and Universal sells the same number of jerseys as last year, but does not raise the price it charges, the company will report a much smaller profit.
How much would Universal need to raise the price of a baseball jersey to cover the increase in cost and earn the same operating profit as last year?
The solution to this problem isn’t as simple as adding $0.74 to the price because Universal pays a commission based on a percentage of sales revenue—6%, to be exact. Therefore, if the sales price per unit changes, so must the commission per unit. Solving for the sales price, SP, we find that the new price per jersey would need to be $20.79:
The new sales commission would be $20.79 X 0.06 = $1.247 per jersey, rounded up to $1.25. Therefore, the contribution margin per unit would be $20.79 − 15.54 − 1.25 = $4. Notice that this amount is the same as the original contribution margin. If Universal raised the price to $20.79 and the number of units sold remained the same, operating income would not change.
Think About It 3.2
If Universal were to raise the sales price of its baseball jersey by $0.79, would the number of units sold remain the same? What if the price were to rise by $5 to $25?
Refer back to the original situation. Assume Universal is considering a new advertising campaign that would cost $10,000. By how much would sales need to increase for the company to make the same operating income as last year?
Adding a new advertising campaign would increase fixed expenses to $178,000. This is a target income problem, and the target is last year’s operating income, $42,000 (see
Exhibit 3-1
on page 83):
So the answer to the question of how much sales would need to increase is:
WATCH OUT!
When volume changes, total sales revenue, total variable expenses, and total contribution margin all change. Students typically change total sales revenue but forget to change total variable expenses. The safest bet is to start with contribution margin per unit X sales volume to be sure to capture the change in total sales and variable expenses.
We could have considered this question in a different manner by asking how much additional contribution margin would be needed to cover the $10,000 in additional fixed expenses. The answer is $10,000. How much in additional sales does that amount imply? Since the contribution margin is 20% of sales, we simply divide the additional contribution margin needed by the contribution margin ratio:
Limitations of CVP Analysis
CVP analysis is a powerful tool for assessing the profit implications of various business decisions. However, the predictions provided by the analysis are only as good as the data they are based on. And when using CVP as a decision tool, we have to make several assumptions about the data. The primary assumptions we have made in our use of CVP in this unit are:
· All costs can be easily and accurately separated into fixed and variable categories.
· A linear relationship exists between total variable expenses and sales activity over the relevant range of interest.
· Total fixed expenses and variable costs per unit remain constant across all sales levels.
· Inventory is sold during the same period it is purchased or produced.
Even with these assumptions, managers find CVP to be a useful tool in evaluating business opportunities.
Cost Structure and Operating Leverage
Up to this point, we have considered the levels of variable and fixed costs to be given, changeable only by increases or decreases in cost. To some degree, however, firms can, over time, control the relative size of variable and fixed costs in order to establish a particular cost structure. Why would this cost structure matter to a company? Remember that variable costs are incurred only with some type of activity. For example, variable selling expenses are incurred only when sales are made, whereas fixed selling expenses are incurred regardless of the level of sales. Companies that carry a high level of fixed costs relative to variable costs are considered to have greater risk than companies with a high level of variable costs relative to fixed costs.
One measure that is directly affected by the company’s cost structure is operating leverage, or the change in operating income relative to a change in sales. A company with high operating leverage will experience a large percentage change in operating income as a result of a small percentage change in sales. Refer back to
Exhibit 3-1
, which shows Universal’s contribution format income statement. If sales were to increase by 10% ($105,000), the contribution margin would increase by 10% ($21,000), increasing operating income by $21,000. Compared to the original operating income of $42,000, that is a 50% increase in operating income! Of course, the bad news is that if sales were to decrease by 10%, operating income would decrease by 50%.
Another way to compute the expected change in operating income due to a change in sales volume at a given level of sales is to compute the degree of operating leverage.
Universal’s degree of operating leverage is 5, computed as follows:
That is why a 10% increase in sales due to sales volume (not due to a change in sales price) will increase operating income by 50%: a 10% increase in sales × 5 = a 50% increase in operating income.
Firms can manage their degree of operating leverage by converting variable costs to fixed costs, and vice versa. In a production facility, for example, welders who are paid by the hour (a variable cost) could be replaced by a welding machine (a fixed cost). In Universal’s case, managers could replace the sales commission (a variable cost) with a salary (a fixed cost).
Exhibit 3-3
compares Universal’s contribution format income statement for last year to what it would have looked like if the sales commission had been replaced with a salary.
The $63,000 in original sales commissions has been added to the original $116,500 fixed selling and marketing expenses, yielding new fixed selling and marketing expenses of $179,500. Notice that under the salary alternative, the contribution margin per unit has risen to $5.20. For every unit sold, Universal retains $1.20 more revenue to cover fixed expenses and contribute to profit.
Under the new salary alternative, as before, a 10% increase in sales ($105,000) will increase contribution margin by 10%, or $27,300. But the $27,300 added to operating income represents a 65% increase ($27,300 ÷ $42,000). The degree of operating leverage, then, has increased from a factor of 5 to a factor of 6.5 ($273,000 ÷ $42,000). With more fixed and fewer variable costs, the new cost structure creates a higher degree of operating leverage, and thus a higher degree of risk. The payoff is bigger when sales increase, but the downside is bigger when sales decrease.
EXHIBIT 3-3 Universal Sports Exchange’s contribution format income statement.
The profit–volume graph in
Exhibit 3-4
compares Universal’s profit over several sales levels under the two cost structures, one with a sales commission and the other with a sales salary. The point at which the profit line intersects the y-axis represents total fixed expenses—$168,000 under the commission scenario and $231,000 under the salary scenario. The point at which the profit line crosses the x-axis is the breakeven point, where profit equals zero. Under the commission scenario, only 42,000 jerseys must be sold to break even; under the salary scenario, 44,423 jerseys must be sold to break even. The difference in the breakeven points represents another type of risk related to operating leverage: As operating leverage rises, more jerseys must be sold to break even.
EXHIBIT 3-4 Profit-volume graph for Universal Sports Exchange.
Reality Check—Fixed versus variable costs
We believe that a simpler business model will better serve our customers and lower costs and is required in the demanding, competitive industry in which we operate today.
Circuit City Stores, Inc., is a good example of the double-edged sword of sales commissions, which affect both sales revenue and sales cost. Until early 2003, 60% of Circuit City’s sales force was paid on commission; the remaining 40% was paid on an hourly basis. In 2003, in an effort to control costs, Circuit City converted its commission-based employees to hourly salaries. Although many employees who had been paid on commission chose to accept an hourly rate, not all employees did. As a result, the company laid off 3,900 commission-based employees and hired 2,100 new hourly workers.
Unfortunately, many of the laid-off workers were among Circuit City’s best salespeople. One former salesman who had been with the company for more than five years had averaged about $28 per hour in commissions and other incentives. On four occasions he had been honored as one of the company’s top 200 salespeople. Why would Circuit City let him and others go when the results could be lower sales? In its 2003 annual report, Circuit City’s management stated that they had “changed the compensation structure in our stores, adapting to the preferences of today’s consumer as well as the industry’s new product trends. This change also was a major step towards simplifying our business. We believe that a simpler business model will better serve our customers and lower costs and is required in the demanding, competitive industry in which we operate today.”
And save money the company did—approximately $130 million in payroll costs in fiscal 200
4. A
fter a disappointing fiscal year 2004, the company’s sales and performance measures rebounded in 2005 and again in 2006.
But the switch in cost structure didn’t solve all the company’s wage issues. On March 28, 2007, Circuit City announced a “wage management initiative” that resulted in the termination of 3,400 of its highest paid salespeople in favor of new, lower paid, less experienced salespeople. The terminated employees were told, however, that they could reapply for their positions after ten weeks, but at the lower salary. Estimated savings to Circuit City? $250,000 over the next two years.
Again, this wasn’t enough savings to solve the company’s problems, as the firm declared bankruptcy and in January 2009 announced liquidation plans for all stores to close by March 31, 2009. On May 19, 2009, the brand was purchased by Systemax, Inc., and will be relaunched as an online retailer. With a significantly lower level of fixed costs than the brick-and-mortar version, perhaps this reincarnation will be successful.
Sources: David Carr, “Thousands Are Laid Off at Circuit City. What’s New?” The New York Times, April 2, 2007,
http://www.nytimes.com/2007/04/02/business/media/02carr.html
(accessed March 13, 2008); “Circuit City … The ReLaunch,”
http://www.circuitcity.com
(accessed May 22, 2009); “Circuit City Stores, Inc. Announces Additional Changes to Improve Financial Performance,” Circuit City Stores, Inc. news release, March 28, 2007,
http://newsroom.circuitcity.com/releasedetail.cfm?ReleaseID=235835
(accessed March 13, 2008); Parija B. Kavilanz, “Circuit City to Shut Down,” CNNMoney.com,
http://money.cnn.com/2009/01/16/news/companies/circuit_city/
(accessed May 22, 2009); David Lazarus, “Circuit City Firing Its Best Salesmen,” San Francisco Chronicle, February 12, 2003; Barry Willis, “Cutbacks at Circuit City,”Stereophile, February 9, 2003,
http://stereophile.com/news/11569/
(accessed February 23, 2006); Circuit City 2003 Annual Report; Circuit City 2004 Annual Report; Circuit City 2005 Annual Report; Circuit City 2006 Annual Report.
At 52,500 jersey sales, the point where the two profit lines cross, the two scenarios return equal profits. At lower sales levels, profit is higher under the commission scenario; at higher sales levels, profit is higher under the salary scenario. The choice of cost structure, then, is critical. Depending on the company’s sales volume, it can greatly affect profit.
Changing a company’s cost structure affects more than its operating leverage, however. It may have behavioral implications for the employees. In Universal’s case, the company paid sales commissions to encourage the sales staff to sell more units, to make more money both for themselves and for the company. When the sales commission is eliminated, so is the financial incentive for the sales staff to sell more. The Reality Check on page 94 describes what happened to Circuit City’s sales when managers dropped the sales commission.
Think About It 3.3
Assume you are running a new start-up company in which you have invested a good deal of money. What type of cost structure will you use to pay your sales staff—commission or salary? Why?
UNIT 3.2 REVIEW
KEY TERMS
Cost-volume-profit analysis (CVP) p. 88
Degree of operating leverage p. 92
Operating leverage p. 92
SELF STUDY QUESTIONS
1. LO 2 Pete’s Pretzel Stand sells jumbo pretzels for $2 each. Pete’s variable cost per pretzel is $0.50, and total fixed expenses are $3,000 per month. If Pete wants to earn a monthly operating income of $9,000, how many pretzels must he sell during the month?
1. 8,000
1. 6,000
1. 4,000
1. 2,000
1. LO 2 Marisol’s Parasols sells novelty umbrellas for $10 each. Marisol’s variable costs are $4 per unit, and her fixed expenses are $3,000 per month. If Marisol’s tax rate is 25%, how many umbrellas must Marisol sell each month if she wants to earn $9,000 in net income?
2. 500
2. 2,000
2. 2,500
2. 3,500
1. LO 3 All other things equal, a 20% increase in the number of units sold will yield a 20% increase in net income. True or False?
1. LO 3 All other things equal, an increase in the number of units sold will
4. increase operating income.
4. increase total variable expenses.
4. increase total contribution margin.
4. all of the above.
1. LO 3 Ellis McCormick and Elaine Sury are owners of MeetingKeeper, a company that sells personalized daily planners. Last month, the company sold 1,500 planners at a price of $6 per planner. Variable costs were $2.40 per unit; fixed expenses were $3,600. This month, Ellis and Elaine have decided to spend $2,000 to advertise in the local newspaper. They believe that the additional advertising will generate 25% more sales volume than last month. What will be this month’s operating income?
5. $3,150
5. $1,150
5. $775
5. ($1,100)
1. LO 4 All other things equal, a company can increase its operating leverage by converting commission-based salespeople to salaries. True or False?
1. LO 4 Dawson Enterprises’ current degree of operating leverage is 8. A planned promotion campaign is expected to increase sales by 15%. What is the expected increase in operating income?
7. 8%
7. 15%
7. 23%
7. 120%
1. LO 4 Festive Foods Caterers’ income statement for last month follows. What is Festive Foods’ degree of operating leverage?
8. 0.7
8. 3
8. 7
8. 10
UNIT 3.2 PRACTICE EXERCISE
Use this income statement and your calculations from the Unit 3.1 Practice Exercise to answer the following questions.
1. How many units would the company need to sell to earn $2,000 in operating income?
2. How many units would the company need to sell to earn $1,140 in net income if the tax rate is 25%?
3. B
y how much would operating income change with a 10% increase in units sold?
SELECTED UNIT 3.2 ANSWERS
Think About It 3.2
Kids who play baseball need baseball jerseys. The question is, will consumers continue to buy those jerseys from Universal, or will they go elsewhere? For an additional $0.79, Universal may not see much of a change in demand for its jerseys; the increase in price is less than 4%. At a $5 increase in price, however, consumers may look for a better deal somewhere else.
Think About It 3.3
You should offer a commission. A start-up company typically has little self-generated cash and few customers. Salaries would have to be paid no matter what, even if no sales were made. With a commission, the sales staff is paid only when the company earns revenue. Because many employees are not willing to bear the total risk of compensation tied to sales, some companies offer a combination of salary and commission (a mixed cost).
Self Study Questions
1. A
2. C
3. False
4. D
5. B
6. True
7. D
8. C
Unit 3.2 Practice Exercise
1. You know from the Unit 3.1 Practice Exercise that the contribution margin is $16/unit and total fixed expenses are $1,200. Now, use the target income formula to solve for the number of units:
2. First, you must convert net income to operating income:
3. First, you must compute the degree of operating leverage
Now, multiply the degree of operating leverage by the percentage change in the number of units sold to arrive at the change in operating income: 4 × 10% = 40% increase in operating income. Therefore, a 10% increase in unit sales results in a $160 (0.4 × $400) increase in operating income. This answer can also be calculated by multiplying the increase in the number of units sold (0.1 × 100 = 10) by the contribution margin per unit: 10 × $16 = $160
UNIT 3.3 Multiproduct CVP Analysis
GUIDED UNIT PREPARATION
Answering the following questions while you read this unit will guide your understanding of the key concepts found in the unit. The questions are linked to the learning objectives presented at the beginning of the chapter.
1. What is meant by the term sales mix? LO 5
2. How do you calculate the sales required to break even or achieve a target income in a multiproduct setting? LO 5
3. What assumption is required in multiproduct CVP analysis but is not necessary in single-product CVP analysis? LO 5
The CVP analyses you have conducted so far focus on decisions about a single product. While this type of analysis is useful in small start-up businesses and divisions with only a single product line, most companies produce or sell more than one type of product. Companies that sell multiple products need to know what results are required for the company, not individual products, to achieve certain targets. To solve this type of problem, managers must have a good grasp of the sales mix—that is, the sales of each product relative to total sales.
We will illustrate multiproduct CVP analysis with another retail sporting goods store—Landon Sports, one of Universal’s competitors. Landon sells the same baseball jerseys as Universal, but it also sells athletic shoes. Unit data for the jerseys and shoes are as follows:
Note that Landon prices its jerseys the same as Universal (to be competitive) and offers employees the same 6% commission on sales. The athletic shoes that Landon sells are priced higher than the jerseys, and they cost the company more to sell.
Last year, Landon sold 40,000 jerseys and 10,000 pairs of shoes, so the sales mix is four jerseys for every pair of shoes sold.
Exhibit 3-5
shows Landon’s income statement by product type and in total. Note that no fixed expenses are assigned to either jerseys or shoes. As long as the company keeps selling jerseys and shoes, the fixed expenses will not change, so they are deducted in total rather than allocated to the individual product lines.
EXHIBIT 3-5 Landon Sports’ income statement.
The profit formula for a company with multiple products (in this case, jerseys and shoes) and a specified sales mix is:
This equation can be expanded to accommodate as many products as the company sells.
Reality Check—What’s in the mix?
As Warner’s sales mix moves toward digital recordings, the amount of sales revenue required to break even will decrease
Warner Music Group is a leading player in the music industry. According to its 2005 annual report, the company seeks to “drive innovation within the industry by making the transition from a records and songs-based company to a music-based content company.” The company’s product lines include CDs, digital music, videos, and sheet music.
So how has this transition progressed? The company’s 2008 annual report stated, “We continue to transform our recorded music business within the music value chain, while broadening our revenue mix into growing areas of the music business.” Sales of digital music exploded between 2006 and 2008—up 79% during the period. And in 2008, digital revenue provided 17% of the company’s total revenues, up from 9.5% in 2006.
