Managerial Accounting: Test And Apply Knowledge, Increase Report Writing Skills, Illustrate Real-world Scenarios And Alternative Evaluation Methods

Estimating Contribution to Profit Using Variable and Fixed Costs

To estimate the contribution which will be made to the given charity event, it is extremely important to estimate the given variable costs relating to the particular event. These costs include the costs of food and other beverages along with labor which are variable to the number of guests. In any case, the situation with respect to the expenses which are overhead is not that clear (Crosson & Needles, 2013).  It is better to plot the labor hour with the overhead expense data in a scatter graph to understand the situation in a better manner.

It reflects upon the relationship between overhead expenses and the hours of labor which is well explained from the diagram. However, it also shows that as the labor hour’s increase there exists a slight bend present.

Refer to Appendix 1 for the diagram

As the data points on the diagram are close to the straight line, it indicates the variation which is present in the overhead expenses related to the labor hours.

In order to find out the estimated contribution to profit,   the fixed cost component can be divided into two parts which are the fixed as well as the variable elements using the method of high lo, least squares regression or the quick and dirty method (Demski, 2013).

In the given case, the high low method shall be used. In the given method, the elements and estimates of only two months will be considered that is the highest level of activity month and the lowest.

Variable cost = Change in cost/Change in activity=16720/2400

=6.967 per labor hour.

Fixed cost element = Total cost – Variable cost element

= 65120 – 6.967 per labor-hour ×

 3900 labor-hours

= $37949

The total variable cost lost is as follows:

Food and beverages                                                     $19.00
Labor (0.5 hour @ $15.00 per hour)                          $ 7.50
Overhead (0.5 hour @ $5.5 per hour)                    $2.75
Total cost per guest                                                       $29.25

And the total contribution from 180 guests paying $31 each is computed as follows:

In the above calculation, the fixed costs have not been computed as it had not been indicated than an extra fixed cost would be incurred in that charity party (DRURY, 2013).   If we are assuming that no additional fixed costs would be incurred, they should not be subtracted from the earnings to determine the profits.

As we have been assuming that there are no additional fixed costs for the caterer, any amount 30$ can be bid and it shall contribute well to the profits.

As mentioned earlier, any bid which would be above 30$ would be contributing to the contract. Hence, it would be preferable if the bidding is slightly less than the competitor, she is more likely to get the contract. Contributing to profits is not everything but showing the capabilities of the company to the clients is equally important (Edmonds et al., 2016). The only problem in the given case is that if the bid is made lower than 45$ as suggested, it will set a norm for future and the company ill indulged in a price war. It is suggested that this price is not publicized and the case could be later on justified to the clients stating that the reason behind the low cost was the charity event.

Recommendation to Use Own Sales Force Instead of Commission

In order to maintain the reputation, Christine can also sell at her normal price with extra services at no cost. This decision lies in the hands of the caterer to decide upon the strategy (Eldenburg et al., 2016).

Break even sales

Contribution ratio =Contribution margin / Revenue

Case 1

• 3750000/15000000
• 25%

Case 2

• 3300000/15000000
• 22%

Case 3

• 4800000/15000000
• 32%

Break even sales in dollars

Break even= Fixed expenses/ Ratio

Case 1

• 3400000/25%
• 136000000$

Case 2

• 3400000/22%
• 15454545$

Case 3

• 4300000/32%
• 13437500$

Dollar sales to attain profit= target profit+ Fixed expenses/ the CM ratio

= -100000+3400000/0.22

= 15909091$

Case 2

 The net operating income at outside commission

= 0.22*3400000

=$748000

Case 3

The net operating income at own force

=0.22*4300000

=946000

Therefore equating,

=946000=748000

=126470500$

Letter Memo

This is with regard to the situation which related to the hiring of an internal sales force versus hiring external agent’s matter which is bringing about a huge cost difference for the organization.

After analyzing the situation, it can be recommended that the company should employee its own sales force instead of hiring one on commission (Weygandt, Kimmel & Kieso, 2015). . This has been stated because, although the fixed cost component of the company will be increasing once a permanent sales force is hired, but there will not be any variable costs that will derive from the particular commission aspect. When the company is hiring a separate sales force for its selling it is earning a profit of $500000. On the other hand, if it continuous to pay a commission of 22% to the agents, the company will incur a loss of $100000. This is not acceptable and therefore, it is suggested that the company keeps its own sales force.

 Estimated total manufacturing overhead/ estimated total amount of allocation base

=$3800000/57000 DLHs

=$66.67 per DLH

The predetermined overhead rate which was revised is more than the original rate, the reason being that the automated milling machine will be increasing the overhead for the year and this shall be decreasing the direct labor hours. Due to this double whammy effect, the predetermined overhead rate increases.

The milling machine acquisition which is automated will be increasing the costs of all the jobs and not just the ones which will be affected by the new machine (Warren, Reeve, & Duchac, 2015). The reason behind this is that the organization makes use of a plant overhead rate, had it been using a different rate, this would not have been the case.

The predetermined overhead rate is much higher than it was earlier. This will have a penalizing effect on the products which will be using the similar kind of direct labor hours. These products will presently deem to be less profitable and the present managers will be appear to be performing not so well (Gitman, Juchau & Flanagan, 2015). There may exist pressure to increase the given prices of the products although there has not been any increase in the real costs of the product.

The calculation of the costs savings was in an error. Although it may be a good idea to buy a new equipment because of better capabilities. The earlier calculations assumed that the overhead would go down because of the reduced labor hours. However, actually the overheads increased because the machine was new equipment (Schaltegger & Burritt, 2017).   A cost analysis which would be differential in nature would reveal that the machine has increased the cost by around 316000$ in a year in a case where the labor reduction is only by 2000 hours.

It can be seen that even though there has been a reduction in the labor hours, which would have added only $164000(4000*41) in the savings of the cost. The net increase in the costs annually would have been just $152000 and the machine would have remained as unattractive option (Hilton & Platt, 2013).  This is by no measure automatic as the 6000 hour reduction may be achieved in case the workers retire or quit.

First of all, pre determined overhead rates should not be assumed to be similar as the variable costs, and a reduction in labor requirements does not always lead to a reduction in the hours paid.

References

Crosson, S. V., & Needles, B. E. (2013). Managerial accounting. Cengage Learning.

Demski, J. (2013). Managerial uses of accounting information. Springer Science & Business Media.

DRURY, C. M. (2013). Management and cost accounting. Springer.

Edmonds, T. P., Edmonds, C. D., Tsay, B. Y., & Olds, P. R. (2016). Fundamental managerial accounting concepts. McGraw-Hill Education.

Eldenburg, L. G., Wolcott, S. K., Chen, L. H., & Cook, G. (2016). Cost management: Measuring, monitoring, and motivating performance. Wiley Global Education.

Gitman, L. J., Juchau, R., & Flanagan, J. (2015). Principles of managerial finance. Pearson Higher Education AU.

Hilton, R. W., & Platt, D. E. (2013). Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.

Schaltegger, S., & Burritt, R. (2017). Contemporary environmental accounting: issues, concepts and practice. Routledge.

Warren, C. S., Reeve, J. M., & Duchac, J. (2015). Managerial accounting. Nelson Education.

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting. John Wiley & Sons.

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