Cost-Volume-Profit Analysis For Daphne International Holdings Limited (DIHL)

Question 1: Determine DIHL’s budgeted net profit for the year 2018.

Eliana is a student currently completing her Bachelor of Science in Computational Finance at the City University of Hong Kong (CityU). In her final year, she is required to conduct a small research project in the field of accounting covering any area of her interest. After consulting with her lecturer, Eliana decided to focus on cost-volume-profit analysis and picked Daphne International Holdings Limited (DIHL) as her case company. DIHL is a Hong Kong-based investment holding company, who is also one of the largest shoe manufacturers in China. The Company operates through several segments, including the sales of footwear products under Daphne and Shoe Box and other brands; the manufacturing of fashion and accessory products; and the e-commerce businesses through its subsidiaries. The Company mainly operates its businesses in China, Asia, Europe and North America. For the purpose of her research, Eliana decided to focus on the shoe manufacturing branch by taking three sample products and denoted them as ‘Shoe-A’, ‘Shoe-B’ and ‘Shoe-C’.

Eliana obtained budgeted annual data for 2018 from the finance department of DIHL. Budgeted sales volume for the year includes 4,500 pairs of shoes each for Shoe-A and Shoe-B while that of Shoe-C is 6,000 pairs. Budgeted fixed costs for the year comprise of $189,500 for manufacturing and $80,000 for selling and administrative costs. The tax rate applicable for DIHL in Hong Kong is 30 per cent. Additional budgeted total annual data for the three products for the year 2018 is presented as follows.

Required: You are hired as a part-time research assistant to help Eliana address the following requirements (treat each requirement independently, show all computations and explain your results). 

Determine DIHL’s budgeted net profit for the year 2018. (Hint: use contribution margin approach to income statement or variable costing statement).  

The above computation has been carried out by Using formula of Sales less variable cost i.e. contribution. Further, contribution is reduced by Fixed Cost to give profit before tax. Post that, tax has been deducted on profits @30% as stated in the details given above to give net profit by manufacturing shoes.(Anon., n.d.)

Further, fixed cost has not been allocated over different grade of shoes as the question states about DIHL’s budgeted profitability and not on profit of individual shoes. Accordingly, the budgeted profit of the company stands at AUD 100,100/-.

Part 2

Assuming the sales mix remains constant though out 2018, determine how many pairs of shoes must be sold for each type in order to breakeven. 

On perusal of the table, one can understand that breakeven sales for the company stands at 9800 units based on sales mix computed above. The formula for computation of breakeven quantity has been provided here-in-below(WebFinance Inc, 2018)

(Fixed Cost of company/ Contribution as per sales mix)* Sales Mix Quantity.

Further, sales mix has been derived by taking ratio of budgeted sales quantity provided in question.

In addition contribution per unit has been derived by computing contribution per grade of shoe divided by total budgeted sales quantity of such grade.

Question 2: Assuming the sales mix remains constant throughout 2018, determine how many pairs of shoes must be sold for each type in order to break-even.

Post the aforesaid; the breakeven quantity has been allocated over each grade on the basis of sales mix. Thus, the break-even sales of each shoe grade is 2940, 2940 and 3920 units for A, B and C respectively.

Part 3 (A)

Calculate the projected safety margin in units for the year 2018 and explain the importance of such information for DIHL

Answer 3(A)

On perusal of the above table, one can understand that margin of safety in unit’s stands at 5200 units. The same has been further allocated over the grades on the basis of sales mix and accordingly the sales of each grade under margin of safety stands at 1560, 1560 and 2080 units for A, B and C respectively.(Anon., 2018)

Further, margin of safety units have been computed using the formula provided here-in-below:

Total Budgeted sales Quantity-Break Even Sales Quantity.