Because digital files do not require a case or printed materials, digital recordings cost less than CDs to manufacture. Moreover, there are no inventory storage costs for digital recordings, and distribution costs are much lower (there is no shipping cost for a downloaded digital file). Warner reports that two-thirds of online sales come from older releases, whose marketing costs are lower than those for new releases.
All these savings mean that the contribution margin ratio for digital recordings is much higher than that for CDs. While the sales price of a digital download is less than that of a CD, more of each sales dollar is available to cover fixed costs and provide a profit. As Warner’s sales mix moves more toward digital recordings, the amount of sales revenue required to break even will decrease. That’s how Warner was able to achieve higher income on lower sales revenue. Clearly, sales mix is an important consideration in decision making.
Sources: Rob Curran, “Warner Music’s Earnings Surge 92% on Digital Sales, Lower Costs,” The Wall Street Journal, February 15, 2006; “Warner Music Group Corp. Reports Fiscal First Quarter Results for the Period Ended December 31, 2005,” Warner Music Group news release, February 14, 2006,
http://investors.wmg.com/phoenix.zhtml?c=182480&p=irol-news
(accessed February 22, 2006); Warner Music Group 2008 Annual Report; Warner Music Group 2007 Annual Report; Warner Music Group 2005 Annual Report.
Landon Sports breaks even when:
The preceding equation has two unknowns and an infinite number of solutions. However, when we require that the sales mix is held constant, then we know the number of jerseys sold is four times the number of pairs of shoes sold. If we let x equal the number of pairs of shoes sold, we have the following equation and solution:
Breakeven in sales dollars is $1,000,000: $640,000 for jerseys ($20 × 32,000) and $360,000 ($45 × 8,000) for shoes.
WATCH OUT!
Do not split fixed expenses between the multiple products and try to come up with individual product breakeven points or target income points. This will result in units sold that do not adhere to the sales mix ratio.
The formula is easily adapted to target income problems. Suppose the CFO at Landon Sports wanted to know how many jerseys and pairs of shoes needed to be sold to earn $66,900 in operating income:
If the sales mix changes, so do the breakeven point and the other targets.
Exhibit 3-6
shows what Landon’s income statement would look like if Landon Sports still sold a total of 50,000 units, but the sales mix changed to 30,000 jerseys and 20,000 pairs of shoes (instead of 40,000 jerseys and 10,000 pairs of shoes). The company would make more money, even though it sold the same number of units as in the previous scenario because more of those units sold were shoes, which generate a higher contribution margin per unit.
EXHIBIT 3-6 Landon Sports’ revised income statement.
Let’s see what the breakeven point is with this new sales mix. Since sales of jerseys are 1.5 times the number of shoe sales , we will replace 4x from the original formula with 1.5x in the new formula:
Breakeven in sales dollars is $1,087,865: $435,140 for jerseys ($20 × 21,757) and $652,725 ($45 × 14,505) for shoes. More sales dollars are needed to break even and achieve other income targets relative to the original sales mix because, although the shoes have a higher contribution margin per unit than the jerseys ($6.30 compared to $4.00), the contribution margin ratio for shoes is lower than the contribution margin ratio for jerseys. That means that with this mix, less of each sales dollar is available after covering variable expenses to cover fixed expenses and profit.
Think About It 3.4
Consider Landon’s original sales mix of 40,000 jerseys and 10,000 shoes. In an effort to stimulate jersey sales, Landon has increased the sales commission paid on each jersey to 12.3%. The company believes that this move will generate additional sales of 10,000 jerseys, with no effect on shoe sales. How will this move alter Landon’s sales mix? How will it affect the breakeven point? Do you think this change is a good move?
Limitations of Multiproduct CVP Analysis
In Unit 3.2, you learned about the assumptions of CVP analysis, and all those assumptions apply in a multiproduct environment. However, there is another assumption that we make in a multiproduct environment: The sales mix can be determined and will remain constant.
UNIT 3.3 REVIEW
KEY TERMS
Sales mix p. 97
SELF STUDY QUESTIONS
1. LO 5 If a company sells more than one product, it cannot use CVP analysis to examine the effect of changes in costs on operating income. True or False?
2. LO 5 Which of the following is not a limiting assumption of multiproduct CVP analysis?
2. Fixed cost per unit remains constant within the relevant range.
2. A
ll variable cost relationships are linear with respect to activity.
2. All costs can be easily separated into variable and fixed categories.
2. The sales mix can be determined and remains constant over time.
1. LO 5 Blalock Training sells three online training courses in database programming skills. For every 12 people who take the introductory course, 5 take the intermediate course and 3 take the advanced course. Blalock’s CFO has calculated a breakeven point of 10,000 courses. How many of those 10,000 courses will be introductory?
3. 1,200
3. 6,000
3. 8,000
3. 10,000
1. LO 5 Montelone Images, a photography studio, sells two photo packages. The standard package has a contribution margin of $5, and the deluxe package has a contribution margin of $12. Montelone sells five standard packages for every one deluxe package. If fixed expenses total $74,000, how many standard and deluxe packages must be sold to break even?
4. 14,800 standard; 6,167 deluxe
4. 4,353 standard; 4,353 deluxe
4. 9,280 standard; 2,300 deluxe
4. 10,000 standard; 2,000 deluxe
1. LO 5 Assume a company sells 10,000 units –5,000 of product A and 5,000 of product B. Product A has a contribution margin of $6.00 per unit, while Product B has a contribution margin of $4.00 per unit. If the sales mix changes to 5,500 units of Product A and 4,500 units of product B, which of the following is true?
5. The company will make more money because more of the product with the higher contribution margin per unit is being sold.
5. It will take fewer total units to break even now that more of the product with the higher contribution margin per unit is being sold.
5. The breakeven point depends on the current sales volume as it effects the sales mix.
5. All of the above are true.
UNIT 3.3 PRACTICE EXERCISE
Hometown Bakery sells three types of doughnuts: glazed, jelly, and cake. The following table shows the sales price and variable costs for each type. The bakery incurs $300,000 a year in fixed expenses. Assume that it sells two glazed doughnuts for every one jelly doughnut and every one cake doughnut.
Required
1. How many doughnuts of each type will be sold at the breakeven point?
2. What amount of revenue would need to be generated by each type of doughnut for the company to earn $60,000 in operating income?
SELECTED UNIT 3.3 ANSWERS
Think About It 3.4
The new sales commission is expected to generate sales of an additional 10,000 jerseys. With total sales of 50,000 jerseys and 10,000 pairs of shoes, the new sales mix would be five jerseys for every one pair of shoes. The new contribution margin for jerseys would be:
Breakeven is now:
By lowering the contribution margin per unit of jerseys and shifting a greater percentage of sales to those jerseys, more jerseys and more shoes will have to be sold in order to break even.
Is this change a good move? An increase in the breakeven point creates more risk for the company, but it might be considered a good move if greater income can be generated. Since the number of shoes sold is expected to remain constant at 10,000, we only need to consider the contribution margin generated by the jerseys.
If the new commission strategy only generates an additional 10,000 jersey sales, then it is not a good move, since total contribution margin, and therefore operating income, decreases by $23,000.
Self Study Questions
1. False
2. A
3. B
4. D
5. D
Unit 3.3 Practice Exercise
1. ($0.15 × 2x) + ($0.05 × x) + ($0.13 × x) − $300,000 = $0
$0.48x = $300,000
x = 625,000 jelly doughnuts
x = 625,000 cake doughnuts
2x = 1,250,000 glazed doughnuts
2. ($0.15×2x)+($0.05×x)+($0.13×x) − $300,000=$60,000
$0.48x = $360,000
x = 750,000 jelly doughnuts × $0.50 = $375,000
x = 750,000 cake doughnuts × $0.40 = $300,000
2x = 1,500,000 glazed doughnuts × $0.35 = $525,000
21h 36m remaining
7
ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT
After studying this chapter, you should be able to meet the following learning objectives (LO).
1. Classify activities as unit-level, batch-level, product-level, customer-level, or organization-level. (Unit 7.1)
2. Calculate activity-based product costs. (Unit 7.2)
3. Explain the difference between traditional product costs and activity-based product costs. (Unit 7.2)
4. Distinguish between value-added and non-value-added activities. (Unit 7.3)
5. Explain how information about activities can be used to make decisions. (Unit 7.3)
The Pitch
It was early in 2012, and C&C Sports’ managers were reeling from the recently released operating results for 2011. Selling more award jackets than budgeted should have increased C&C’s operating income, but that hadn’t happened. Instead, costs had skyrocketed (see
Chapter 6
). Direct material and direct labor costs were part of the problem, but other production costs had come in much higher than expected.
George Douglas, CEO, called a meeting of upper management to discuss the unexpected results. “We’ve never missed budgeted income by this much,” said Douglas. “I am more convinced than ever that we don’t understand what it costs to make our products,” CFO Claire Elliot replied. “You’re right,” Penny Townsley, production operations manager, chimed in, “but our production has been fairly stable for the last several years. As we’ve added more award jackets to the mix, operations have become more complex. I’ve been telling you all that making jackets isn’t the same as making pants and jerseys. I’m not saying that they’re a bad product line, but we have to do a lot more to make a jacket than we do for the other two products.”
“Selling the jackets is no easy job, either,” commented Jonathan Smith, vice president of marketing. “It takes a lot more time and advertising to complete a sale. Thank goodness the jackets are priced high enough to make it worthwhile. Apparently our competitors don’t want to go to as much trouble as we do. We’ve been hearing that our jackets are higher quality and less expensive than our competitors’. I’m convinced that we could sell even more jackets next year.”
“Well, we can’t just stop operations until we figure out this problem,” said George. “Let’s keep to our plan of improving cash flow and meeting sales targets, but let’s not sell any more jackets than we did last year until we know what’s going on. In the meantime, we need to find out why our costs have increased so dramatically.” The meeting adjourned with everyone still scratching their heads.
UNIT 7.1 Activity-Based Costing
GUIDED UNIT PREPARATION
Answering the following questions while you read this unit will guide your understanding of the key concepts found in this unit. The questions are linked to the learning objectives presented at the beginning of the chapter.
1. What is an activity? Provide some examples. LO 1
2. Define the following activity types and provide one example of each: LO 1
2. Unit-level activity
2. B
atch-level activity
2. Product-level activity
2. Customer-level activity
2. Organization-level activity
1. What characteristics of an organization make it a good candidate to implement activity-based costing? When is activity-based costing not likely to benefit an organization? LO 1
In preceding chapters, you have learned how managers use product cost information to make a variety of decisions. But what happens if that product cost information is distorted? Managers may make poor decisions, and results may not occur as expected. That is what C&C Sports’ managers experienced when the company produced and sold more award jackets than budgeted. Revenue increased, but costs increased more than they expected, decreasing the company’s income. Apparently, award jackets cost more to produce than the managers realized.
Managers at Starn Tool & Manufacturing in Meadville, Pennsylvania, had a similar experience. The company’s product costing system did not reflect the way costs were actually incurred on the shop floor. As president and owner Bill Starn realized, some jobs that looked profitable were actually losing money, while others that looked unprofitable were making money. The company turned to activity-based costing. Now that managers better understand the costs the company incurs, job bidding is more accurate.
1
In this unit we will explore the differences between traditional, GAAP-based product costing (see
Chapter 4
) and activity-based costing.
Why Activity-Based Costing?
What leads a manager to question the accuracy of the reported costs of products or services? Typically, doubt arises when a company’s operating or financial results haven’t materialized as expected. At C&C Sports, higher revenue coupled with lower operating income suggested that award jackets might be more costly to produce than profitability reports showed. At other companies, the continual loss of business to a lower bidder, even when managers believe that their bid barely covers costs, might be the source of suspicion.
Recall from
Chapter 4
that direct materials and direct labor costs are directly traceable to products and services. Calculating the direct materials and direct labor costs that have been incurred to produce a product or deliver a service is relatively simple. If all costs could be traced directly to cost objects in this way, there would be no problem. Managers would know exactly how much it cost to produce a product or deliver a service. So if product costs have become a problem, nontraceable costs, such as manufacturing overhead, must be the source. The problem is the way that these manufacturing overhead costs are allocated to a product or service.
When direct materials and direct labor comprise the majority of product costs, manufacturing overhead allocation is not a major issue. But in recent decades, manufacturing overhead has increased in size relative to direct materials and direct labor. Armstrong Laing Group estimates that in the last 35 years, manufacturing overhead cost has more than doubled, climbing to approximately 40% of total product cost.
2
In that same period, direct labor cost has fallen by more than half, to approximately 10% of total product cost. With such a dramatic increase in manufacturing overhead cost, the choice of a method for allocating the cost has become an important managerial decision.
Activity-based costing (ABC) is a costing technique that assigns costs to cost objects such as products or customers, based on the activities those cost objects require. An activity is an event that consumes resources. Activities include tasks such as ordering materials, processing purchase orders, and setting up machines. When Oxford University Library Services implemented an ABC system, it identified activities such as ordering books from publishers, shelving and reshelving books, answering customer inquiries, and processing interlibrary loan requests.
3
A simple ABC model can have fewer than 20 activities; a complex model may include over 500 activities.
4
Frederick Taylor was the first to understand the importance of a business’s activities. In the early 1900s, Taylor examined workers’ jobs as a set of tasks, each of which had a standard completion time.
5
But his idea was slow to catch on. In The Practice of Management (1954), Peter Drucker lamented “To find out what activities are needed to attain the objectives of the business is such an obvious thing to do that it would hardly seem to deserve special mention. But analyzing the activities is as good as unknown to traditional theory.”
6
Activity-based costing did not gain widespread popularity until 1987, when Robin Cooper and Robert Kaplan discussed it in their article “How Cost Accounting Systematically Distorts Product Costs.”
7
By 2005, 55% of companies surveyed were actively using activity-based costing; another 32% were considering its adoption.
8
Exhibit 7-1
illustrates the basic concept of overhead usage in activity-based costing. A company incurs costs to obtain resources such as factories, machinery, and workers. Those resources are consumed by the activities performed that produce the product or deliver the service to the customer. With activity-based costing, the goal is to allocate a cost in a manner that reflects the amount of each resource consumed by the activities performed to produce a specific product. For example, C&C makes cash payments (a cost) to obtain a sewing machine (a resource) for use in sewing (an activity) the company’s pants, jerseys, and jackets (products).
EXHIBIT 7-1 Overhead usage in activity-based costing.
Let’s look at a simple example to illustrate the problem of manufacturing overhead cost allocation. C&C incurs costs to purchase and operate a forklift that moves bolts of fabric from the warehouse to the cutting department. In
Chapter 4
you learned that C&C applies manufacturing overhead to its products based on direct labor cost. Of a total $826,600 in direct labor costs, $440,000 is incurred to produce 183,500 pairs of pants, $127,400 to produce 66,500 jerseys, and $259,200 to produce 18,000 award jackets. Since pants have the highest direct labor cost, they are assigned the largest share of the manufacturing overhead costs related to the forklift. But does the cost of labor affect how often the forklift is used to move a pair of pants or a jacket? It takes one trip from the warehouse to deliver the fabric for a batch of pants and one trip to deliver the fabric for a batch of jackets. Use of the forklift, then, is related to the number of batches moved, not to the direct labor cost incurred.
Are manufacturing overhead costs a problem for all companies? Not necessarily. If a company produces products or delivers services that are very similar, or that consume resources in the same way, then analyzing the details associated with overhead is unlikely to offer greater precision in product costing. Likewise, if a company makes different products, but does so in a separate production facility for each product, there would be no confusion about which overhead costs are incurred for specific products. However, if a company produces products or delivers services that differ in complexity or in their consumption of common (overhead) resources, then greater attention to overhead and the activities that generate overhead costs could provide better cost information for decision making. Indicators that an activity-based costing analysis may be appropriate include the following.
9
· Bids for complex products are accepted, while bids for simple products are rejected.
· High-volume jobs show losses or minimal profits, while low-volume jobs show healthy profits.
· Bids for jobs that require “special” processing are always accepted.
· Some manufacturing departments run at capacity, whereas others have minimal operations.
Would an activity-based analysis that focused only on manufacturing overhead improve GAAP-based financial statements? No. Because the balances in inventory and cost of goods sold, the two accounts that contain product costs, are aggregate numbers, not much will be gained from shifting costs from one product to another (only to add them together again). But an activity-based analysis that focused on all costs to produce and deliver a product or service, not just the production costs, would enhance decision making. This means that the activity-based analysis would include selling and administrative activities and costs. For example, the total activity-based cost should include the cost to deliver a product to a customer.
Including these nonproduct costs in the activity-based costing analysis means that the resulting costs cannot be used for GAAP-based financial reporting of inventory or cost of goods sold. However, if a company wants to use activity-based costing for financial reporting, the approach can easily be adapted to comply with GAAP.
