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ACC 2002

Week 3 Discussion Questions

Chandralekha Thanabalan (A0126124U)


Jia Yan (A0130618M)
Tay Woon Min (A0126898J)
Jolyn Ng (A0131113E)
Problem 7-38
Boundaries
Downtown
Store Mall Store Total
$600,00
Sales $240,000 $360,000 0
$(252,000 $(348,00
Less: Variable Costs $(96,000) ) 0)
Contribution $108,00 $252,00
Margin(CM) $144,000 0 0
$(120,000$(180,00
Close Mall Store
Important Information:
1. Close Mall Store10% decrease in Downtown Stores sales
Close Downtown Store No effect on Mall Stores sales
2. of each stores fixed costs would continue through 31 Dec
20X5, if either stores are closed.(Even if either of the stores are
closed, only of its respective fixed costs can be saved; it
cannot be entirely eliminated with its closing.)
3. The operating results of Nov 20x4 is representative of all
1. If Mall Store is closed,

(108,00
Decrease in Mall Store's CM 0)

Decrease in Downtown Store's CM


[10%*144,000] (14,400)
Decrease in Mall Store's fixed costs
[*120,000] 90,000
Total increase/(decrease) in (32,400
Operating Income )
1. If Mall Store is closed,
Downtown
Store Mall Store Total
Contribution $252,00
$129,600 1
$0 $129,6
Margin(CM) $144,0002 $108,000 0
$(90,000) $0 00
$(90,00
$(120,000 $(180,00
Less: Fixed Costs $(60,000)
$39,600 $0
) 0)
0)
$39,60
1
: 144,000-(10%*144,000) $(12,000
Original Operating 0
Operating
=129,600Income $84,000Income-New) $72,000
Operating
2
Income
: 60,000+( *120,000)
= $72,000-$39,600
=90,000
= $32,400 decrease
New Promotional Campaign at Mall
Store
Important Information:
1. It would not affect Downtown Store at all.
2. Annual promotional expenses increased by $180,000.
3. Mall Store sales increase by 10%.
2. New Promotional Campaign at Mall
Store

Increase in monthly promotional


expenses
[180,000/12] (15,000)
Increase in Mall Store's CM
[10%*108,000] 10,800
Total increase/(decrease) in
Operating Income (4,200)
2. New Promotional Campaign at Mall
Store
Downtown
Store Mall Store Total
Contribution
$118,800 $262,80
Margin(CM) $144,000 $108,000 $252,000
1
$(135,00 0
$(195,00
$(120,000
2
$(180,000
Less: Fixed Costs $(60,000) 0))
$(16,200 0)
$67,800
)
1
: )
$(12,000
Operating Income
108,000+(10%*108,000) Original
$84,000 Operating
) $72,000
=118,800 Income-New Operating
Income
2
: 120,000+(180,000/12) = $72,000-$67,800
Deletion of some items at
Mall Store

Important Information:
1. One half of dollar-sales items(which are sold at Variable costs;
CM=0) are to be deleted.
2. Reduce fixed expenses by 15%
3. 20% decrease in sales volume
4. This change would not affect Downtown Store.
3. Deletion of some items at Mall
Store

Decrease in Mall Store's CM


[20%*108,000] (21,600)
Decrease in Mall Store's Fixed costs
[15%*120,000] 18,000
Total increase/(decrease) in
Operating Income (3.600)
3. Deletion of some items at Mall
Store
Downtown
Store Mall Store Total
Contribution
$86,400 1 $230,40
Margin(CM) $144,000 $108,000 $252,000
$(102,00 0
$(162,00
$(120,000 $(180,000
Less: Fixed Costs $(60,000) 0)) 2
$(15,600 0)
$68,400
)
1
: 108,000-(20%*108,000) )
$(12,000
Operating
=86,400 Income $84,000Original Operating
) $72,000
Income-New
2
: 120,000-(15%*120,000) Operating Income
=102,000 = $72,000-$68,400
4. Downtown Stores
Sales=$235,000 and Variable
Expenses=$90,000
1. If Mall Store is closed, total decrease in
Operating Income=$32,500
2. Promotional campaign at Mall Store, total
decrease in Operating Income=$4,200
3. Deletion of some items at Mall Store, total
decrease in Operating Income=$3,600
Problem 7-44
Launching a new product
2 possible methods:
Labour-Intensive Computer- Assisted
Production System Manufacturing System

Direct Materials $8.40 $7.50


Direct Labour .8DLH @ 10.80 .5DLH @ 9.00
$13.50 $18.00
Variable Overhead .8DLH @ $9.00 7.20 .5DLH @ $9.00 4.50
Fixed Overhead $1,980,000 $3,660,000
*These costs are directly traceable to the new product line.

