Management Decision-Making (Cambridge (CIE) A Level Accounting): Revision Note

Company A manufactures Product X and the following budgeted information is available.

Company A is aware there is an external supplier that can provide 13 000 units of Product X a month, resulting in a contribution of $30 per unit.

Advise Company A on whether they should continue manufacturing Product X internally or purchase from the external supplier.

Answer:

Contribution per unit of producing internally:

Contribution = Selling price - Direct materials - Direct labour

$100 - $30 - (5 × $10) = $20 per unit

This shows that purchasing from the external supplier would give a greater contribution; $30 per unit compared to $20 per unit.

Purchasing from the external supplier is better than producing Product X internally.

However, Company A must also make note that the external supplier can only supply 13 000 units each month, which is 1 000 units less than the monthly sales, meaning 1 000 units of sales will be lost each month.

Z Limited manufactures product Q and the following data is available.

The directors are considering accepting a special order from a customer. The order is for 500 units and there are slight changes to the product design which will add $2.50 per unit to variable costs. The customer has offered to pay $30 per unit.

Advise the directors whether or not they should accept the special order from the customer.

Answer:

Original variable cost per unit:

Selling price per unit - Contribution per unit

$35 - $20 = $15 per unit

New variable cost per unit:

$15 + $2.50 = $17.50 per unit

Contribution per unit from special order:

$30 - $17.50 = $12.50 per unit

The directors should accept the special order. Although the contribution is less than normal orders ($12.50 per unit compared to $15 per unit), the special order still provides positive contribution. Fixed costs remain unchanged and the special order contributes to covering fixed costs. The factory is currently producing 1 400 units (2 000 × 70%) and is able to accept the 500 unit special order which will prevent redundancies.

The directors must ensure the special order is kept separate from regular orders and that regular orders are met comfortably and prioritised.

A factory manufactures Product C and D. There is a forecasted loss of Product D.

The directors are considering discontinuing Product D.

Discontinuing D would result in redundancy costs of $2 000 (because the supervisor for Product D would no longer be required) but is expected to increase the sales revenue of Product C by 20%.

Advise the directors on whether they should discontinue Product D or not.

Answer:

Find the profit/loss for both products

Current net profit:

$1 500 - $400 = $1 100

Product C new sale revenue

$10 000 × 20% = $2 000

$10 000 + $2 000 = $12 000

Product C new profit:

$1 500 + $2 000 = $3 500

Redundancy cost incurred $2 000

New net profit

$3 500 - $2 000 = $1 500

The directors should discontinue product D. The net profit increases by $400 if product D is discontinued. However, directors must consider how reliable the forecast that sales revenue will increase by 20% is. They also must consider how staff redundancy will impact staff morale and motivation. Existing customers may also be made unhappy by the discontinuation of product D and may be lost to competitors.

G Limited manufactures the following products and the following data is available.

Only 40 000kg of materials are available in the month of February.

Calculate the optimum production plan to maximise profit.

Answer:

Calculate the contribution per unit per kg

Use the resources in the following order:

• Priority 1: Product H

• Priority 2: Product G

• Priority 3: Product F

Product H

2 500 units × 7kg = 17 500kg

Product G

40 000kg - 17 500kg = 22 500kg

5 000 units × 4kg = 20 000kg

Product F

22 500kg - 20 000kg = 2 500kg

2 500kg ÷ 10kg = 250 units

The optimum production plan is:

Company Z manufactures a single product and the following data is available for a month.

The directors require a target profit of $75 000 next month.

Calculate the sale revenue required to achieve the target profit.

Answer:

Calculation the contribution

Contribution = Sales revenue - Variable costs

$500 000 - $150 000 = $350 000

Calculate the contribution to sales revenue

Contribution to sales ratio = Contribution ÷ Sales revenue

$350 000 ÷ $500 000 = 0.70

Use the formula

Sales revenue required to achieve target profit = (Fixed costs + Target profit) ÷ Contribution to sales ratio

($50 000 + $75 000) ÷ 0.70 = $178 571.4286

Sales revenue required is $178 572