Analyzing the activities that consume manufacturing overhead, selling, and administrative resources is a time-consuming process. Therefore, managers need to decide what the information will be used for and whether the expected benefit from the new information will be worth the cost to gather it. Because the main reason for generating new information is to help managers make better decisions, we will focus our discussion on providing better product costing information for internal decision making.
Classification of Activities
All activities are not created equal. In an activity-based costing system, activities are classified into five categories: (1) unit-level; (2) batch-level; (3) product-level; (4) customer-level; and (5) organization-level. This classification recognizes that different activities consume resources differently and that different cost objects use activities differently.
Unit-level activities are performed for each individual unit of product. Since each unit of a particular product requires the same level of activity, each unit consumes the same amount of resources that provide that activity. The total level of activity performed varies proportionately with the number of units produced. At C&C Sports, providing electricity to run the sewing machines is a unit-level activity, since the amount of electricity used is a function of the number of units sewn.
Batch-level activities are performed all at once on groups, or batches, of products. Since the activity is based on the existence of the batch rather than on the number of units in the batch, a batch consumes the same amount of resources whether it contains 20 units or 2,000 units. At C&C Sports, pants are produced in batches of 50, jerseys in batches of 35, and jackets in batches of five. When production begins on pants, the forklift operator gathers enough fabric to make 50 pairs of pants and moves it from the raw materials warehouse to the cutting tables, all at once. The same is true for jerseys and jackets, except that the amount of fabric moved is enough to make 35 jerseys or five jackets, respectively. So even though the batches include fabric for ten times more pants than jackets, the cost of moving each batch is the same.
Think About It 7.1
If a batch of 5 jackets and a batch of 50 pants cost the same amount to move, what is the relative moving cost of one jacket compared to one pair of pants?
Product-level activities, also referred to as product-sustaining activities, are those that support the products or services a company provides. These activities are performed for the entire product line, regardless of how many units or batches are produced. At C&C Sports, creating a pattern for a new style of jersey is a product-level activity. When a product is eliminated, these activities are no longer performed.
Customer-level activities are performed for specific customers. For example, making a sales call and processing a sales order are customer-level activities. These activities, and the resources consumed to perform them, do not affect product costs. Rather, the resources are consumed to deliver customer support services, so the associated costs should be used to determine the cost to serve a particular customer. These activities are explored further in Focus on Customer Profitability Analysis.
Reality Check—At the center of activity
Plexus has built a profitable niche by producing a relatively high number of different products in numerous small batches
Understanding business activities is critical to understanding costs. Without such an understanding, a manager can unwittingly drive an organization into a financial tailspin.
One company that appears to understand how activities work is Plexus Corp., an assembler of electronic goods. Plexus has built a profitable niche by producing a relatively high number of different products in numerous small batches. This company takes on jobs that many larger companies find too small.
Understanding how resources are consumed by batch activities is essential to Plexus’s success. Each time the company changes from one small batch to the next, the production line must be retooled for the next product. Through careful facility arrangement and cross-training, Plexus has reduced the time required for such changeovers to as little as 30 minutes.
But just because an organization understands activities doesn’t mean that its customers do. Following a U.S. Postal Service rate increase for magazines in July 2007, some publishers showed a clear misunderstanding of the relationship between activities and resource consumption. In a Los Angeles Times editorial, they commented that “Rather than base rates on total weight and total number of pieces mailed, the new, complex formula is full of incentives that take into account packaging, shape, distance traveled and more.”
The incentives referred to in this quotation include a discounted rate for magazines that bear computer-readable mailing labels, which eliminate the need for human sorting, and a discount for dropping off magazines at a location closer to their final destination, which minimizes final delivery transportation cost. Basically, the new pricing structure is designed to charge for the resources consumed based on the activities performed. But apparently, some people don’t want to pay for what they get.
Sources: William M. Bulkeley, “Plexus Strategy: Smaller Runs of More Things,” The Wall Street Journal, October 8, 2003; Nate Guidry, “Magazines Brace for Higher Postage,” Pittsburgh Post-Gazette, July 10, 2007; Teresa Stack and Jack Fowler, “Magazines Feeling Postal Pinch,” Los Angeles Times, May 28, 2007.
Organization-level activities are required to provide productive capacity and to keep the business in operation. These activities do not provide identifiable benefits to specific products or services, but without them there would be no business. At C&C Sports, renting factory space and managing the organization (by the CEO or CFO, for example) are examples of organization-level activities that support the entire business. Regardless of how many units, batches, or products are produced or how many customers are served, these activities must continue. Therefore, the cost of the resources consumed by these activities should not be allocated to products or customers. Notice that this approach differs from GAAP-based product costing, in which costs such as factory rent are included as part of overhead and in the product costs that are used to prepare the financial statements.
Of the five categories of activities, only the first three are product- or service-related. Therefore, we will focus only on those activities in determining the resources that a product or service consumes.
Exhibit 7-2
compares the components of product cost used in traditional costing under GAAP-based financial reporting to the components used in internal decision making under activity-based costing.
EXHIBIT 7-2 Comparison of GAAP-based and activity-based product costs.
Although costs of the resources consumed by customer-level and organization-level activities can be allocated to products or services, determining a reasonable activity measure for use in allocating the costs would be difficult, and the information would not be helpful in decision making. Does that mean managers should ignore these costs? Absolutely not. Instead, managers need to find other ways of determining whether the benefits received from these resources are worth their cost.
Once a company has classified its activities and identified the related resources, managers may discover that some manufacturing overhead costs can be traced directly to products. A “traceable overhead cost” may sound like an oxymoron, because if a cost is traceable, it doesn’t need to be allocated. The problem is that companies will often aggregate any manufacturing costs that are not for direct materials or direct labor in manufacturing overhead without considering whether they are traceable. An example of a traceable manufacturing overhead cost at C&C Sports is the cost of operating the chenille machine. This cost, which totals $132,600 and includes depreciation and indirect materials, is directly traceable to the award jackets because the chenille machine is used only to produce award jackets, and should not be allocated to pants and jerseys.
Under GAAP-based product costing, selling and administrative costs are not allocated to products. However, under activity-based costing, these costs should be allocated to products if they are incurred to provide resources that are consumed by unit-level, batch-level, or product-level activities. As with manufacturing overhead costs, some selling and administrative costs may be directly traceable to products. At C&C Sports, three selling costs are traceable to products: shipping, commissions, and a portion of advertising costs. Shipping of $0.40 per unit and commissions of 5% of the sales price are unit-level costs that are easily assigned to products. Direct advertising costs include $85,000 to advertise award jackets and $20,000 each to produce a pants catalog and a jerseys catalog.
As we develop C&C Sports’ activity-based product costs, we will use budgeted information to establish performance standards.
Exhibits 7-3
and
7-4
show C&C Sports’ budgeted production and selling and administrative costs for 2011. This is the same information used to calculate the master budget in
Chapter 5
. The 2011 budget is based on the following estimated production and sales levels:
Since the number of units produced differs from the number of units sold, we will analyze production activities separately from selling and administrative activities.
EXHIBIT 7-3 2011 budgeted annual manufacturing overhead costs.
EXHIBIT 7-4 2011 budgeted annual selling and administrative costs.
UNIT 7.1 REVIEW
KEY TERMS
Activity p. 357
Activity-based costing p. 357
Batch-level activity p. 359
Customer-level activity p. 359
Organization-level activity p. 360
Product-level activity p. 359
Unit-level activity p. 359
SELF STUDY QUESTIONS
1. LO 1 Which of the following would be considered a unit-level activity?
1. Ordering direct materials
1. Making a sales call
1. Preparing the annual budget
1. Placing a UPC label on each package
1. LO 1 Mary’s Mix-ins makes custom ice cream by mixing various candies into vanilla and chocolate ice cream. Orders range in size from 1 to 5 quarts. After each order has been mixed and packed into one-quart containers, the mixing equipment must be cleaned. Cleaning the mixing equipment is an example of
2. a unit-level activity.
2. a batch-level activity.
2. a product-level activity.
2. an organization-level activity.
1. LO 1 Increasing the number of units in a batch will increase the batch-level costsassociated with the product. True or False?
1. LO 1 Which of the following would be considered a product-level activity?
4. Building a prototype of a product
4. Creating the company’s advertising campaign
4. Training warehouse employees
4. Organizing the annual sales meeting
1. LO 1 Which of the following would be considered a customer-level activity?
5. Ordering the direct materials used in all products
5. Cleaning the machines before beginning a production run
5. Making a sales call
5. Supervising production workers
UNIT 7.1 PRACTICE EXERCISE
Place an “X” in the column that corresponds to the type of activity level referred to in each scenario.
SELECTED UNIT 7.1 ANSWERS
Think About It 7.1
One jacket costs ten times more to move than one pair of pants. To illustrate, let’s say that the cost to move a batch is $100. For a batch of 50 pants, the cost would be $2 per pair ($100 ÷ 50 pairs). For a batch of 5 jackets, the cost would be $20 per jacket ($100 ÷ 5 jackets).
Self Study Questions
1. D
2. B
3. False
4. A
5. C
Unit 7.1 Practice Exercise
Place an “X” in the column that corresponds to the type of activity-level referred to in each scenario.
UNIT 7.2 Developing Activity-Based Product Costs
GUIDED UNIT PREPARATION
Answering the following questions while you read this unit will guide your understanding of the key concepts found in this unit. The questions are linked to the learning objectives presented at the beginning of the chapter.
1. What is an activity cost pool? LO 2
2. How are activity cost pool rates calculated? LO 2
3. How many overhead charges will a cost object have under an activity-based costing system? LO 2
4. How are product costs determined in an activity-based costing system? LO 2
5. Why are organization-level costs not allocated to products under activity-based costing? LO 2
6. What does using a “traditional” costing system mean in terms of overhead costs? LO 3
7. When a company switches from a traditional costing system to activity-based costing, overhead costs typically shift from the high-volume/low-complexity product to the low-volume/high-complexity product. Why is this the case? LO 3
Once a company has decided to implement an activity-based costing system, work begins to identify activities and the resources consumed by those activities. By completing the following five steps, a company can implement an activity-based costing system. To be successful, these efforts must have the full support of top management. Although the following discussion may make the process appear to be relatively easy, in reality it is a complex, time-consuming effort. Once the system is in place, however, decision makers will benefit from improved information.
Step 1: Identify Activities
The first step in developing activity-based product costs is to identify the activities performed in the organization. Think of activities as “verbs” that answer the question “What do you do?” If you had to answer the question, what might be some of your responses? “I study, I sleep, I eat.” Asking this question of employees is one way to determine the activities they perform; another is to observe what they do. Either way, this step is the most time-consuming part of implementing an activity-based costing system and the one that can generate the greatest error.
In addition to identifying the activities, you need to determine how much time employees spend performing each activity. Let’s go back to your answer to the question “What do I do?” While you might find it easy to list what you do, saying how much time you spend on each activity might be harder. For instance, the amount of time you spend studying probably varies each week, depending on what tests you have. The same is true for many employees; the time they spend on certain tasks varies from one month to the next. Nevertheless, employees must make such an estimate so that the resources consumed by the activities (that is, their salaries and other costs) can be calculated.
A critical question to ask during activity identification is “What level of detail does the company want to collect?” The greater the level of detail, the greater the chance of misclassifying some costs and activities. For example, instead of identifying “studying” as an activity, let’s say you provide greater detail, such as “studying accounting” or “studying economics.” You will likely misestimate the time you spend on each, although you may be fairly confident of the total time you spend studying. Of course, if you could make a detailed estimate without error, breaking “studying” down by your courses would provide better information. The same would be true of any activity costing system: the greater the error-free distinction between activities, the better the information.
As you identify activities, remember that once an activity has been defined, the time spent on that activity and the resources consumed by that activity must be tracked. Thus, defining activities in greater detail will require more monitoring. Will the benefits of defining more detailed activities outweigh the effort needed to monitor activity performance, and the resulting potential for error? To minimize both the cost of collecting the information and the potential for error, most companies that use activity-based costing systems combine related activities into one larger activity. For example, the activities in C&C Sports’ cutting department include layering fabric, laying out the pattern, cutting the fabric, collecting the cut pieces, and disposing of waste fabric. While C&C’s managers could have chosen to monitor the time spent on each of those activities, they chose instead to group them as a single cutting activity. Since all these activities are batch-level activities, combining them is not an issue. One caution, however: Activities from different categories (say, unit-level versus batch-level) should not be combined.
Step 2: Develop Activity Cost Pools
After all the activities have been identified and the appropriate level of detail has been selected, the activities are combined into activity cost pools based on their cost drivers. For example, C&C Sports’ managers determined that “moving materials from the storeroom to the cutting room” and “packing finished products” were both batch activities. Because pants, jerseys, and jackets are produced in batches, the number of batches produced determines the frequency of these warehousing and packaging activities and the resources consumed. Therefore, managers combined those two activities into one pool. After gathering all the relevant information about activities and their drivers, C&C Sports’ managers determined that the company had the following five activity pools:
10
Once the activity pools have been determined, manufacturing overhead costs can be assigned to them. This is referred to as a first-stage allocation because costs are assigned first to the activity pools before being assigned to cost objects.
Exhibit 7-5
shows the first-stage allocation of manufacturing overhead resources for C&C Sports. These allocations were based on employee estimates of time spent and the resources used to complete the activities. Notice that the $132,600 that relates to the chenille machine is not included in the costs allocated to the activity pools, since those costs are traceable directly to the jackets. All the remaining manufacturing overhead costs are allocated to the activity pools. Compare
Exhibit 7-5
to
Exhibit 7-3
to see that all the manufacturing overhead costs have been accounted for.
EXHIBIT 7-5 Step 2: Allocation of manufacturing overhead costs to activity pools.
Step 3: Calculate Activity Cost Pool Rates
After the manufacturing overhead costs have been assigned to activity cost pools, the next step in developing activity-based product costs is to calculate an activity rate for each cost pool. This calculation is similar to the predetermined overhead rate calculation under traditional job order costing (see
Chapter 4
):
Exhibit 7-6
shows the calculation of the four activity rates for C&C Sports. Let’s review the calculations. For product design, the activity cost totals $83,889 (see
Exhibit 7-5
). Since the number of product lines is the cost driver and C&C has three product lines (pants, jerseys, and jackets), the denominator is 3 product lines. The calculation of the activity rate is:
EXHIBIT 7-6 Step 3: Calculation of activity rates.
For warehousing/packaging, the activity cost totals $170,562. The number of batches produced is the cost driver for this activity pool. It is calculated as follows:
Given this number of batches, the activity rate for this pool is calculated as:
Think About It 7.2
Why would the batch size differ for the three product lines?
For cutting, the activity cost totals $147,108. The number of cuts is the cost driver for this activity pool; it is calculated as follows:
Given this number of cuts, the activity rate is calculated as:
Think About It 7.3
Refer to
Exhibit 7-5
to see what costs were allocated to the cutting pool. What specific costs might be included in the cutting pool?
WATCH OUT!
Always label the activity rate with the activity driver. Saying, for example, that the sewing activity rate is $2.40 is not sufficient; it is $2.40 per direct labor hour. With the activity driver included, you will know what to multiply therate by to calculate the allocated cost. To calculate the allocated cost for sewing, for example, you will know that you should multiply the $2.40 by the number of direct labor hours—not, say, the number of units produced.
Finally, for sewing, the activity cost totals $206,820. Direct labor hours is the cost driver for this activity pool, and it is calculated as follows:
Given this number of direct labor hours, the activity rate is calculated as:
Step 4: Allocate Costs to Products or Services
With the activity rates calculated, you are ready to allocate the costs to products or services.
11
This calculation is similar to the calculation for applying overhead costs to products or services under traditional job order costing (see
Chapter 4
):
Exhibit 7-7
shows the cost allocations to the three products. Notice that each product has four allocations, one for each of the activity pools. Notice, too, that the activity rate column for each product is the same, since the activity rates are constant, regardless of the product that is consuming the resource. However, each product uses the activities to different degrees, and those differences in usage drive the differences in allocated costs. For example, the cutting cost allocated to pants is $2.60 × 14,680 cuts = $38,168; to award jackets, it is $84,240—why? The answer is that jackets require many more cuts than pants, even though the company makes fewer jackets than pants.
Let’s reconcile how the overhead costs from the first-stage allocation (see
Exhibit 7-5
) were allocated to the three products:
EXHIBIT 7-7 Step 4: Allocating activity costs to products.
All the overhead costs have been accounted for. When the overhead cost allocated to the award jackets is added to the chenille costs traced to the award jackets, the total overhead cost of the award jackets becomes $376,563. Notice that this amount is more than the overhead cost allocated to pants. Even though budgeted production called for only 18,000 jackets as compared to 183,500 pants, jacket production requires many more activities than pants production.