Unit sale price: $45


Selling expense: $750,000 (fixed), $3 (Unit variable)
1. Calculate the BEP of the new
product for each method
(a) Labor-intensive production system:

Unit variable cost = $8.4 + $10.8 + $7.2


+ $3
= $29.4

Fixed cost = $1,980,000+ $750,000


= $2,730,000

Break-even point in annual unit sales Q:


45Q = $2,730,000 + $29.4Q
Q = 175,000 units
1. Continued
(b) Computer-assisted manufacturing
system:

Unit variable cost = $7.5 + $9 + $4.5 +


$3
= $24

Fixed cost = $3,660,000+ $750,000


= $4,410,000

Break-even point in annual unit sales Q:


45Q = $4,410,000 + $24Q
Q = 210,000 units
2. Determine the annual unit sales volume at which the
firm would be indifferent between the two
manufacturing methods.

Being indifferent between the two manufacturing


methods implies that both methods yield the same
profit at that particular annual unit sales volume.
Unit price is the same for both manufacturing
methods, hence consider cost factor only.
2. Continued
Considering cost factor:
Labor-intensive production system:
Computer-assisted
Unit variable cost = $29.4 manufacturing system:
Fixed cost = $2,730,000 Unit variable cost = $24
Fixed cost = $4,410,000

Let the annual unit sales volume be denoted by Q:


29.4Q + 2,730,000 = 24Q + 4,410,000
Q = 311,111 units
3. Management must decide which manufacturing method to employ. One
factor it should consider is operating leverage. Explain the concept of
operating leverage. How is this concept related to Zodiac's decision?

A measure, at any given level of sales, of how a


percentage change in sales volume will affect profits.

Degree of operating leverage =

Given an increase in sales volume, a higher operating


leverage will cause profit to increase more drastically.
3. Continued
Based on this concept, Zodiac should opt for the production
method with a higher operating leverage.

To have a larger operating leverage, a particular production


method should have a lower variable cost and a higher fixed
cost at any given level of sales.

Hence, if we use operating leverage as the criterion for


decision making, Zodiac should choose computer-assisted
manufacturing system.
4. Describe the circumstances under which the firm
should employ each of the two manufacturing methods.
Cost

Sales
Volume
Graphs of cost functions of the two types of
manufacturing methods
labor-intensive
4. Continued

Point of intersection is the indifference point.

If sales volume is expected to be less than 311,111 units,


choose labor-intensive production system as a lower cost will
be incurred.

If sales volume is expected to be more than 311,111 units,


choose computer-assisted manufacturing system to save cost
and to earn a higher profit.
4. Continued

However, there might be some limitations to this method


because it is difficult for companies to gauge accurately what
sales volume a new product will generate.

Therefore, companies should also consider other business


factors.
5. Identify some business factors other than operating
leverage that management should consider before
selecting the manufacturing method.

Other possible business factors to consider:

Type of product: customized vs. homogeneous/standardized


Risk profile: ability to take risks
Capital / Willingness to take loan: to finance the automated
system
Ability to train and re-train staff and workers
Methods employed by competitors in the industry
Problem 7-46
Saturn Game Company manufactures computer games.
1
Last year Saturn sold 40,000 games at $55 each. Total
costs amounted to $1,150,000 of which $350,000 2
3
were considered fixed.
In an attempt to improve its product, the company is
considering replacing a component part that has a
cost of $6 with a new and better part costing $12
4
per unit in the coming year. A new machine would also
be needed to increase plant capacity. The machine
would cost $51,000 with a useful life of six years
and no salvage value. The company uses straight-line
depreciation on all plant assets. (Ignore income taxes.)
1. What was Saturn Game Companys break-even point in
number of units last year?

