EXCEL PROFESSIONAL INSTITUTE. LECTURE 6 Holy & Winfred

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1 EXCEL PROFESSIONAL INSTITUTE 1 LECTURE 6 Holy & Winfred

2 2 Q1. a) Investment Appraisal Lecture 10 &11 i. Types of Investment and Capital Expenditure ii. Objectives of Investment appraisal iii. Investment Appraisal Techniques iv. Capital Rationing v. Adjusting for Risk, Inflation and Taxation in Investment Appraisal vi. Specific Investment Decision (Lease or Buy, Asset Replacement) (10 marks) b) Performance Measurement Systems, Measurements & Control i. Performance Management Information Systems ii. Sources of management information and management reporting Lecture 1 iii. Scope of performance management & divisional performance appraisal. Lecture 12 iv. Transfer pricing Lecture 12 v. Performance analysis in not-for-profit organisations and public sector. Lecture 12 Vi External considerations & Behavioural aspects. Lecture 12 (15 marks)

3 3 Question 2 a) Nature, Purpose & Sources of Management Information i. Accounting for management Lecture 1 ii. Sources of data, cost classification and presentation of information. Lecture 1 (5marks) b) Budgeting & Budgetary Control Lecture 7 i. The concept of budgeting, objectives, types, administration and stages of budgeting process. ii. Preparation and analysis of Cash, Functional and Master Budgets. iii. Behavioural aspects of Budget. (15 marks) QUESTION 3 (25 marks) Cost accounting Techniques i. Accounting for material, labour & Overheads Lecture 2 ii. Absorption & Marginal costing, Job costing, Batch costing, Service costing, and Contract and Process costing. Lecture 2, & 3 (15 marks) b) Specialized cost & Management Accounting Techniques- Lecture 4 Activity Based Costing Target Costing Life cycles costing Throughput accounting (10 marks)

4 4 QUESTION FOUR (15 marks) a) Decision making techniques i. Relevant Costs Lecture 6 ii. Cost Volume Analysis Lecture 5 iii. Limiting factors Lecture 5 iv. Pricing Decisions Lecture 5 v. Make or buy decision, outsourcing, split or further processing, special order acceptance decisions. Lecture 6 vi. Dealing with risk and uncertainty in decision making (Profitability & Expected Values) Lecture 6 QUESTION FIVE (15 marks) a) Standard Costing & Variance Analysis Lecture 8 & 9 i. Nature, scope & objectives of standard costing, behavioural aspects of standard costing. ii. Types of standards and standard setting process. iii. Basic variances, mix and yield variances, causes and analysis of variance. iv. Operating Statements (Reconciliation of budgeted results with actual results using variances. v. Productivity, efficiency and capacity ratios.

5 5 Question 1 Two products (Y and Z) are jointly produced in a single process. Joint costs for a period totalled GHS52,000. Output of the two products in the period was: Product Y 2,000 units Product Z 3,500 units There was no opening or closing work-in-progress or finished goods stock (inventory). Both products are currently sold without further processing for: Product Y Product Z GHS12.00 per unit GHS16.00 per unit Sales values are used as the basis for apportioning joint costs. Required Prepare a statement showing the gross profit (in total and per unit) for each product in the period. (9 marks) In another process operation joint products A and B are produced. Joint costs, apportioned on the basis of weight of output, are GHS9.80 per kg. Product A can be sold at the split-off point for GHS9.00 per kg. Alternatively the product can be processed further, at an incremental cost of GHS2.10 per kg, and sold as Product AA at a price of GHS11.50 per kg. Required Comment on each of the following statements concerning Product A: The product should be processed further because if sold as Product A the selling price is below cost. (2 marks) The product should be processed further because profit would increase. (Show calculations clearly to support your comment.) (3 marks) OWL has been measuring the performance of its divisions using traditional profit measures. Whilst the divisions all make differing products all the products do have limited shelf lives. After attending a recent conference on throughput accounting the finance manager decided to look at the divisions performance on the basis of throughput accounting. The results for the last year (2016) were as follows: Required O W L Net profit margin 20% 5% 30% TPAR (a) Suggest one key reason why the relative performance is different using the two approaches. (2 marks) (b) Explain the significance of W's TPAR and suggest how it may be improved. (3 marks) (c) Explain why the TPAR may be a better measure of performance than profit for OWL. (3 marks)

6 6 SHORT TERM DECISION MAKING TECHNIQUES DECISION MAKING TECHNIQUES Cost Volume Profit Analysis Limiting factor analysis Pricing decisions Relevant Cost Decisions Make or buy decisions Other decisions

7 7 Break-even analysis examines the short term relationship between changes in volume of output, sales revenue, and net profit. In other words, break even analysis helps to understand how cost, volume of output and profit relate to each other. The strength of break-even-analysis lies in its ability to provide solution and decision points for several scenarios. Progressive firms usually develop break even financial models with Microsoft office excel to provide decision points for multiple scenarios. Break even analysis can be used for sensitivity analysis.