Step 5: Calculate Unit Product Costs
The last step in the preparation of activity-based costing data is to calculate the unit product cost. In Step 4 we calculated the total overhead allocated to each product. For decision-making purposes, we need to convert that amount to a unit cost by dividing the total overhead cost by the total number of units produced. For example, the overhead cost for a pair of pants would be $1.33 (rounded), calculated as
To calculate the total product cost per unit, we need to add the direct materials and direct labor costs to this overhead cost. The total activity-based cost for a pair of pants would be
Exhibit 7-8
shows the calculation of the total product costs and unit costs for all three products based on the budgeted production for 2011.
WATCH OUT!
With all the work they put into calculating overhead allocations, students sometimes forget the easiest part of calculating the total product cost—adding the direct materials and direct labor costs to overhead.
Reality Check—Can activity-based costing solve the FAA’s funding crisis?
Commercial passenger and freight carriers accounted for just 65.5% of all flights, yet they paid 91.4% of the funds contributed to the FAA.
A Boeing 737 can carry up to 190 passengers; a Gulfstream G450 carries a maximum of 19. But do the two planes make the same demands on air traffic controllers? That was the question being debated as the Federal Aviation Administration (FAA) sought renewal of its funding before a September 30, 2007 deadline.
In 2004, commercial passenger and freight carriers accounted for just 65.5% of all flights, yet they paid 91.4% of the funds contributed to the FAA. Business aviation, such as corporate jets and charters, accounted for 18.5% of all flights, yet those flights contributed only 4.9% of the FAA’s funds.
Why the difference in payments? It is built into the fee structure. In 2004, commercial passenger carriers paid a 7.5% tax on the price of each ticket, plus a $3.20 fee for each flight segment, a $14.20 fee for each international departure or arrival, and a 4.3¢-per-gallon fuel tax. Corporate carriers paid only 21.8¢ tax on each gallon of fuel. For a flight between Atlanta and Dallas, a commercial carrier would have been charged approximately $1,356 in fees; a business carrier would have paid only $161.
According to the FAA and others, this fee structure has nothing to do with the FAA’s resources, which are consumed in directing the flights from point to point. Each plane must take off and land, and each must be directed between takeoff and landing. But does a landing at a busy airport like Atlanta require the same resources as a landing at a smaller airport? Does a takeoff at a prime time like 5:00P.M. require the same resources as a takeoff at 11:00P.M.? What about a half-full plane versus a full plane?
Perhaps a close look at activity-based costing can help to solve the debate over the FAA’s funding. Developing a better understanding of how resources are consumed by activities may lead to a more equitable sharing of the costs of safe air travel.
Sources: GAO, “Observations on Potential FAA Funding Options,” September 2006,
http://www.gao.gov/highlights/d06973high
(accessed May 19, 2007); Laura Meckler, “Collision Course: Why Big Airlines Are Starting a Fight with Business Jets,” The Wall Street Journal, June 1, 2006; Chrisopher Palmeri, “Snarl in the Sky,” BusinessWeek, June 5, 2006, 26–29;
http://www.smartskies.org/LearningCenter/faa_funding/calculator.htm
(accessed May 19, 2007).
EXHIBIT 7-8 Step 5: Calculating unit product costs.
EXHIBIT 7-9 Comparison of traditional and activity-based costing.
Let’s compare the activity-based overhead allocation to C&C’s original allocation, based on direct labor dollars.
Exhibit 7-9
shows the manufacturing overhead costs allocated to each of the products under the two methods. Notice that the total amount of manufacturing overhead allocated to the products differs between the two methods—$1,033,250 under the traditional approach and $740,979 under the activity-based approach. The difference between the amount of manufacturing overhead allocated under the two methods is the $292,271 general overhead cost pool that was not allocated to products under activity-based costing.
Although the total amount of allocated overhead differs between the two methods, we can still compare the percentage of overhead allocated to each product. Notice where the big differences occur in
Exhibit 7-9
. Under the traditional costing method, pants were allocated 53.23% of manufacturing overhead, yet under activity-based costing, pants received just 33% of manufacturing overhead. The other major difference between the two methods was for award jackets, which were allocated 31.36% of total overhead under the traditional method and 50.82% under activity-based costing.
What caused the differences in the relative amount of manufacturing overhead allocated under the two methods to pants, a high-volume product, and jackets, a low-volume product? One obvious cause is the costs associated with the chenille machine. Under traditional costing, these costs were shared by all three products. However, under activity-based costing, these costs are traced directly to jackets, reducing the amount of overhead allocated to pants and increasing the amount of overhead allocated to jackets.
A second cause of the difference in costs results from the cutting operation. Jacket production required more cutting than pant production, even though C&C produced only one-tenth the number of jackets as pants. This shift in cost from a high-volume to a low-volume product is quite common in newly implemented activity-based costing systems. That is because low-volume products, like jackets, tend to use as many product-level activities as other products, while generating as many or more batch-level activities.
EXHIBIT 7-10 Activity-based costing at C&C Sports: An overview.
You have now learned the five steps of calculating product costs under activity-based costing.
Exhibit 7-10
summarizes the results of these steps for C&C Sports. Remember, however, that the product costs shown there include just direct materials, direct labor, and manufacturing overhead. To get a more accurate picture of total product costs, C&C will need to complete an activity-based analysis of selling and administrative costs.
UNIT 7.2 REVIEW
KEY TERMS
Activity cost pool p. 365
Activity rate p. 366
First-stage allocation p. 366
SELF STUDY QUESTIONS
1. LO 2 In an activity-based costing system, which of the following costs would most likely not be included in the allocation of overhead cost to products, but would instead be left in the “General” category?
1. Indirect materials
1. Factory rent
1. Equipment depreciation
1. Machine maintenance
1. LO 2 Managers of the Chadwick Company want to identify an appropriate cost driver for the quality control overhead cost pool. Which of the following would be the most appropriate choice?
2. Number of units produced
2. Number of quality engineers employed
2. Number of quality inspections performed
2. Number of returned units
1. LO 2 A firm produces and sells two products, SG8 and DY9. The following information relates to setup costs (a part of factory overhead) of $120,000.
Activity-based costing would allocate which of the following amounts of setup cost to each unit (rounded to the nearest dollar)?
1. LO 2 Walker Texas produces two kinds of recliners, Standard and Deluxe. Information about the two products follows.
Production costs are as follows:
The activity rate for the cost of moving and warehousing is:
4. $255 per batch.
4. $11.33 per unit.
4. $675 per batch.
4. $30 per unit.
1. LO 2 Refer to the information in question 4. Under activity-based costing, the total product cost per unit for the Deluxe recliner is:
5. $49.
5. $155.
5. $174.
5. $204.
1. LO 2 Refer to the information in question 4. Under activity-based costing, the total product cost per unit for the Standard recliner is:
6. $615,000.
6. $735,000.
6. $20.50.
6. $110.50.
1. LO 3 Under traditional costing systems, machine costs incurred specifically for one product might be allocated to all products. True or False?
1. LO 3 Activity-based costs can be higher than traditional product costs because of the inclusion of selling and administrative costs. True or False?
1. LO 3 In changing from a traditional costing system to an activity-based costing system, overhead costs tend to shift from high-volume standard products to low-volume premium products, because
9. companies usually make more premium products than standard products.
9. standard products use more total activities than premium products.
9. premium products use more total direct materials and direct labor than standard products.
9. premium products usually consume more activities per unit than standard products.
UNIT 7.2 PRACTICE EXERCISE
Babytime, Inc., manufactures two products, Piglets and Rattles. Piglets are the more complex of the two products, requiring more direct labor time and more machine time per unit than Rattles.
Manufacturing overhead is currently assigned to the products on the basis of direct labor hours. The company has gathered some activity information and is interested in the differences between its present costing method and activity-based costing. All overhead costs should be allocated to the products. The overhead cost pools and activity drivers are as follows:
Other product information is as follows:
Required
0. Using the traditional method of allocating overhead based on direct labor hours, compute the unit product cost of Rattles and Piglets:
0. Determine the overhead rate per direct labor hour.
1. Allocate overhead to each product based on the direct labor hours used by each.
2. Divide the total overhead allocated to each product by the number of products produced to obtain the overhead cost per unit.
3. Add the overhead cost per unit to the direct materials and direct labor costs per unit to obtain the unit product cost.
1. Using an activity-based costing approach, compute the unit product cost of Rattles and Piglets:
0. Determine the three activity rates.
1. Allocate overhead to each product based on the activity drivers used by each. Total the three activity allocations to arrive at the total overhead allocated to each product.
2. Divide the total overhead allocated to each product by the number of products produced to obtain the overhead cost per unit.
3. Add the overhead cost per unit to the direct materials and direct labor costs per unit to obtain the unit product cost.
2. Why do your answers to a(iv) and b(iv) differ? Be specific.
SELECTED UNIT 7.2 ANSWERS
Think About It 7.2
Something in the processing of the different products must require different batchsizes. In a clothing factory, fabric characteristics (for example, its thickness) determine how many units can be cut at one time. Cutting several units at once is more efficient and uses less labor than cutting units individually. However, the quality of the cut must be taken into consideration. C&C Sports’ production manager has likely determined the maximum number of units per batch so as to balance efficiency and quality.
Think About It 7.3
The three categories of costs allocated to the cutting pool were indirect labor, indirect materials, and other. Indirect labor is likely to include the costs of cleaning around the cutting tables and setting up various machines and tables for cutting. It would not include the labor cost of cutting the fabric—that is included in the direct labor cost of making various products (refer back to
Chapter 4
to see that cutting and sewing are direct labor costs). Indirect materials would include the knives and any other materials necessary to cut the fabric. It is difficult to say what “other” might include, since companies usethat category for a variety of items.
Self Study Questions
1. B
2. C
3. B
4. A
5. D
6. D
7. True
8. True
9. D
Unit 7.2 Practice Exercise
c. The unit product costs in a(iv) and b(iv) differ because of the activities consumed by each product. In the traditional system, with overhead cost allocated by direct labor hours, each rattle uses only 0.75 hours (30,000 hours ÷ 40,000 units), whereas each piglet requires 2 hours (20,000 hours ÷ 10,000 units). Because piglets use 2.667 times more direct labor hours than rattles, they are allocated 2.667 times the overhead cost ($20.08 = 2.667 3 $7.53). Under activity-based costing, resources are used by each product as shown in the following table:
In terms of setups, one piglet consumes 28 times the resources that one rattle does. Another way to think about this problem is that rattles are produced in batches of 100 (40,000 units ÷ 400 setups = 100 units per setup); piglets, on the other hand, are produced in batches of three or four. Therefore, each piglet consumes a much larger share of the setup cost than each rattle—more than its relative share of overhead based on direct labor hours. In terms of machine hours, each piglet consumes 9.6 times the resources that one rattle does. Again, each piglet consumes a much larger share of the machine operating cost than each rattle. Consumption of purchasing resources is almost the same for the two products.
PJ
3 Discussion
1. Discuss the concepts that were most challenging for you in the readings and review material.
How did the practice exercises help clarify these?
2. What did you learn that will help you analyze LGI’s cost structure to increase its productivity and put the company on a path to a sustainable future?
PLEASE FIX THE ANSWRS BECAUSE THE EXCEL WORDBOOK IS DIFFERENT FROM THE FIRST ONE. CHECK IT PLEASE AND FOLLOW AND CHECK THE EVALUATION CRITERIA (BELOW) IN ORDER FOR ME TO PASS WITH THE CORRECT ANSWERS
Project 3 Questions – Report Template
Instructions: Answer the five questions below. They focus entirely on improving the EBITDA of Largo Global Inc. (LGI) based on the information provided in the Excel workbook. Provide support for your reasoning from the readings in Project 3, Step 1, and the discussion in Project 3, Step 3. Be sure to cite your sources in APA 7th ed. style.
Provide a detailed response below each question. Use 12-point font and double spacing. Maintain the existing margins in this document. Your final Word document, including the questions, should not exceed 5 pages. Include a title page in addition to the five pages. Any tables and graphs you choose to include are excluded from the five-page limit.
Name
your document as follows: P3_Final_lastname_Report_date.
You must address all five questions and make full use of the information on all tabs.
You are strongly encouraged to exceed the requirements by refining your analysis. Consider other tools and techniques that were discussed in the required and recommended reading for Project 3. This means adding an in-depth explanation of what happened in the year for which data was provided to make precise recommendations to LGI.
Check Your Evaluation Criteria
Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work. A good practice would be to use each competency as a self-check to confirm you have incorporated all of them. To view the complete grading rubric, click My Tools, select Assignments from the drop-down menu, and then click the project title.
· 3.1: Identify numerical or mathematical information that is relevant in a problem or situation.
· 3.2: Employ mathematical or statistical operations and data analysis techniques to arrive at a correct or optimal solution.
· 3.3: Analyze mathematical or statistical information, or the results of quantitative inquiry and manipulation of data.
· 10.3: Determine optimal financial decisions in pursuit of an organization’s goals.
· 10.5: Develop operating forecasts and budgets and apply managerial accounting techniques to support strategic decisions.
Title Page
Name
Course and section number
Faculty name
Submission date
1. How much of the costs were allocated between the standard and deluxe models of the product? Is the marketing manager correct that LGI is making significant margins on the Deluxe Loot Box? Please elaborate on your answer and include evidence from Tab 1 of the Excel workbook.
The standard costs for the product are 15.93 while the deluxe loot box is $21.54. the marketing manager is making significant margins on the deluxe loot box as the profit margin is highest for the Deluxe Loot Box.
2. The IT manager indicated that splitting the costs, as you have done in the calculations performed in Tab 2, does nothing to improve the bottom line. She said: “The amounts are relatively small and as it all comes from the same pot in the end, there is no need to split the costs, it just creates additional coding categories for the system.” Explain why the calculation performed in Tab 2 is important. In your discussions, also indicate the benefit of accurate costing when trying to improve profit margins.
Splitting costs will enable the organization assess the costs and profits per products. It will aid the organization comprehend each product and assist in strategic decision making.
3. Based on the calculations in Tab 3 using ABC, comment on the profits made for each product type. Explain in your report why this has changed under ABC costing. Also indicate which one of the two systems; that is, historical cost or ABC, provides the best answers for decision making to improve cost management to improve EBITDA.
In this methodology, the standard loot box was positive whereas the deluxe loot box is negative 35%. The costs have changed as the apportioning is different. The historical method is preferred as it expounds the costs.
4. The marketing manager suggested that to improve EBITDA and increase sales volume, the Deluxe Loot Box should be sold at the same margin as the Standard Loot Box. Base your answers on the ABC calculations performed in Tab 3 to indicate how much Largo will need to charge for the Deluxe Loot Box. Indicate how many Deluxe Loot Boxes the company will have to sell at the new price to break even. Discuss whether changing the price is a viable option for Largo. Provide evidence from the Excel workbook, Tab 4.
The break-even point will be 92 units.
5. If Largo Global Inc. is unable to sell the Deluxe Loot Box for more than $27.86, discuss possible alternatives. Doing the same thing LGI is already doing is not an option; you must suggest how to improve EBITDA.
Discuss the facts that should be considered in determining whether manufacturing the Loot Boxes in-house could lead to a price reduction. No calculations are required for Question 5
Deluxe can opt for removing the product from the market. They can also think of increasing the standard product.
>Sheet Maximization has been populated in Cells A to H of Q 1. Assuming the company operates months of the year convert the information from Project 2 to annual information for both Standard and Deluxe Boxes.