Unit contribution margin Sales Price - Unit Variable cost


Total costs
$1,115,000 - $350,000 amounted to
$55 - $1,150,000 of
40,000 units which $350,000
were considered
$35 per unit fixed

Fixed costs
Break - even point (in units)
Unit contribution margin
$350,000

$35
10,000 units
2. How many units of product would the company
have had to sell in the last year to earn $210,000?

fixed costs target net profit


Number of sales units required

to earn target net profit unit contribution margin
$350,000 $210,000

$35
16,000 units
3. If management holds the sales price constant and
makes the suggested changes, how many units of
product must be sold in the coming year to break even?

New Unit contribution margin Sales Price - New Unit Variable cost replacing a
$1,115,000 - $350,000 component
$55 - part that has
40,000 units -6 a cost of $6
with a new
$29 per unit and better
part costing
new fixed costs $12 per unit
New break - even point (in units)
new unit contribution margin
New machine
$350,000 ($510,000/6) would cost
$51,000 with a
$29 useful life of six
years and no
15,000 units salvage value

P7-46
4. If the firm holds the sales price constant and makes the suggested
changes, how many units of product will the company have to sell to make
the same net income as last year?

Last years net = Sales- TotalCost


income = 40,000
units$55- $1,115,000
= $1,050,000

Number of sales newfixedcosts+targetnetprofit


= New
units required newunitcontributi
onmargin Machine

$1,050,000
+$350,000
+$510,000/6
=
$29
= 51,207
units(nearest
wholenumber)
5. If Saturn Game Company wishes to maintain the same contribution-margin
ratio, what selling price per unit of product must it charge next year to cover
the increased direct-material cost?

$35
Old contribution - margin ratio
$55
7

11
5. Continued
Let P denote the price required to cover increased
direct-material cost and maintain the same
contribution margin ratio:
P - $20- 6 7
=
P 11
11P - 286=7P
P =$71.5
Problem 7-47
Refer to the original data given for Saturn Game Company
in the preceding problem. An activity-based costing study
has revealed that Saturns $300,000 of fixed costs include
the following components:
Setup (40 setups at $800 per setup) $32,000
Engineering (500 hours at $50 per hour) $25,000
Inspection (1,000 inspections at $60 per $60,000
inspection)
General factory overhead $123,000
Total $240,000
Fixed Selling and administrative costs $60,000
Total fixed cost $300,000
New Proposed Approach 1

Under the proposed JIT approach, there would be 300 setups per
year at $100 per setup. Since a total quality control program would
accompany the move toward JIT, only 100 inspections would be
anticipated annually, at a cost of $90 each. After the installation
2
3
of the new production system, 800 hours of engineering would
4
be required at a cost of $56 per hour. General factory
overhead would increase to $332,200.
5
However, the automated equipment would allow Saturn to cut its
unit variable cost by 20 percent. Moreover, the more consistent
product quality anticipated would allow management to raise the
6
price of computer games to $52 per unit. (Ignore income taxes.)
1. I thought you told me this $300,000
cost was fixed. These dont look like fixed
costs at all. What youre telling me now
is that setup costs us $800 every time we
set up a production run. What gives? As
Saturns controller, write a short memo
explaining to the vice president what is
going on.
The $300,000 cost that has been characterized as fixed
is fixed with respect to sales volume. This cost will not
increase with increases in sales volume.
It is recognized in ABC that costs vary with respect to a
variety of cost drivers, not just sales volume, as activity-
based costing analysis demonstrates, these costs are not
fixed with respect to other important cost drivers.
2. Compute Saturns new break-even point if the
proposed automated equipment is installed.
raise the price
Sales price $52 of computer
games to $52
Costs that are variable (with respect to sales volume):
per unit
Unit variable cost (0.8 $30) $24
cut its unit variable
cost by 20 percent.
Unit contribution margin $28

Costs that are fixed (with respect to sales volume):


Setup (300 setups at $100 per setup) $ 30,000
Inspection (100 inspections at $90 per inspection) 9,000
Engineering (800 hours at $56 per hour) 44,800
General factory overhead332,200
Total $416,000
Fixed selling and administrative costs 60,000
Total costs that are fixed (with respect to sales volume) $476,000

2. Continued
fixed costs
Break - even point (in units)
unit contribution margin
$476,000

$28
17,000 units
3. Determine how many units Saturn will have to sell to
show a profit of $280,000, assuming the new
technology is adopted.