Further, the importance of margin of safety has been described here-in-below

• It helps to analyse the management regarding the decline in sales of quantity which can lead to break-even;
• It helps in decision making regarding expansion in sales;
• Higher Margin of Safety is indicative of chances of profitability being high;(Accounting For Management, 2018)

Part 3 (B)

Compute the projected safety margin in sales dollars for the year 2018 and interpret what your answer means to DIHL. 2 Mark

Answer 3(B)

On perusal of above table, one can understand that margin of safety in terms of value stands at AUD 780,000 representing near about 35% of sales volume which is good for future prospect of the company. The margin of safety has been computed by multiplying individual grade margin of safety quantity with the budgeted sales price.  Accordingly, the margin of safety sales stands at AUD 187,200, 218,400 and 374,400 for A, B and C respectively.

The above result implies that if the sales of the company fall by 35% then the company shall reach its break-even situation (Assuming variable cost fall with same proportion. Further, it also shows that DIHL is in a solid position and a margin of safety at high level indicates higher profitability of company. Thus, in short Margin of Safety sales at 35% of budgeted sales indicates solid position of company.(Simister, 2013)

Part 4 (A)

After submitting his research paper, Eliana got an email from the accountant at DIHL advising him the expected fluctuations that he has to note and include in a separate analysis. Variable manufacturing cost of Shoe-A would increase by 12 per cent, and the variable selling cost of Shoe-C is expected to increase by $5.00 per pair of shoes. However, management at DIHL have decided not to change the selling price of the products.

Taking into accounting the above change of circumstances, determine how many pairs of each shoe would DIHL have to sell in order to break even in the year 2018. 3 Marks

Answer 4(A)

On the basis of details provided in the above stated question required alteration in the projection has been made, thus, one can see that breakeven quantity of the company has increased from 9800 units to 11914 units (11920 units to be in alignment with sales mix) on account of change in contribution per unit for two grades of shoes. Further, the Contribution on the basis of sales mix has also changed from 275 to 226.2 resulting in increase in break-even quantity which is not good for the company.

Accordingly, the break-even quantity has been allocated over different grade of shoes on the basis of sales mix. Thus, the break-even quantity for grade A, B and C stands at 3576, 3576 and 4768 units.   

Assume the maximum demand for each type of shoe could reach 6000 pairs for 2018. However, the realistic estimate of maximum total number of shoe pairs that DIHL can produce is 17,000 due to limited financial resources. The company is desperate to maximise its profitability for 2018 by manipulating its sales mix. For this reason, the accountant at DIHL has asked you to propose the relative sales mix (or proportion) of each product that the company should sell. Provide explanation for your proposed  

For answering these question details presented in part 4(a) has been used.

On perusal of the above table, one can understand that the sales mix has been chosen at 5:6:6 for shoes A, B and C respectively as the contribution is maximum under grade B and C. Thus, more quantity of grade b and c shall be prepared compared to grade a. However, there is a cap of 6000 units of each grade and overall manufacturing of 17000 Units. Thus, grade b and c has been given preference. According, the sales stand at 5000, 6000 and 6000 for grades A, B and C respectively.

Further, the maximum profit that can be attained under the current situation stands as AUD 117,500.(Ingram Digital Media, inc , 2018)

References:

Accounting For Management, 2018, Margin of safety, [Online]
Available at: https://www.accountingformanagement.org/margin-of-safety/
[Accessed 15 September 2018].

Anon., 2018, Margin of Safety, [Online]
Available at: https://www.myaccountingcourse.com/financial-ratios/margin-of-safety
[Accessed 15 September 2018].

Anon., n.d, Contribution Margin, [Online]
Available at: https://financeformulas.net/Contribution-Margin.html
[Accessed 15 September 2018].

Ingram Digital Media, inc , 2018, Product Mix and Constrained Resources, [Online]
Available at: https://accountinginfocus.com/managerial-accounting-2/short-term-decision-making/product-mix-and-constrained-resources/
[Accessed 15 September 2018].

Simister, P., 2013, What Is The Margin Of Safety In Break Even Analysis And Why Is It Important?. [Online]
Available at: https://businessdevelopmentadvice.com/blog/what-is-the-margin-of-safety-in-break-even-analysis-and-why-is-it-important/
[Accessed 15 September 2018].

WebFinance Inc, 2018, breakeven formula, [Online]
Available at: https://www.businessdictionary.com/definition/breakeven-formula.html
[Accessed 15 September 2018].

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