22
( obtain from Project 2)
12 Boxes sold per month in millions
/unit
VC Costs (FC+VC)
(millions)
0.00
$ 10.00 0.00
$ 50.00 20.00
$ 600.00 0
.80
$ 10.00 $ 10.00 $ 120.00 0
$ 10.00 $ 10.00 $ 720.00 $ 120.00 5.20
$ 10.00 $ 65.00 $ 10.00 $ 780.00 $ 120.00 00.00
2.80
$ 10.00 $ 70.00 $ 10.00 $ 840.00 $ 120.00 0.00
$ 10.00 $ 75.00 $ 10.00 $ 65.00 .00
$ 900.00 $ 120.00 $ 780.00 $ 10.00 $ 80.00 $ 10.00 $ 960.00 $ 120.00 $ 10.00 $ 85.00 $ 10.00 $ 1,020.00 $ 120.00 .40
$ 10.00 $ 90.00 $ 10.00 $ 1,080.00 $ 120.00 .00
$ 10.00 $ 95.00 $ 10.00 $ 1,140.00 $ 120.00 $ 10.00 $ 100.00 $ 10.00 $ 70.00 $ 1,200.00 $ 120.00 $ 1,320.00 $ 840.00 $ 10.00 $ 105.00 $ 10.00 $ 69.80 $ 1,260.00 $ 120.00 $ 837.60 $ 10.00 $ 110.00 $ 10.00 $ 120.00 $ 69.20 $ 1,320.00 $ 120.00 $ 830.40 $ 10.00 $ 115.00 $ 10.00 $ 68.20 $ 1,380.00 $ 120.00 .00
$ 818.40 $ 10.00 $ 120.00 $ 10.00 $ 66.80 $ 1,440.00 $ 120.00 $ 801.60 $ 10.00 $ 125.00 $ 10.00 $ 65.00 $ 1,500.00 $ 120.00 $ 780.00 $ 10.00 $ 130.00 $ 10.00 $ 62.80 $ 1,560.00 $ 120.00 $ 753.60 $ 10.00 $ 135.00 $ 10.00 $ 60.20 $ 1,620.00 $ 120.00 $ 722.40 $ 10.00 $ 140.00 $ 10.00 $ 150.00 $ 57.20 $ 1,680.00 $ 120.00 $ 1,800.00 $ 686.40 $ 105.00 12 Price Annual Revenue (millions) Annual VC (millions) Annual FC (millions) Annual Total Costs (millions) $ 30.00 $ 10.00 $ 10.00 $ 10.00 $ 120.00 $ 120.00 $ 120.00 $ 10.00 $ 10.00000 $ 120.00 $ 10.00 $ 10.00000 00
$ 120.00 $ 10.00 $ 10.00000 00
$ 180.00 $ 120.00 $ 10.00 $ 10.00000 00
$ 120.00 $ 10.00 $ 16.00 $ 10.00000 00
$ 18.00 $ 120.00 $ 10.00 $ 10.00000 00
$ 120.00 $ 26.50 $ 10.00 $ 10.00000 $ 18.05 $ 120.00 $ 216.60 $ 26.00 $ 10.00 $ 10.00000 $ 18.00 $ 120.00 $ 216.00 $ 25.50 $ 10.00 $ 18.00 $ 10.00000 $ 17.90 $ 216.00 $ 120.00 $ 214.80 $ 25.00 $ 10.00 $ 10.00000 $ 17.75 $ 120.00 $ 213.00 $ 10.00 $ 10.00000 $ 120.00 $ 10.00 $ 10.00000 $ 120.00 $ 10.00 $ 20.00 $ 10.00000 $ 17.00 $ 240.00 $ 120.00 $ 360.00 $ 204.00 $ 10.00 $ 10.00000 $ 120.00 $ 10.00 $ 10.00000 $ 120.00 $ 22.00 $ 10.00 $ 10.00000 $ 120.00 $ 21.50 $ 47.30 $ 10.00 $ 22.00 $ 10.00000 $ 567.60 $ 264.00 $ 120.00 $ 21.00 $ 47.25 $ 10.00 $ 22.50 $ 10.00000 $ 567.00 $ 120.00 and 1.5 Million Deluxe Boxes per month. With environmental concerns over the use of the materials and techniques to make the Deluxe Boxes the company director is concerned over its longterm feasibility. The marketing manager is convinced that under the current cost allocation Deluxe boxes is the highest contributor to company gross profit. How much profit is made on each product ? Also calculate the Gross Profit percentage for each product. HINT Use the annual information calculated in to complete Question 2. Complete the grey spaces
per month )
9 10.5 18 $ (in millions) $ (in millions) $ 1,080.00 $ 1,260.00 $ 13.50 $ 120.00 $ 120.00 $ 240.00 9 1.5 10.5 108 18 126 10.00 10.00 20.00 Millions Millions $ 2,030.40 $ 513.00 $ 1,080.00 $180 $ 8.80 $ 13.50 $ 120.00 $ 120.00 $ 830.40 $ 213.00 40.90% 41.50% below. How much overhead would be allocated to Standard and Deluxe Boxes ( in total and per unit) using this method? Show all supporting calculations. Complete the grey spaces
of Drivers
$ 47.00 $ 50.00 500 1,000 7,000 Labour Hours $ 5.00 200 800 1,000.00 9,000.00 10,000.00 6.00
N/A N/A 108 18 N/A $ – 0 Question 1 $ 2,030.40 $ 513.00 Profit % 40.90% 41.50% Box.
18.00 $ 18.80 15 40.90% Question 2 -11.00% 41.00% $ 120.00 18 $ 15.00 Total $ 90.00 $15 $ 180.00 Fixed Costs $ 120.00 Top of Form On Sheet 1: Table 2 should use Fixed cost per month “$3 million (instead of $10) per month” because Project 2->Tab 2->Question #3 states that “The variable cost per unit is $10 and the fixed costs are $3 million per month.” Please correct the related numbers on Question 2 accordingly. Question #2: “Marginal Contribution = Revenue – Variable Costs” is the correct formula you should use. Question #2: You should use the formula “Profit % = Profit / Revenue” when calculating Profit % for Total (in cell D70). Do not use ‘sum’ function at here. On Sheet 2: Sheet 3: For Question #1, Total Allocated costs (row 14) for Cost of Standard Boxes (Column H) should be the sum of the computed results in column H (=16.84). Your calculations for the Allocated cost per box are incorrect. For example, for Standard boxes, Allocated Cost per box = Total Allocated costs (16.84) / Number of boxes per year (108) = 0.16. Please correct your related calculations for both standard boxes and Deluxe boxes. On Sheet 4: Feedback Date Feb 15, 2022 2:57 PM Assignment Project 3 >Instructions
Largo Global Inc. is a fictious firm that is will be used to allow you to understand the market forces of supply and demand as they impact a company as well as the industry in which the company operates. The company produces two types of boxes, a Standard box and a Deluxe box. These boxes are also produced by many other companies. after reading the instructions, you will chart the supply and demand curves for the two different boxes. In tab 2 you will focus on the price elasticity of demand for these two products. In tab 3 you will determine at what price the company can maximize the profitability of both boxes. 1. In step 2, you will complete this Excel file by placing your answers to the questions in the boxes provided. You may submit this file as the Milestone submission so you can receive feedback on the accuracy of your calculations. 20. Each team member will have three deliverables for the project. First, each team member will complete the Excel spreadsheet. Second, each team member will serve as the team’s primary respondent for one of the five topics and will answer all questions for that topic. Third, team members will serve as the secondary respondent to one of the five topics and submit their answers to the primary for that topic. The primary respondent will coordinate the answers for that topic and submit them to the editor for the team’s Word file. Once the faculty member’s feedback is provided, the primaries will coordinate any changes to the team’s answers to the topic questions. per box
.00
2 1 0.6 0.8 0.4 0.2 1 0.1 0.740 Future Supply and Demand for cardboard boxes 2 0.3 0
0.4 1.6 0.5 0
1.4 0.6 1.2 0.7 0
1 0.8 0.8 0.9 0
0.6 1 0.4 1.1 0
0.2 1.2 0.1 Given: 0
0.872 Future Supply & Demand for Standard Boxes Daily US supply of Standard boxes (in billions of boxes per day) 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1. 00000000000001 17 17.2 17.399999999999999 17.600000000000001 17.8 18 18.2 18.399999999999999 18.600000000000001 18.8 19 Daily US demand of Standard boxes (in billions of boxes per day) 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0.1 17 17.2 17.399999999999999 17.600000000000001 17.8 18 18.2 18.399999999999999 18.60000000 0000001 18.8 19 Billions of Boxes per Day Price per Box Future Supply & Demand for Deluxe Boxes Daily US demand of Deluxe boxes (in billions of boxes per day) 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0.1 30 29.5 29 28.5 28 27.5 27 26.5 26 25.5 25 Daily US supply of Deluxe boxes (in billions of boxes per day) 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1000000000000001 1.2 1.3 30 29.5 29 28.5 28 27.5 27 26.5 26 25.5 25 Billions of Boxes per Day Price per Box 1. Based on the information provided in Table 1, create a chart in the space below showing the supply and demand curves for the number of Standard boxes in the United States per day. This information is helpful in knowing how many boxes to produce. After you have examined the graph below, identify the price and quantity at which market equilibrium exists.
2. Based on the information provided in Table 2, create a chart in the space below showing the supply and demand curves for the number of Deluxe boxes in the United States per day. This information is helpful in knowing how many boxes to produce. After you have examined the graph below, identify the price and quantity at which market equilibrium exists. ity
Price % change 8%
98%
Price $ 10.00 $ 10.00 $ 10.00 Quantity Price 17.60 New % change % change Elasticity of Demand 5
Elasticity: Price Elastic Price Revenue (millions) Variable Cost per cardboard box Variable Cost (millions) Fixed cost per month (millions) Monthly Profit (millions) 9.5 $ 18.40 $ 174.80 $ 10.00 $ 95.00 $ 10.00 $ 105.00 $ 69.80 $ 10.00 $ 105.00 $ 10.00 $ 69.80 Quantity Price 5
$28.00 Original $29.00 New % change % change Elasticity of Demand .793%
Elasticity: Price Elastic )
Price Revenue (millions) Variable Cost (millions) Fixed cost per month (millions) Total Cost (Millions) Monthly Profit (millions) $28.00 $ 10.00 00
$ 10.00 0
$ 3.00 00
Quantity Price $27.00 New % change % change Elasticity of Demand Elasticity: Price Elastic Price Revenue (millions) Variable Cost per metal box Variable Cost (millions) Fixed cost per month (millions) Total Cost (Millions) Monthly Profit (millions) 1.35 $29.00 $ 39.15 $ 10.00 $ 3.00 $ 22.65 $ 10.00 $ 16.50 $ 3.00 00
Price Elastic 1. Last month the company sold 10 million of their Standard boxes at an average price of $18.00 per box. This week the company raised the average price to $18.40 per box. The company sold 9.5 million boxes for the month. The variable cost per unit is $10 and the fixed costs are $10 million per month. 2. After reviewing last month’s results, the company decided to lower the price of a Standard box to $17.60. After this change, the volume sold increased to 10.5 million boxes for the month. 3. Last month the company sold 1.55 million Deluxe boxes at an average price of $28 per box. This month the company raised the price to $29 and sold 1.35 million boxes. The variable cost per unit is $10 and the fixed costs are $3 million per month. 4. After reviewing the last results, the company decided to lower the price to $27 and sold 1.65 million boxes for the month.1
In this Project you will analyse managerial and costing information to improve the company’s EBITDA. You will use what you have learned about cost behavior and apply activity-based costing and cost-volume-profit analysis to make recommendations about LGI’s operational productivity. Use Information you calculated in project 2 Tab 3
Profit
12
1
10
Question 1
Profit Maximization
Standard Boxes
Quantity
Price
Revenue
VC
FC / per month (millions)
Total
Daily profit (revenue -all costs)
Annual Revenue (millions)
Annual VC (millions)
Annual FC (millions)
Annual
Total Costs
Annual Profit
5
$ 22.00
$
11
$
10.00
$ 50.00
$
6
$ 1,3
20.00
$ 600.00
$ 120.00
$
7
5.5
$ 2
1.6
$ 11
8
$ 55.00
$ 65.00
$ 53.80
$ 1,425.60
$ 660.00
$ 780.00
$ 645.60
6
$ 2
1.2
$ 127.20
$ 60.00
$ 70.00
$ 57.20
$ 1,526.40
$ 840.00
$ 686.40
6.5
$ 20.80
$
13
$ 75.00
$ 60.20
$ 1,622.40
$
9
$ 722.40
7
$ 20.40
$
14
$ 80.00
$ 62.80
$ 1,713.60
$ 960.00
$ 753.60
7.5
$ 20.00
$
15
$ 85.00
$ 1,
800
$ 1,020.00
8
$ 19.60
$ 156.80
$ 90.00
$ 66.80
$ 1,881.60
$ 1,080.00
$ 801.60
8.5
$ 19.20
$ 163.20
$ 95.00
$ 68.20
$ 1,958.40
$ 1,140.00
$ 8
18
9
$ 18.80
$ 169.20
$ 100.00
$ 69.20
$ 2,030.40
$ 1,
200
$ 830.40
9.5
$ 18.40
$ 174.80
$ 105.00
$ 69.80
$ 2,097.60
$ 1,260.00
$ 837.60
10
$
18.00
$ 180.00
$ 110.00
$ 2,160.00
10.5
$ 17.60
$ 184.80
$ 115.00
$ 2,217.60
$ 1,380.00
11
$ 17.20
$ 189.20
$ 2,270.40
$ 1,440.00
1
1.5
$ 16.80
$ 193.20
$ 125.00
$ 2,318.40
$ 1,
500
12
$ 16.40
$ 196.80
$ 130.00
$ 2,361.60
$ 1,560.00
12.5
$ 16.00
$ 200.00
$ 135.00
$ 2,400.00
$ 1,620.00
13
$ 15.60
$ 202.80
$ 140.00
$ 2,433.60
$ 1,680.00
13.5
$ 15.20
$ 205.20
$ 145.00
$ 2,462.40
$ 1,740.00
14
$ 14.80
$ 207.20
$ 2,486.40
$ 168.80
$ 63.80
$ 2,025.60
Profit Maximization
Deluxe Boxes
Deluxe boxes sold per month (millions)
Revenue (price x volume)
Variable Cost per standard box
Variable Cost (cost per unit x volume)
Fixed cost per month (millions)
Total Cost (Fixed + Variable)
Daily Profit (revenue – all costs)
Annual Profit (millions)
1
$ 30.00
$ 10.00000
$ 20.0000
$ 360.00
$ 240.00
1.2
$ 29.50
$ 35.40
$ 12.00
$ 22.0000
$ 13.40
$ 424.80
$ 144.00
$ 264.00
$ 160.80
1.35
$ 29.00
$ 39.15
$ 13.50
$ 23.50
$ 15.65
$ 469.80
$ 162.00
$ 282.00
$ 187.80
1.5
$ 28.50
$ 42.75
$ 15.00
$ 25.00
$ 17.75
$ 513.00
$ 300.00
$ 213.00
1.55
$ 28.00
$ 43.40
$ 15.50
$ 25.50
$ 17.90
$ 520.80
$ 186.00
$ 306.00
$ 214.80
1.6
$ 27.50
$ 44.00
$ 26.00
$ 528.00
$ 192.00
$ 312.00
$ 216.00
1.65
$ 27.00
$ 44.55
$ 16.50
$ 26.50
$ 18.05
$ 534.60
$ 198.00
$ 318.00
$ 216.60
1.7
$ 45.05
$ 17.00
$ 27.0000
$ 540.60
$ 204.00
$ 324.00
1.75
$ 45.50
$ 17.50
$ 27.5000
$ 546.00
$ 210.00
$ 330.00
1.8
$ 45.90
$ 28.0000
$ 550.80
$ 336.00
1.85
$ 46.25
$ 18.50
$ 28.5000
$ 555.00
$ 222.00
$ 342.00
1.9
$ 24.50
$ 46.55
$ 19.00
$ 29.0000
$ 17.55
$ 558.60
$ 228.00
$ 348.00
$ 210.60
1.95
$ 24.00
$ 46.80
$ 19.50
$ 29.5000
$ 17.30
$ 561.60
$ 234.00
$ 354.00
$ 207.60
2 $ 23.50
$ 47.00
$ 30.0000
$ 564.00
2.05
$ 23.00
$ 47.15
$ 20.50
$ 30.5000
$ 16.65
$ 565.80
$ 246.00
$ 366.00
$ 199.80
2.1
$ 22.50
$ 47.25
$ 21.00
$ 31.0000
$ 16.25
$ 567.00
$ 252.00
$ 372.00
$ 195.00
2.15
$ 47.30
$ 21.50
$ 31.5000
$ 15.80
$ 567.60
$ 258.00
$ 378.00
$ 189.60
2.2
$ 32.0000
$ 15.30
$ 384.00
$ 183.60
2.25
$ 32.5000
$ 14.75
$
270.00
$ 390.00
$ 177.00
$ 44.13
$ 27.66
$ 16.48
Question 2
The Company currently operates by selling 9 Million
Standard Boxes
Question 1
37.5
Standard Boxes Deluxe Boxes Total
Number Of Boxes (in
Millions
1,5
Volume per year ( millions)
108
126
$ (in millions)
Revenue $ 2,030.40 $ 513.00
$ 2,543.40
Less:
Variable Costs
$180
Marginal
Contribution
$ 8.80
$ 22.30
Less:
Fixed Costs
Profit $ 830.40 $ 213.00
$ 1,043.40
Profit
%
40.90%
41.50%
82.40%
Sheet2
Question 1
A new intern at the company believes that fixed cost based and allocated on a daily basis is incorrect and suggests allocating the Fixed Costs between Standard and Deluxe Boxes Based on the number of boxes sold. How much costs are allocated to each product based on the method suggested by the intern? To prove s/he point the intern also calculated the profit percentage. Complete the grey spaces
Standard Boxes Deluxe Boxes Total
Volumes (per Month)
Volumes per year ( millions)
Total Fixed Costs (Millions- from Tab1)
New Profit
Sales
Less VC
Contribution Margin
Less Fixed Costs
Operting Profit
Profit %
Sheet3
Question 1
LGI’s production managers recently attended a course at UMGC where they learned about ABC costing. They propose allocating the total fixed costs between Standard and Deluxe boxes based on this method . They collected information about the cost drivers and the break up of the total costs in
Table 1
Table 1
Manufacturing overhead
$ Amount
Cost driver
Standard Box
Deluxe Box
Totals
Cost of
Deluxe Boxes
Cost of Standard Boxes
Total Cost Check (must agree to Column B7:B14)
Depreciation
$47.00
Square feet
7,000
80,000
87,000
$ 43.22
$ 3.78
Maintenance
$50.00
Direct
Labour Hours
1,000
9,000
10,000
$ 45.00
$ 5.00
Purchase order processing
$9
Number of purchases orders
4,500
5,000
$ 8.10
$ 0.90
$ 9.00
Inspection
$34
Number of employees
6000
$ 29.14
$ 4.86
$ 34.00
Indirect Materials
$5.00
1,000.00
9,000.00
10,000.00
$ 4.50
$ 0.50
Supervision
$7.00
#of inspections
1000
$ 5.60
$ 1.40
$ 7.00
Supplies
$4.00
Units manufactured
$ 3.60
$ 0.40
$ 4.00
Total Allocated costs
$15
N/A
$ – 0
Number of boxes per year
Allocated Cost per Box
Deluxe Boxes Deluxe Boxes Total
Sales
Less: Variable Costs $ 1,080.00 $180
Contribution $ 8.80 $ 13.50
Less: Fixed Costs $ 120.00 $ 120.00
Profit $ 830.40 $ 213.00
Sheet4
Question 1
The sustainability manager is concerned about the long term sustainability implications of Deluxe boxes on the environment and suggest changing to sustainable materials for the production of a
Sustainable Deluxe
If the company switches to their current quantity of Deluxe Boxes sold to Sustainable Deluxe Boxes there will be some cost implications.
