In: Accounting
Table MA.1
Current product data
Volume (000 bottles) Selling price per bottle £ Direct costs per
bottle £ Distribution cost per bottle £ Bottles per machine hour
Bottles per labour hour
Shampoo 2,000 1.50 0.6 0.20 2,600 14,000
Conditioner 1,500 1.75 0.5 0.20 3,100 6,700
Liquid soap 500 1.25 0.4 0.30 2,010 1,500
Note: Assume direct costs and distribution are 100% variable. The
majority of direct costs are materials with a small proportion of
direct labour.
Table MA.2
Factory indirect costs £k
Supervisor salaries 94.3
Insurance 194.6
Depreciation: equipment 120.6
Power 274.9
Factory administration 142.3
Total manufacturing cost 826.7
Notes: Indirect costs are currently allocated on a direct labour
hour basis.
Non-manufacturing costs include sales and marketing of £675,000,
allocated on sales volume, and a head office charge of 10% of sales
revenue.
Table MA.3
Current product profitability (allocations on labour hour
basis)
Sales revenue £k Direct costs £k Indirect (overhead) £k Gross
margin £k Distribution £k Sales & marketing £k Head office £k
Operating profit £k
Shampoo 3,000 1,200 169 1,631 400 338 300 593
Conditioner 2,625 750 264 1,611 300 253 263 795
Liquid soap 625 200 394 31 150 84 63 (266)
Total 6,250 2,150 827 3,273 850 675 626 1,122
Required:
a) Calculate an overhead rate based on the machine hours in Table
MA.1, and use this to recalculate the current product
profitability. Why would this be a more appropriate method of
allocating overheads than shown in Table MA.3?
b) How would your revised product profitability affect your advice
to the board about discontinuing the sales of liquid soap?
c) Assess the proposal of the sales director, by quantifying the
impact of reducing prices by 10% and increasing volume by 15%.
Would running an advertising campaign costing £250,000 to increase
volume by the same amount but leaving the selling price unchanged
be more cost effective?
d) Using the costing information in Table MA.1, assess the impact
of agreeing to a contract to manufacture a supermarket’s own-label
shampoo. The operations director confirms that the contract would
be for 500,000 bottles and be sold at a 20% discount on current
selling prices. Direct costs would be the same, but there would be
a bulk delivery charge of £85,000. What other factors should be
taken into account?
e) The marketing director has given the management accountant
some estimates on which to base her calculations for the launch of
a shower gel (see Tables MA.4 and MA.5). She forecasts that they
could sell 350,000 bottles in the first year, with growth of 10%
per annum thereafter. She would expect to adopt a penetrating price
strategy initially, with prices at £2 per bottle, but hopes to
increase prices by 2% every year after that. She proposes to
support the new shower gel with promotions costing £45,000 per
year. Distribution costs are expected to be in line with existing
products. By calculating the net present value over the next five
years using a discount rate of 5%, advise the board whether they
should invest £250,000 in equipment for this project. You should
also outline the limitations and non-financial considerations that
also need to be taken into account.
Table MA.4
Shower gel: raw material costs
Per bottle Quantity Cost
Detergent 200 ml per bottle £1.50 per litre
Perfume 50 ml per bottle £20.00 per litre
Bottle 1 per bottle £0.03 per bottle
Cap 1 per bottle £0.01 per bottle
Table MA.5
Shower gel: assumptions
Per 1,000 bottles Quantity Cost
Direct labour 10 hours £10 per hour
Outer packaging 10 boxes £15 per box
Current product data | ||||||||
Volume (000 bottles) | Selling price per bottle £ |
Direct costs per bottle £ | Distribution cost per bottle £ |
Bottles per machine hour | Bottles per labour hour | No of Machine Hours | No of Labour Hours | |
Shampoo | 2000 | 1.5 | 0.6 | 0.2 | 2,600 | 14,000 | 769 | 143 |
Conditioner | 1500 | 1.75 | 0.5 | 0.2 | 3,100 | 6,700 | 484 | 224 |
Liquid soap | 500 | 1.25 | 0.4 | 0.3 | 2,010 | 1,500 | 249 | 333 |
1502 | 700 | |||||||
Table MA.2 | ||||||||
Factory indirect costs | ||||||||
Supervisor salaries | 94.3 | |||||||
Insurance | 194.6 | |||||||
Depreciation: equipment | 120.6 | |||||||
Power | 274.9 | |||||||
Factory administration | 142.3 | |||||||
Total manufacturing cost | 826.7 | |||||||
Notes: Indirect costs are currently allocated on a direct labour hour basis. | ||||||||
Non-manufacturing costs include sales and marketing of £675,000, allocated on sales volume, and a head office charge of 10% of sales revenue. | ||||||||
Current product profitability (allocations on labour hour basis) | ||||||||
Sales Revenue | Direct Costs | Indirect Overhead | Gross Margin | Distribution | Sales and Marketing | Head Office | Operating Profit | |
Shampoo | 3000 | 1200 | 169 | 1631 | 400 | 338 | 300 | 593 |
Conditioner | 2625 | 750 | 264 | 1611 | 300 | 253 | 263 | 795 |
Liquid soap | 625 | 200 | 394 | 31 | 150 | 84 | 63 | -266 |
6250 | 2150 | 827 | 3273 | 850 | 675 | 626 | 1,122 | |
Current product profitability (allocations on Machine Hours) | ||||||||
Sales Revenue | Direct Costs | Indirect Overhead | Gross Margin | Distribution | Sales and Marketing | Head Office | Operating Profit | |
Shampoo | 3,000 | 1,200 | 423 | 1,377 | 400 | 338 | 300 | 339 |
Conditioner | 2,625 | 750 | 266 | 1,609 | 300 | 253 | 263 | 793 |
Liquid soap | 625 | 200 | 137 | 288 | 150 | 84 | 63 | (9) |
6,250 | 2,150 | 827 | 3,273 | 850 | 675 | 626 | 1,122 | |
Machine Hours is more appropriate in allocating the overheads, since the indirect Overhead which included Insurance, power, depreciation expenses majorly are for Machine , rather than for labours and thus be allocated based on Machine Hours used instead of Direct Labour Hours | ||||||||
Liquid Soap, Gross margin percentage is 46% greater than Shampoo, however because of allocation of Non manufacturing Expenses , the net operating profit is negative, thus the divison is recovering the variable costs and Manufacturing Costs and should not be discontinued. | ||||||||