Number of sales units fixed costs target net profit



required unit contribution margin
to earn target net profit
$476,000 $280,000

$28
27,000 units
4. If Saturn adopts the new manufacturing technology,
will its break-even point be higher or lower?

(Theoretically)
If management adopts the new manufacturing technology:
Its break-even point will be higher
The number of sales units required to show the same amount of profit
will be lower

These results are typical situations where firms adopt advanced


manufacturing equipment and practices. The break-even point
increases because of the increased fixed costs due to the large
investment in equipment.

However, at higher levels of sales after fixed costs have been covered,
the larger unit contribution margin earns a profit at a faster rate. This
5. In order to support the proposed acquisition, the vice president for manufacturing asked the controller to prepare a report on the financial implications
of the decision. As part of the report, the vice president asked the controller to compute the new break-even point, assuming the installation of the
equipment. The controller complied, as in requirement (2) of this problem.
When the vice president for manufacturing saw that the break-even point would increase, he asked the controller to delete the break-even analysis from
the report.
What should the controller do? Which ethical standards for managerial accountants are involved here?
5. Continued

The controller should include the break-even analysis in


the report.
The Board of Directors need the break-even point
for a complete picture of the financial
implications of the proposed equipment
acquisition.
The controller should accompany the break-even
analysis with an explanation as to why the
break-even point will increase.
The controller should also point out in the report
that the advanced manufacturing equipment would
require fewer sales units at higher volumes in
5. Continued

To withhold the break-even analysis from the controller's


report would be a violation of the following ethical
standards:
Competence: Provide decision support information
and recommendations that are accurate, clear,
concise, and timely.

Integrity: Refrain from engaging in any conduct that


would prejudice carrying out duties ethically.

Credibility: Communicate information fairly and


objectively. Disclose all relevant information that could
reasonably be expected to influence an intended
Problem 7-55
Year ended Dec 31, 20X4
Agent Commission: 20% of Sales

*Assuming COGS is 100% Variable cost


1. Based on the budgeted Income
Statement, determine BEP
Contribution Margin : $3,000,000

CM Ratio : CM / Sales Volume


= 3,000,000 / 15,000,000 = 0.2

Break-even point : Total fixed cost / CM Ratio


= $150,000 / 0.2
= $750,000
Possibility of employing full time
personnel
3 sales personnel
Fixed annual salary of $45,000 each
Combined annual variable salary of 5% of sales volume
2 sales manager
Fixed annual salary of $120,000 each
All other cost remains the same
New variable selling cost 0.05 x Sales Volume = 0.05 x
$15,000,000 = $750,000
New fixed selling cost 3 x $45,000 + 2 x $120,000 +
$150,000 = $525,000
Year ended Dec 31, 20X4
Own Sales Personnel

*Assuming COGS is 100% Variable cost


2. Based on hiring own employees,
determine BEP
Contribution Margin : $5,250,000

CM Ratio : CM / Sales Volume


= 5,250,000 / 15,000,000 = 0.35

Break-even point : Total fixed cost / CM Ratio


= 525,000 / 0.35
= $1,500,000
Year ended Dec 31, 20X4
Requested Agent Commission: 25%
of Sales

*Assuming COGS is 100% Variable cost


3. Agreeing to their demand of 25% sales commission, compute
the estimated volume in sales dollar that will yield the same
net income as projected in the budgeted income statement.

Contribution Margin : $2,250,000

CM Ratio : CM / Sales Volume


= 2,250,000 / 15,000,000 = 0.15

Target Profit (Income before tax): $2,850,000

Volume Required : (Total Fixed cost + Target profit) / CM Ratio


= (150,000 + 2,850,000 ) / 0.15
4. Compute the estimated volume in sales dollars that would generate an identical net
income for the year ending December 31, 20x4, regardless of whether they employ its own
sales personnel or continues to use the independent sales agents and pays them a 25
percent commission.

Let X be the estimated volume in sales dollar


0.35X 525,000 = 0.15X 150,000
0.2X = 375,000
X = $1,875,000

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