The Sustainable Deluxe Boxes could be made cheaper, and the sustianability manager believes that the company could bring down the selling price to $15 per box which would entice current Deluxe Box customers to accept the switch over. The new Sustainable Deluxe Boxes will attract 60% of total fixed costs calculated for the Deluxe Boxes under the ABC method. The number of boxes sold will not be affected by this new selling price, as the company will in future have to do marketing to sell more boxes at the lower price. Calculate the new Gross profit and profit percentage. Complete the grey spaces
Standard Boxes Sustainable Deluxe Total
Quantity
108.00
126.00
Sellin price per unit
$ 33.80
Sales $ 2,030.40 270.00
$ 2,300.40
VC $ 1,080.00 $180 20.00
Contribution $ 8.80 $ 13.50 $ 22.30
Fixed Costs $ 120.00 $ 120.00 $ 240.00
Profit $ 830.40
– 30.00
$ 800.40
GP %
-11.00%
The manager is concerned about the massive reduction in profit from the Sustainable Deluxe Boxes but realizes that because of the change in materials, they will no longer be able to charge the price of $18 per box. The manager wants to achieve at least the same profit percentage for the deluxe boxes as they have on standard boxes. How much additional profit are they requiring? Complete the grey spaces.
Required profit
41.00%
See Tab 3
Less: Existing profit
See Q 1 above
Equals: Difference in additional profit required
52.00%
Question 3
Work out the percentage that they should mark up on the costs to achieve the same profit % as for the standard boxes. Complete the grey spaces
%
Sales $ 2,030.40
Less Required GP%
Equals: Mark up percentage on cost
$ 2,029.99
Question 4
Use the percentage calculated in Question 3 to determine how much the company should charge per product to reach the same profit percentage as for the standard boxes . Assume the company can still sell the same quantity of the Sustainable Deluxe Boxes as for the Deluxe Boxes. Complete the grey spaces
Totals
Variable Costs $ 180.00
Fixed Cost
Total Costs $ 300.00
Sales
$ 270.00
Units sold
Sales Price per unit
Question 5
Prove that your calculation in Q 4 is correct. Complete the grey boxes.
Proof:
Per Unit
Sales $ 270.00 $ 15.00
Less VC $ 180.00 12
Contribution
$ 8.00
Fixed Costs $ 120.00
Net Profit
Profit %
33.00%
Question 5
The marketing manger is concerned that the change could havea significant impact on sales as ciustomers may see the sustaiable boxes as an inferiror product for which they still have to pay only a little bit less than the orginal price of the Deluxe Boxes. How many boxes would the company have to sell to break even on the new Sustainabale Deluxe Boxes based on the new selling price? Complete the grey boxes.
$ Totals
Selling price
Less: Variable costs
Contribution $ 13.50
Breakeven Quantity
– 0.73
BreakEven Value
$ 8.89
Please do not use “Total Fixed Costs (Millions- from Tab1)” which is inaccurate statement.
For Question #1, you need to carefully read the assumptions which indicate that the Fixed Costs is allocated based on the number of boxes sold. For example, Total FC for Standard Boxes = (Volumes per year for Standard Boxes/Total Volume for both boxes) * Total FX = (108/126) * 156 =133.71. You need to correct all related calculations accordingly.
For Question #1, check “Fixed Costs” and “Contribution” numbers if you revised the costs on Sheet 3. They should be consistent.
Revised other related questions caused by the above changes.
2
In Project 2, you will learn about how to apply the tenets of microeconomics to improve the company’s profitability. In tab
1
Follow these steps to complete Project 2:
2. In step 3, you will answer the questions provided in the Word file for this project that will guide/give direction to your analysis. These questions will constitute the core of your report where you will be asked to make key recommendations.
Project 2 is the team assignment in MBA 6
All team members must submit their three deliverables in order to receive a grade for the project. Your faculty member will let you know how you will submit your deliverables as well as the team’s consolidated Word file which will be graded.
Tab 1 – Supply and Demand Graph
Table 1
Future Supply and Demand for cardboard boxes
Price
Daily US demand of Standard boxes (in billions of boxes per day)
Daily US supply of Standard boxes (in billions of boxes per day)
$1
7
0.1
$17.20
1.
8
0.2
$17.40
1.6
0.3
$
17.60
1.4
0.4
$17.80
1.2
0.
5
$
18.00
0.6
$18.20
0.8
0.7
$
18.40
$18.60
0.
9
$18.80
$19.00
1.1
Question 1:
Create a Supply and Demand Chart for the Standard box below
Given:
Demand Slope
y=-.977x+18.6
Supply Slope
y=.5x-8.4
solve for value of x at intersect
-.977x+18.6=.5x-8.4
add 8.4
-.977x+27=.5x
add .977x
27=1.477x
divide by 1.477
18.280
solve for Y
y=.5(18.28)-8.4
0.740
y=-.977(18.28)+18.6
Equilibrium:
.74 Billion boxes per day, at a price of $18.28 per box
Table 2
Price per box
Daily US demand of Deluxe boxes (in billions of boxes per day)
Daily US supply of Deluxe boxes (in billions of boxes per day)
$30.00
$2
9.5
1.8
$29.00
$2
8.5
$28.00
$2
7.5
$27.00
$2
6.5
$26.00
$2
5.5
$25.00
1.3
Question 2:
Create a Supply and Demand Chart for the deluxe box below
Demand Slope
y=.391x-9.74
Supply Slope
y=-.2x+6.3
solve for value of x at intersect
.391x-9.74=-.2x+6.3
add 9.74
.391x=-.2x+16.04
add .2x
.591x=16.04
divide by .4
11
27.
14
solve for Y y=-.2x+6.3
0.872
y=.391(27.14)-9.74
Equilibrium:
.87 Billion Boxes per Day, at a price of $27.14 per box
10
Tab 2 –
Price Elastic
Price Elasticity
Quantity
10 18.00
Original
9.5 18.40
New
% change
Elasticity of Demand
-5.
12
2.1
2.33
Elasticity:
Price Elastic
By how much did revenues increase or decrease as a result of the change in price?
$ (5.20)
By how much did profits increase or decline?
$ (0.20)
Standard Boxes sold per monthly (millions)
Revenue (millions)
Variable Cost per cardboard box
Variable Cost (millions)
Fixed cost per month (millions)
Total Cost (millions)
Monthly Profit (millions)
10
$ 18.00
$ 180.00
$ 10.00
$ 100.00
$ 110.00
$ 70.00
9.5
$ 18.40
$ 174.80
$ 95.00
$ 105.00
$ 69.80
9.5 18.40 Original
10.5
10.000%
-4.444%
2.2
By how much did revenues increase or decrease as a result of the change in price?
$ (0.80)
By how much did profits increase or decline?
$ – 0
Standard Boxes sold per month (millions)
Total Cost (Millions)
10.5
$ 17.60
$ 184.80
$ 115.00
1.5
1.35
–
13
3.509%
3.93
By how much did revenues increase or decrease as a result of the change in price?
$ (4.25)
By how much did profits increase or decline?
$ (
2.25
Deluxe boxes sold per month (millions)
Variable Cost per metal box
1.55
$ 43.40
$ 15.50
$ 3.00
$ 18.50
$ 24.90
1.35 $29.00
$ 39.15
$
13.5
$ 16.50
$ 22.65
1.35 $29.00 Original
1.65
20.000%
-7.143%
2.80
By how much did revenues increase or decrease as a result of the change in price?
$ 5.40
By how much did profits increase or decline?
$ 2.40
Deluxe boxes sold per month (millions)
$ 13.50
$ 16.5000
1.65 $27.00
$ 44.55
$ 19.50
$ 25.05
Select One
Price Inelastic
Unit Price Elastic
What is the price elasticity of demand?
Can the demand be characterized as price elastic, price inelastic, or neither?
By how much did revenues increase or decrease as a result of the change in price?
By how much did profits increase or decline?
What is the price elasticity of demand?
Can the demand be characterized as price elastic, price inelastic, or neither?
By how much did revenues increase or decrease as a result of the change in price?
By how much did profits increase or decline?
What is the price elasticity of demand?
Can the demand be characterized as price elastic, price inelastic, or neither?
By how much did revenues increase or decrease as a result of the change in price?
By how much did profits increase or decline?
What is the price elasticity of demand?
Can the demand be characterized as price elastic, price inelastic, or neither?
By how much did revenues increase or decrease as a result of the change in price?
By how much did profits increase or decline? Tab 3 –
| Standard boxes sold per month (millions) | Revenue (price x volume) | Variable Cost per standard box | Variable Cost (cost per unit x volume) | Total Cost (Fixed + Variable) | Monthly Profit (revenue – all costs) | MR | MC | Difference | |||||||||||||||||
| $ 22.00 | $ 50.00 | $ 10.00000 | $ 60.00 | ||||||||||||||||||||||
| $ 21.60 | $ 118.80 | $ 55.00 | $ 65.00 | $ 53.80 | $ 7.60 | ||||||||||||||||||||
| $ 21.20 | $ 127.20 | $ 70.0000 | $ 57.20 | $ 16.80 | $ 6.80 | ||||||||||||||||||||
| $ 20.80 | $ 135.20 | $ 75.00 | $ 60.20 | $ 16.00 | $ 6.00 | ||||||||||||||||||||
| $ 20.40 | $ 142.80 | $ 80.00 | $ 62.80 | $ 15.20 | $ 5.20 | ||||||||||||||||||||
| $ 20.00 | $ 150.00 | $ 85.00 | $ 14.40 | $ 4.40 | |||||||||||||||||||||
| $ 19.60 | $ 156.80 | $ 90.00 | $ 66.80 | $ 13.60 | $ 3.60 | ||||||||||||||||||||
| $ 19.20 | $ 163.20 | $ 95.0000 | $ 68.20 | $ 12.80 | $ 2.80 | ||||||||||||||||||||
| $ 18.80 | $ 169.20 | $ 100.0000 | $ 69.20 | $ 12.00 | $ 2.00 | ||||||||||||||||||||
| $ 105.0000 | $ 11.20 | $ 1.20 | |||||||||||||||||||||||
| $ 110.0000 | $ 10.40 | $ 0.40 | |||||||||||||||||||||||
| $ 115.0000 | $ 9.60 | $ (0.40) | |||||||||||||||||||||||
| $ 17.20 | $ 189.20 | $ 120.00 | $ 8.80 | $ (1.20) | |||||||||||||||||||||
| 11.5 | $ 193.20 | $ 125.00 | $ 8.00 | $ (2.00) | |||||||||||||||||||||
| $ 16.40 | $ 196.80 | $ 130.00 | $ 7.20 | $ (2.80) | |||||||||||||||||||||
| 12.5 | $ 200.00 | $ 135.00 | $ 6.40 | $ (3.60) | |||||||||||||||||||||
| $ 15.60 | $ 202.80 | $ 140.00 | $ 5.60 | $ (4.40) | |||||||||||||||||||||
| $ 205.20 | $ 145.0000 | $ 4.80 | |||||||||||||||||||||||
| $ 14.80 | $ 207.20 | $ 150.0000 | $ 4.00 | $ (6.00) | |||||||||||||||||||||
| Standard Boxes priced at $18 | |||||||||||||||||||||||||
| $ 30.00 | $ 3.00000 | $ 13.00 | $ 17.00 | ||||||||||||||||||||||
| $ 29.50 | $ 35.40 | $ 15.00 | $ 27.00 | ||||||||||||||||||||||
| $ 29.00 | $ 25.00 | ||||||||||||||||||||||||
| $ 28.50 | $ 42.75 | $ 18.0000 | $ 24.75 | $ 24.00 | $ 14.00 | ||||||||||||||||||||
| $ 28.00 | |||||||||||||||||||||||||
| $ 27.50 | $ 44.00 | $ 19.00 | |||||||||||||||||||||||
| $ 11.00 | $ 1.00 | ||||||||||||||||||||||||
| 1.7 | $ 26.50 | $ 45.05 | $ 20.0000 | ||||||||||||||||||||||
| 1.75 | $ 26.00 | $ 45.50 | $ 17.50 | $ 20.50 | $ 9.00 | $ (1.00) | |||||||||||||||||||
| $ 25.50 | $ 45.90 | $ 21.00 | |||||||||||||||||||||||
| 1.85 | $ 46.25 | $ 21.50 | $ 7.00 | $ (3.00) | |||||||||||||||||||||
| 1.9 | $ 24.50 | $ 46.55 | $ 22.0000 | $ 24.55 | $ (4.00) | ||||||||||||||||||||
| 1.95 | $ 46.80 | $ 22.50 | $ 24.30 | $ 5.00 | $ (5.00) | ||||||||||||||||||||
| $ 23.50 | $ 47.00 | $ 23.00 | |||||||||||||||||||||||
| 2.05 | $ 47.15 | $ 23.5000 | $ 23.65 | $ (7.00) | |||||||||||||||||||||
| $ 47.25 | $ 24.0000 | $ 23.25 | $ (8.00) | ||||||||||||||||||||||
| 2.15 | $ 47.30 | $ 24.5000 | $ 22.80 | $ (9.00) | |||||||||||||||||||||
| $ 25.0000 | $ 22.30 | $ (10.00) | |||||||||||||||||||||||
| $ 25.5000 | $ 21.75 | $ (11.00) | |||||||||||||||||||||||
| Deluxe Boxes priced at $26.50 |
1. The company views its goal as profit maximization. Complete the table to the right to approximate the profit-maximizing price for the Standard boxes.
What is the closest price that will help the company maximize the profit on Standard boxes?
2. The company views its goal as profit maximization. Complete the table to the right to approximate the profit-maximizing price for the Deluxe boxes.
What is the closest price that will help the company maximize the profit on Deluxe boxes?
>Sheet Maximization has been populated in Cells A to H of Q 1. Assuming the company operates months of the year convert the information from Project 2 to annual information for both Standard and Deluxe Boxes.
