Question

In: Accounting

Table MA.1 Current product data Volume (000 bottles) Selling price per bottle £ Direct costs per...

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

Solutions

Expert Solution

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.

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