22
( obtain from Project 2)
12 Boxes sold per month in millions
/unit
VC Costs (FC+VC)
(millions)
0.00
.00
00.00
4.00
0
.80
$ 10.00 $ 3.00 $ 36.00 6.00
0
$ 10.00 $ 3.00 $ 36.00 5.20
$ 10.00 $ 3.00 $ 36.00 2.80
$ 10.00 $ 3.00 $ 36.00 0.00
$ 10.00 $ 3.00 .00
$ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 .00
$ 36.00 $ 10.00 $ 3.00 .00
$ 76.80 $ 36.00 $ 921.60 $ 10.00 $ 3.00 $ 76.20 $ 1,320.00 $ 36.00 $ 914.40 $ 10.00 $ 3.00 $ 75.20 $ 36.00 $ 902.40 $ 10.00 $ 3.00 $ 73.80 $ 36.00 $ 885.60 $ 10.00 $ 3.00 $ 72.00 .00
$ 36.00 $ 864.00 $ 10.00 $ 3.00 $ 69.80 $ 36.00 $ 837.60 $ 10.00 $ 3.00 $ 67.20 $ 36.00 $ 806.40 $ 10.00 $ 3.00 $ 64.20 $ 36.00 $ 770.40 $ 98.00 12 Price Annual Revenue (millions) Annual VC (millions) Annual FC (millions) Annual Total Costs (millions) $ 30.00 $ 10.00 $ 10.00 $ 3.00 $ 120.00 $ 36.00 $ 10.00 $ 3.00 00
$ 20.40 $ 36.00 $ 180.00 $ 10.00 $ 3.00 00
$ 36.00 0
$ 10.00 $ 15.00 $ 3.00 $ 180.00 $ 36.00 $ 10.00 $ 3.00 00
$ 36.00 $ 10.00 $ 16.00 $ 3.00 00
$ 36.00 $ 10.00 $ 16.50 $ 3.00 00
$ 198.00 $ 36.00 $ 10.00 $ 17.00 $ 3.00 $ 25.05 $ 204.00 $ 36.00 $ 300.60 $ 10.00 $ 3.00 00
$ 25.00 $ 36.00 $ 300.00 $ 10.00 $ 18.00 $ 3.00 00
$ 24.90 $ 216.00 $ 36.00 $ 298.80 $ 25.00 $ 10.00 $ 18.50 $ 3.00 00
$ 24.75 $ 222.00 $ 36.00 $ 297.00 $ 10.00 $ 19.00 $ 3.00 $ 228.00 $ 36.00 $ 10.00 $ 19.50 $ 3.00 00
$ 234.00 $ 36.00 $ 10.00 $ 20.00 $ 3.00 00
$ 24.00 $ 240.00 $ 36.00 $ 23.00 $ 10.00 $ 20.50 $ 3.00 $ 246.00 $ 36.00 $ 22.50 $ 10.00 $ 21.00 $ 3.00 $ 252.00 $ 36.00 $ 288.00 $ 22.00 $ 10.00 $ 21.50 $ 3.00 $ 258.00 $ 36.00 $ 21.50 $ 47.30 $ 10.00 $ 22.00 $ 3.00 $ 567.60 $ 264.00 $ 36.00 $ 300.00 $ 21.00 $ 47.25 $ 10.00 $ 22.50 $ 3.00 $ 567.00 $ 36.00 and 1.5 Million Deluxe Boxes per month. With environmental concerns over the use of the materials and techniques to make the Deluxe Boxes the company director is concerned over its longterm feasibility. The marketing manager is convinced that under the current cost allocation Deluxe boxes is the highest contributor to company gross profit. How much profit is made on each product ? Also calculate the Gross Profit percentage for each product. HINT Use the annual information calculated in to complete Question 2. Complete the grey spaces
per month )
9 10.5 108 18 $ (in millions) $ (in millions) $ 1,080.00 $ 1,260.00 $ 120.00 $ 36.00 $ 297.00 9 1.5 10.5 108 18 126 156.00 Millions Millions $ 2,030.40 $ 513.00 $ 1,080.00 $180 $ 950.40 $ 333.00 below. How much overhead would be allocated to Standard and Deluxe Boxes ( in total and per unit) using this method? Show all supporting calculations. Complete the grey spaces
of Drivers
$ 47.00 $ 50.00 500 1,000 7,000 Labour Hours $ 5.00 200 800 1,000.00 9,000.00 10,000.00 6.00
N/A $ 18.00 $ 156.00 108 18 N/A Question 1 $ 2,030.40 $ 513.00 Box.
$ 18.80 15 Question 2 40.22% 18.21% 18 Total $ 90.00 $15 $ 180.00 Contribution $ 90.00 Fixed Costs $ 139.16 >Sheet Maximization has been populated in Cells A to H of Q 1. Assuming the company operates months of the year convert the information from Project 2 to annual information for both Standard and Deluxe Boxes.
22
( obtain from Project 2)
12 Boxes sold per month in millions
/unit
VC Costs (FC+VC)
(millions)
0.00
.00
00.00
4.00
0
.80
$ 10.00 $ 3.00 $ 36.00 6.00
0
$ 10.00 $ 3.00 $ 36.00 5.20
$ 10.00 $ 3.00 $ 36.00 2.80
$ 10.00 $ 3.00 $ 36.00 0.00
$ 10.00 $ 3.00 .00
$ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 $ 36.00 $ 10.00 $ 3.00 .00
$ 36.00 $ 10.00 $ 3.00 .00
$ 76.80 $ 36.00 $ 921.60 $ 10.00 $ 3.00 $ 76.20 $ 1,320.00 $ 36.00 $ 914.40 $ 10.00 $ 3.00 $ 75.20 $ 36.00 $ 902.40 $ 10.00 $ 3.00 $ 73.80 $ 36.00 $ 885.60 $ 10.00 $ 3.00 $ 72.00 .00
$ 36.00 $ 864.00 $ 10.00 $ 3.00 $ 69.80 $ 36.00 $ 837.60 $ 10.00 $ 3.00 $ 67.20 $ 36.00 $ 806.40 $ 10.00 $ 3.00 $ 64.20 $ 36.00 $ 770.40 $ 98.00 12 Price Annual Revenue (millions) Annual VC (millions) Annual FC (millions) Annual Total Costs (millions) $ 30.00 $ 10.00 $ 10.00 $ 3.00 $ 120.00 $ 36.00 $ 10.00 $ 3.00 00
$ 20.40 $ 36.00 $ 180.00 $ 10.00 $ 3.00 00
$ 36.00 0
$ 10.00 $ 15.00 $ 3.00 $ 180.00 $ 36.00 $ 10.00 $ 3.00 00
$ 36.00 $ 10.00 $ 16.00 $ 3.00 00
$ 36.00 $ 10.00 $ 16.50 $ 3.00 00
$ 198.00 $ 36.00 $ 10.00 $ 17.00 $ 3.00 $ 25.05 $ 204.00 $ 36.00 $ 300.60 $ 10.00 $ 3.00 00
$ 25.00 $ 36.00 $ 300.00 $ 10.00 $ 18.00 $ 3.00 00
$ 24.90 $ 216.00 $ 36.00 $ 298.80 $ 25.00 $ 10.00 $ 18.50 $ 3.00 00
$ 24.75 $ 222.00 $ 36.00 $ 297.00 $ 10.00 $ 19.00 $ 3.00 $ 228.00 $ 36.00 $ 10.00 $ 19.50 $ 3.00 00
$ 234.00 $ 36.00 $ 10.00 $ 20.00 $ 3.00 00
$ 24.00 $ 240.00 $ 36.00 $ 23.00 $ 10.00 $ 20.50 $ 3.00 $ 246.00 $ 36.00 $ 22.50 $ 10.00 $ 21.00 $ 3.00 $ 252.00 $ 36.00 $ 288.00 $ 22.00 $ 10.00 $ 21.50 $ 3.00 $ 258.00 $ 36.00 $ 21.50 $ 47.30 $ 10.00 $ 22.00 $ 3.00 $ 567.60 $ 264.00 $ 36.00 $ 300.00 $ 21.00 $ 47.25 $ 10.00 $ 22.50 $ 3.00 $ 567.00 $ 36.00 and 1.5 Million Deluxe Boxes per month. With environmental concerns over the use of the materials and techniques to make the Deluxe Boxes the company director is concerned over its longterm feasibility. The marketing manager is convinced that under the current cost allocation Deluxe boxes is the highest contributor to company gross profit. How much profit is made on each product ? Also calculate the Gross Profit percentage for each product. HINT Use the annual information calculated in to complete Question 2. Complete the grey spaces
per month )
9 10.5 108 18 $ (in millions) $ (in millions) $ 1,080.00 $ 1,260.00 $ 120.00 $ 36.00 $ 297.00 9 1.5 10.5 108 18 126 156.00 Millions Millions $ 2,030.40 $ 513.00 $ 1,080.00 $180 $ 950.40 $ 333.00 below. How much overhead would be allocated to Standard and Deluxe Boxes ( in total and per unit) using this method? Show all supporting calculations. Complete the grey spaces
of Drivers
$ 47.00 $ 50.00 500 1,000 7,000 Labour Hours $ 5.00 200 800 1,000.00 9,000.00 10,000.00 6.00
N/A $ 18.00 $ 156.00 108 18 N/A Question 1 $ 2,030.40 $ 513.00 Box.
$ 18.80 15 Question 2 40.22% 18.21% 18 Total $ 90.00 $15 $ 180.00 Contribution $ 90.00 Fixed Costs $ 139.16 Turnitin Report Formatting Title Page Citation Outline1
In this Project you will analyse managerial and costing information to improve the company’s EBITDA. You will use what you have learned about cost behavior and apply activity-based costing and cost-volume-profit analysis to make recommendations about LGI’s operational productivity. Use Information you calculated in project 2 Tab 3
Profit
12
1
10
Question 1
Profit Maximization
Standard Boxes
Quantity
Price
Revenue
VC
FC / per month (millions)
Total
Daily profit (revenue -all costs)
Annual Revenue (millions)
Annual VC (millions)
Annual FC (millions)
Annual
Total Costs
Annual Profit
5
$ 22.00
$
11
$ 10.00
$ 50.00
$ 3.00
$ 53.00
$ 5
7
$ 1,3
20.00
$
6
$ 36.00
$ 636.00
$ 6
8
5.5
$ 2
1.6
$ 1
18
$ 55.00
$ 58.00
$ 60.80
$ 1,425.60
$ 660.00
$ 6
9
$ 729.60
6
$ 2
1.2
$ 127.20
$ 60.00
$ 63.00
$ 64.20
$ 1,526.40
$ 720.00
$ 756.00
$ 770.40
6.5
$ 20.80
$
13
$ 65.00
$ 68.00
$ 67.20
$ 1,622.40
$ 780.00
$ 816.00
$ 806.40
7
$ 20.40
$
14
$ 70.00
$ 73.00
$ 69.80
$ 1,713.60
$ 840.00
$ 876.00
$ 837.60
7.5
$ 20.00
$
15
$ 75.00
$ 78.00
$ 72.00
$ 1,
800
$ 900.00
$ 936.00
$ 864.00
8
$ 19.60
$ 156.80
$ 80.00
$ 83.00
$ 73.80
$ 1,881.60
$ 960.00
$ 996.00
$ 885.60
8.5
$ 19.20
$ 163.20
$ 85.00
$ 88.00
$ 75.20
$ 1,958.40
$ 1,020.00
$ 1,056.00
$ 902.40
9
$ 18.80
$ 169.20
$ 90.00
$ 93.00
$ 76.20
$ 2,030.40
$ 1,080.00
$ 1,116.00
$ 914.40
9.5
$ 18.40
$ 174.80
$ 95.00
$ 98.00
$ 76.80
$ 2,097.60
$ 1,140.00
$ 1,176.00
$ 921.60
10
$
18.00
$ 180.00
$ 100.00
$ 103.00
$ 77.00
$ 2,160.00
$ 1,
200
$ 1,236.00
$ 924.00
10.5
$ 17.60
$ 184.80
$ 105.00
$
108
$ 2,217.60
$ 1,260.00
$ 1,296.00
11
$ 17.20
$ 189.20
$ 110.00
$ 113.00
$ 2,270.40
$ 1,356.00
1
1.5
$ 16.80
$ 193.20
$ 115.00
$ 118.00
$ 2,318.40
$ 1,380.00
$ 1,416.00
12
$ 16.40
$ 196.80
$ 120.00
$ 123.00
$ 2,361.60
$ 1,440.00
$ 1,476.00
12.5
$ 16.00
$ 200.00
$ 125.00
$ 128.00
$ 2,400.00
$ 1,
500
$ 1,536.00
13
$ 15.60
$ 202.80
$ 130.00
$ 133.00
$ 2,433.60
$ 1,560.00
$ 1,596.00
13.5
$ 15.20
$ 205.20
$ 135.00
$ 138.00
$ 2,462.40
$ 1,620.00
$ 1,656.00
14
$ 14.80
$ 207.20
$ 140.00
$ 143.00
$ 2,486.40
$ 1,680.00
$ 1,716.00
$ 168.80
$ 70.80
$ 2,025.60
Profit Maximization
Deluxe Boxes
Deluxe boxes sold per month (millions)
Revenue (price x volume)
Variable Cost per standard box
Variable Cost (cost per unit x volume)
Fixed cost per month (millions)
Total Cost (Fixed + Variable)
Daily Profit (revenue – all costs)
Annual Profit (millions)
1
$ 30.00
$ 13.0000
$ 17.00
$ 360.00
$
156.00
$ 204.00
1.2
$ 29.50
$ 35.40
$ 12.00
$ 15.00
$ 424.80
$ 144.00
$ 244.80
1.35
$ 29.00
$ 39.15
$ 13.50
$ 16.50
$ 22.65
$ 469.80
$ 162.00
$ 198.00
$ 27
1.8
1.5
$ 28.50
$ 42.75
$ 18.0000
$ 24.75
$ 513.00
$ 216.00
$ 297.00
1.55
$ 28.00
$ 43.40
$ 15.50
$ 18.50
$ 24.90
$ 520.80
$ 186.00
$ 222.00
$ 298.80
1.6
$ 27.50
$ 44.00
$ 19.00
$ 25.00
$ 528.00
$ 192.00
$ 228.00
$ 300.00
1.65
$ 27.00
$ 44.55
$ 19.50
$ 25.05
$ 534.60
$ 234.00
$ 300.60
1.7
$ 26.50
$ 45.05
$ 20.0000
$ 540.60
$ 240.00
1.75
$ 26.00
$ 45.50
$ 17.50
$ 20.50
$ 546.00
$ 210.00
$ 246.00
1.8
$ 25.50
$ 45.90
$ 21.00
$ 550.80
$ 252.00
1.85
$ 46.25
$ 21.50
$ 555.00
$ 258.00
1.9
$ 24.50
$ 46.55
$ 22.0000
$ 24.55
$ 558.60
$ 264.00
$ 294.60
1.95
$ 24.00
$ 46.80
$ 22.50
$ 24.30
$ 561.60
$
270.00
$ 291.60
2
$ 23.50
$ 47.00
$ 23.00
$ 564.00
$ 276.00
$ 288.00
2.05
$ 47.15
$ 23.5000
$ 23.65
$ 565.80
$ 282.00
$ 283.80
2.1
$ 47.25
$ 24.0000
$ 23.25
$ 567.00
$ 279.00
2.15
$ 47.30
$ 24.5000
$ 22.80
$ 567.60
$ 294.00
$ 273.60
2.2
$ 25.0000
$ 22.30
$ 267.60
2.25
$ 25.5000
$ 21.75
$ 270.00
$ 306.00
$ 261.00
$ 44.13
$ 20.66
$ 23.48
Question 2
The Company currently operates by selling 9 Million
Standard Boxes
Question 1
37.5
Standard Boxes Deluxe Boxes Total
Number Of Boxes (in
Millions
1,5
Volume per year ( millions)
126
$ (in millions)
Revenue $ 2,030.40 $ 513.00
$ 2,543.40
Less:
Variable Costs
$180
Marginal
Contribution
$ 950.40
$ 333.00
$ 1,283.40
Less:
Fixed Costs
$ 156.00
Profit
$ 830.40
$ 1,127.40
Profit
%
40.90%
57.89%
44.33%
Sheet2
Question 1
A new intern at the company believes that fixed cost based and allocated on a daily basis is incorrect and suggests allocating the Fixed Costs between Standard and Deluxe Boxes Based on the number of boxes sold. How much costs are allocated to each product based on the method suggested by the intern? To prove s/he point the intern also calculated the profit percentage. Complete the grey spaces
Standard Boxes Deluxe Boxes Total
Volumes (per Month)
Volumes per year ( millions)
Total Fixed Costs (Millions- from Tab1)
133.71
22.29
New Profit
Sales
Less VC
Contribution Margin
Less Fixed Costs
$ 133.71
$ 22.29
Operting Profit
$ 816.69
$ 310.71
Profit %
40.22%
11.81%
Sheet3
Question 1
LGI’s production managers recently attended a course at UMGC where they learned about ABC costing. They propose allocating the total fixed costs between Standard and Deluxe boxes based on this method . They collected information about the cost drivers and the break up of the total costs in
Table 1
Table 1
Manufacturing overhead
$ Amount
Cost driver
Standard Box
Deluxe Box
Totals
Cost of
Deluxe Boxes
Cost of Standard Boxes
Total Cost Check (must agree to Column B7:B14)
Depreciation
$47.00
Square feet
7,000
80,000
87,000
$ 43.22
$ 3.78
Maintenance
$50.00
Direct
Labour Hours
1,000
9,000
10,000
$ 45.00
$ 5.00
Purchase order processing
$9
Number of purchases orders
4,500
5,000
$ 8.10
$ 0.90
$ 9.00
Inspection
$34
Number of employees
6000
$ 29.14
$ 4.86
$ 34.00
Indirect Materials
$5.00
1,000.00
9,000.00
10,000.00
$ 4.50
$ 0.50
Supervision
$7.00
#of inspections
1000
$ 5.60
$ 1.40
$ 7.00
Supplies
$4.00
Units manufactured
$ 139.16
$ 16.84
$ 4.00
Total Allocated costs
$15
N/A
$
108.00
Number of boxes per year
$
126.00
Allocated Cost per Box
$ 7.73
$ 0.16
Deluxe Boxes Deluxe Boxes Total
Sales
Less: Variable Costs $ 1,080.00 $180
Contribution $ 950.40 $ 90.00
Less: Fixed Costs $ 16.84 $ 139.16
Profit
$ 933.56
$ 193.84
Profit % 40.22%
37.79%
Sheet4
Question 1
The sustainability manager is concerned about the long term sustainability implications of Deluxe boxes on the environment and suggest changing to sustainable materials for the production of a
Sustainable Deluxe
If the company switches to their current quantity of Deluxe Boxes sold to Sustainable Deluxe Boxes there will be some cost implications.
The Sustainable Deluxe Boxes could be made cheaper, and the sustianability manager believes that the company could bring down the selling price to $15 per box which would entice current Deluxe Box customers to accept the switch over. The new Sustainable Deluxe Boxes will attract 60% of total fixed costs calculated for the Deluxe Boxes under the ABC method. The number of boxes sold will not be affected by this new selling price, as the company will in future have to do marketing to sell more boxes at the lower price. Calculate the new Gross profit and profit percentage. Complete the grey spaces
Standard Boxes Sustainable Deluxe Total
Quantity 108.00 18.00 126.00
Sellin price per unit
$ 33.80
Sales $ 2,030.40 270.00
$ 2,300.40
VC $ 1,080.00 $180 20.00
Contribution $ 950.40 $ 90.00
$ 1,040.40
Fixed Costs $ 16.84 $ 139.16 $ 156.00
Profit $ 933.56
83.50
$ 1,017.06
GP %
18.21%
33.00%
The manager is concerned about the massive reduction in profit from the Sustainable Deluxe Boxes but realizes that because of the change in materials, they will no longer be able to charge the price of $18 per box. The manager wants to achieve at least the same profit percentage for the deluxe boxes as they have on standard boxes. How much additional profit are they requiring? Complete the grey spaces.
Required profit
See Tab 3
Less: Existing profit
83.50%
See Q 1 above
Equals: Difference in additional profit required
-43.28%
Question 3
Work out the percentage that they should mark up on the costs to achieve the same profit % as for the standard boxes. Complete the grey spaces
%
Sales $ 2,030.40
Less Required GP%
Equals: Mark up percentage on cost
$ 2,030.22
Question 4
Use the percentage calculated in Question 3 to determine how much the company should charge per product to reach the same profit percentage as for the standard boxes . Assume the company can still sell the same quantity of the Sustainable Deluxe Boxes as for the Deluxe Boxes. Complete the grey spaces
Totals
Variable Costs $ 180.00
Fixed Cost
$ 83.50
Total Costs
$ 263.50
Sales
$ 487.77
Units sold
Sales Price per unit
$ 27.10
Question 5
Prove that your calculation in Q 4 is correct. Complete the grey boxes.
Proof:
Per Unit
Sales $ 270.00 $ 27.10
Less VC $ 180.00 12
Contribution $ 90.00
Fixed Costs $ 139.16
Net Profit
Profit % 33.00%
Question 5
The marketing manger is concerned that the change could havea significant impact on sales as ciustomers may see the sustaiable boxes as an inferiror product for which they still have to pay only a little bit less than the orginal price of the Deluxe Boxes. How many boxes would the company have to sell to break even on the new Sustainabale Deluxe Boxes based on the new selling price? Complete the grey boxes.
$ Totals
Selling price
Less: Variable costs
Breakeven Quantity
– 0.73
BreakEven Value
$ 8.89
1
In this Project you will analyse managerial and costing information to improve the company’s EBITDA. You will use what you have learned about cost behavior and apply activity-based costing and cost-volume-profit analysis to make recommendations about LGI’s operational productivity. Use Information you calculated in project 2 Tab 3
Profit
12
1
10
Question 1
Profit Maximization
Standard Boxes
Quantity
Price
Revenue
VC
FC / per month (millions)
Total
Daily profit (revenue -all costs)
Annual Revenue (millions)
Annual VC (millions)
Annual FC (millions)
Annual
Total Costs
Annual Profit
5
$ 22.00
$
11
$ 10.00
$ 50.00
$ 3.00
$ 53.00
$ 5
7
$ 1,3
20.00
$
6
$ 36.00
$ 636.00
$ 6
8
5.5
$ 2
1.6
$ 1
18
$ 55.00
$ 58.00
$ 60.80
$ 1,425.60
$ 660.00
$ 6
9
$ 729.60
6
$ 2
1.2
$ 127.20
$ 60.00
$ 63.00
$ 64.20
$ 1,526.40
$ 720.00
$ 756.00
$ 770.40
6.5
$ 20.80
$
13
$ 65.00
$ 68.00
$ 67.20
$ 1,622.40
$ 780.00
$ 816.00
$ 806.40
7
$ 20.40
$
14
$ 70.00
$ 73.00
$ 69.80
$ 1,713.60
$ 840.00
$ 876.00
$ 837.60
7.5
$ 20.00
$
15
$ 75.00
$ 78.00
$ 72.00
$ 1,
800
$ 900.00
$ 936.00
$ 864.00
8
$ 19.60
$ 156.80
$ 80.00
$ 83.00
$ 73.80
$ 1,881.60
$ 960.00
$ 996.00
$ 885.60
8.5
$ 19.20
$ 163.20
$ 85.00
$ 88.00
$ 75.20
$ 1,958.40
$ 1,020.00
$ 1,056.00
$ 902.40
9
$ 18.80
$ 169.20
$ 90.00
$ 93.00
$ 76.20
$ 2,030.40
$ 1,080.00
$ 1,116.00
$ 914.40
9.5
$ 18.40
$ 174.80
$ 95.00
$ 98.00
$ 76.80
$ 2,097.60
$ 1,140.00
$ 1,176.00
$ 921.60
10
$
18.00
$ 180.00
$ 100.00
$ 103.00
$ 77.00
$ 2,160.00
$ 1,
200
$ 1,236.00
$ 924.00
10.5
$ 17.60
$ 184.80
$ 105.00
$
108
$ 2,217.60
$ 1,260.00
$ 1,296.00
11
$ 17.20
$ 189.20
$ 110.00
$ 113.00
$ 2,270.40
$ 1,356.00
1
1.5
$ 16.80
$ 193.20
$ 115.00
$ 118.00
$ 2,318.40
$ 1,380.00
$ 1,416.00
12
$ 16.40
$ 196.80
$ 120.00
$ 123.00
$ 2,361.60
$ 1,440.00
$ 1,476.00
12.5
$ 16.00
$ 200.00
$ 125.00
$ 128.00
$ 2,400.00
$ 1,
500
$ 1,536.00
13
$ 15.60
$ 202.80
$ 130.00
$ 133.00
$ 2,433.60
$ 1,560.00
$ 1,596.00
13.5
$ 15.20
$ 205.20
$ 135.00
$ 138.00
$ 2,462.40
$ 1,620.00
$ 1,656.00
14
$ 14.80
$ 207.20
$ 140.00
$ 143.00
$ 2,486.40
$ 1,680.00
$ 1,716.00
$ 168.80
$ 70.80
$ 2,025.60
Profit Maximization
Deluxe Boxes
Deluxe boxes sold per month (millions)
Revenue (price x volume)
Variable Cost per standard box
Variable Cost (cost per unit x volume)
Fixed cost per month (millions)
Total Cost (Fixed + Variable)
Daily Profit (revenue – all costs)
Annual Profit (millions)
1
$ 30.00
$ 13.0000
$ 17.00
$ 360.00
$
156.00
$ 204.00
1.2
$ 29.50
$ 35.40
$ 12.00
$ 15.00
$ 424.80
$ 144.00
$ 244.80
1.35
$ 29.00
$ 39.15
$ 13.50
$ 16.50
$ 22.65
$ 469.80
$ 162.00
$ 198.00
$ 27
1.8
1.5
$ 28.50
$ 42.75
$ 18.0000
$ 24.75
$ 513.00
$ 216.00
$ 297.00
1.55
$ 28.00
$ 43.40
$ 15.50
$ 18.50
$ 24.90
$ 520.80
$ 186.00
$ 222.00
$ 298.80
1.6
$ 27.50
$ 44.00
$ 19.00
$ 25.00
$ 528.00
$ 192.00
$ 228.00
$ 300.00
1.65
$ 27.00
$ 44.55
$ 19.50
$ 25.05
$ 534.60
$ 234.00
$ 300.60
1.7
$ 26.50
$ 45.05
$ 20.0000
$ 540.60
$ 240.00
1.75
$ 26.00
$ 45.50
$ 17.50
$ 20.50
$ 546.00
$ 210.00
$ 246.00
1.8
$ 25.50
$ 45.90
$ 21.00
$ 550.80
$ 252.00
1.85
$ 46.25
$ 21.50
$ 555.00
$ 258.00
1.9
$ 24.50
$ 46.55
$ 22.0000
$ 24.55
$ 558.60
$ 264.00
$ 294.60
1.95
$ 24.00
$ 46.80
$ 22.50
$ 24.30
$ 561.60
$
270.00
$ 291.60
2
$ 23.50
$ 47.00
$ 23.00
$ 564.00
$ 276.00
$ 288.00
2.05
$ 47.15
$ 23.5000
$ 23.65
$ 565.80
$ 282.00
$ 283.80
2.1
$ 47.25
$ 24.0000
$ 23.25
$ 567.00
$ 279.00
2.15
$ 47.30
$ 24.5000
$ 22.80
$ 567.60
$ 294.00
$ 273.60
2.2
$ 25.0000
$ 22.30
$ 267.60
2.25
$ 25.5000
$ 21.75
$ 270.00
$ 306.00
$ 261.00
$ 44.13
$ 20.66
$ 23.48
Question 2
The Company currently operates by selling 9 Million
Standard Boxes
Question 1
37.5
Standard Boxes Deluxe Boxes Total
Number Of Boxes (in
Millions
1,5
Volume per year ( millions)
126
$ (in millions)
Revenue $ 2,030.40 $ 513.00
$ 2,543.40
Less:
Variable Costs
$180
Marginal
Contribution
$ 950.40
$ 333.00
$ 1,283.40
Less:
Fixed Costs
$ 156.00
Profit
$ 830.40
$ 1,127.40
Profit
%
40.90%
57.89%
44.33%
Sheet2
Question 1
A new intern at the company believes that fixed cost based and allocated on a daily basis is incorrect and suggests allocating the Fixed Costs between Standard and Deluxe Boxes Based on the number of boxes sold. How much costs are allocated to each product based on the method suggested by the intern? To prove s/he point the intern also calculated the profit percentage. Complete the grey spaces
Standard Boxes Deluxe Boxes Total
Volumes (per Month)
Volumes per year ( millions)
Total Fixed Costs (Millions- from Tab1)
133.71
22.29
New Profit
Sales
Less VC
Contribution Margin
Less Fixed Costs
$ 133.71
$ 22.29
Operting Profit
$ 816.69
$ 310.71
Profit %
40.22%
11.81%
Sheet3
Question 1
LGI’s production managers recently attended a course at UMGC where they learned about ABC costing. They propose allocating the total fixed costs between Standard and Deluxe boxes based on this method . They collected information about the cost drivers and the break up of the total costs in
Table 1
Table 1
Manufacturing overhead
$ Amount
Cost driver
Standard Box
Deluxe Box
Totals
Cost of
Deluxe Boxes
Cost of Standard Boxes
Total Cost Check (must agree to Column B7:B14)
Depreciation
$47.00
Square feet
7,000
80,000
87,000
$ 43.22
$ 3.78
Maintenance
$50.00
Direct
Labour Hours
1,000
9,000
10,000
$ 45.00
$ 5.00
Purchase order processing
$9
Number of purchases orders
4,500
5,000
$ 8.10
$ 0.90
$ 9.00
Inspection
$34
Number of employees
6000
$ 29.14
$ 4.86
$ 34.00
Indirect Materials
$5.00
1,000.00
9,000.00
10,000.00
$ 4.50
$ 0.50
Supervision
$7.00
#of inspections
1000
$ 5.60
$ 1.40
$ 7.00
Supplies
$4.00
Units manufactured
$ 139.16
$ 16.84
$ 4.00
Total Allocated costs
$15
N/A
$
108.00
Number of boxes per year
$
126.00
Allocated Cost per Box
$ 7.73
$ 0.16
Deluxe Boxes Deluxe Boxes Total
Sales
Less: Variable Costs $ 1,080.00 $180
Contribution $ 950.40 $ 90.00
Less: Fixed Costs $ 16.84 $ 139.16
Profit
$ 933.56
$ 193.84
Profit % 40.22%
37.79%
Sheet4
Question 1
The sustainability manager is concerned about the long term sustainability implications of Deluxe boxes on the environment and suggest changing to sustainable materials for the production of a
Sustainable Deluxe
If the company switches to their current quantity of Deluxe Boxes sold to Sustainable Deluxe Boxes there will be some cost implications.
The Sustainable Deluxe Boxes could be made cheaper, and the sustianability manager believes that the company could bring down the selling price to $15 per box which would entice current Deluxe Box customers to accept the switch over. The new Sustainable Deluxe Boxes will attract 60% of total fixed costs calculated for the Deluxe Boxes under the ABC method. The number of boxes sold will not be affected by this new selling price, as the company will in future have to do marketing to sell more boxes at the lower price. Calculate the new Gross profit and profit percentage. Complete the grey spaces
Standard Boxes Sustainable Deluxe Total
Quantity 108.00 18.00 126.00
Sellin price per unit
$ 33.80
Sales $ 2,030.40 270.00
$ 2,300.40
VC $ 1,080.00 $180 20.00
Contribution $ 950.40 $ 90.00
$ 1,040.40
Fixed Costs $ 16.84 $ 139.16 $ 156.00
Profit $ 933.56
83.50
$ 1,017.06
GP %
18.21%
33.00%
The manager is concerned about the massive reduction in profit from the Sustainable Deluxe Boxes but realizes that because of the change in materials, they will no longer be able to charge the price of $18 per box. The manager wants to achieve at least the same profit percentage for the deluxe boxes as they have on standard boxes. How much additional profit are they requiring? Complete the grey spaces.
Required profit
See Tab 3
Less: Existing profit
83.50%
See Q 1 above
Equals: Difference in additional profit required
-43.28%
Question 3
Work out the percentage that they should mark up on the costs to achieve the same profit % as for the standard boxes. Complete the grey spaces
%
Sales $ 2,030.40
Less Required GP%
Equals: Mark up percentage on cost
$ 2,030.22
Question 4
Use the percentage calculated in Question 3 to determine how much the company should charge per product to reach the same profit percentage as for the standard boxes . Assume the company can still sell the same quantity of the Sustainable Deluxe Boxes as for the Deluxe Boxes. Complete the grey spaces
Totals
Variable Costs $ 180.00
Fixed Cost
$ 83.50
Total Costs
$ 263.50
Sales
$ 487.77
Units sold
Sales Price per unit
$ 27.10
Question 5
Prove that your calculation in Q 4 is correct. Complete the grey boxes.
Proof:
Per Unit
Sales $ 270.00 $ 27.10
Less VC $ 180.00 12
Contribution $ 90.00
Fixed Costs $ 139.16
Net Profit
Profit % 33.00%
Question 5
The marketing manger is concerned that the change could havea significant impact on sales as ciustomers may see the sustaiable boxes as an inferiror product for which they still have to pay only a little bit less than the orginal price of the Deluxe Boxes. How many boxes would the company have to sell to break even on the new Sustainabale Deluxe Boxes based on the new selling price? Complete the grey boxes.
$ Totals
Selling price
Less: Variable costs
Breakeven Quantity
– 0.73
BreakEven Value
$ 8.89
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