8 8 The behaviour of total revenue is linear. The behaviour of total cost is linear over the relevant range. Embedded in this assumption is that every cost can be classified as either fixed or variable. Fixed cost is constant over the relevant range and variable cost varies in direct proportion to output. Efficiency of production process and workers remain constant. In a multi-product organisation, the sales mix remains constant over a relevant range. In manufacturing firms, all units produced are sold

9 9 The limitations of break-even analysis are derived from the assumptions. In situations where the assumptions do not hold, break even analysis could be of a limited benefit. For instance, where the entity has semi-fixed costs, break even analysis could be of limited use. Similarly, where the firm enjoys significant efficiency both in production process and labour, it will be difficult to perform break even analysis. For emphasis, absence of the assumptions is the limitations of breakeven analysis.

10 10 CVP analysis is an important tool for short-term planning and decision making. Example of these decisions include 1. choice of sales mix optimum sales mix 2. derivation of optimum pricing policy, given cost structure and volume of sales 3. determination of volume to be sold to breakeven 4. determination of how many units to be sold to achieve a target profit 1. decision point for whether a special order be accepted or rejected 2. Modelling for will profits if a new product or service is introduced.

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12 12 Key formulas to know: Break-Even Quantity = Fixed Cost/Contribution per unit Break-even value = Fixed cost/cmr Margin of Safety = Budgeted Volume of Sales - Breakeven quantity Unit to sell in achieve a target profit Fixed Cost +Target Profit Contribution per unit

13 13 Illustration: Tango Ltd Tango Ltd produces and sell a packaged fruit Juice; Quench. The following cost information has been provided Selling Price Prime cost per unit GHC8.00 GHC3.00 Variable non production cost per unit GHC2.00 Fixed cost per Annum GHC30, 000 Budgeted Annual sales volume 12,000 units Required: By how many units can Tango Ltd reduce their sales volume without falling into a loss making zone? Will Tango Ltd be able to make an annual after tax profit of at least GHC18,000 with their current budgeted annual production and sales level? (Assume tax rate of 25%) Tango Ltd can procure a technology that will reduce prime cost by 20%. This technology will mean the organization incurs an extra GHC5,000 in fixed cost. Should this technology be adopted?

14 14 Break even analysis is essentially a decision making model. Decision makers will want to know how much a firms bottom line (profit) will change when there is a change in either variable cost or revenue. Degree of operating leverage (DOL) provides a solution. DOL is computed as =Contribution/Net Profit DOL is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. We illustrate the importance of DOL with an example: Jean Ltd produces and sell ceramic tiles. Cost build up for a square metre of their product is analysed as follows: Budgeted annual volume Annual fixed cost Variable cost GHC50,000 Selling price per square metre GHC120,000 20,000 units GHC15 Required: If variable cost per unit increase by 20% by how much will profit change?

15 15 Break even analysis can be applied for firms that deal in multiple products. The caveat is that the sales mix should be constant over the given period. The following procedures may be useful in determining the break-even point for an organization with a multiple product: Determine the sales mix ratio/percentage for each product. A ratio might be given else compute as sales quantity for the product divided by total sales volume of the company. Find the unit contribution for each of the products Compute the weighted average unit contribution for each product by multiplying the contribution by the product s respective sales mix ratio. Add up to derive the weighted average unit contribution of the company. Break-even quantity of the company is derived as: Fixed Cost/Weighted Average unit contribution To make more sense, split the break-even point for each unit by multiplying the total break eve- point in (4) with the respective sales mix ratios.

16 16 Illustration Samfafa Ltd Samfafa Limited manufactures and sells Motor King to customers dividend into High Quality, Medium Quality and Low Quality motor Kings and categories below: It is on record that sale quantities of Low Quality Motor King are twice compared to Medium. Medium has same quantity as High Quality Motor Kings. Annual fixed cost of GHC313,200 is expected to be incurred. Sales Price Involved cost GHC GHC GHC High quality 3,400 1, Medium quality 2,300 1, Low quality 1, commission on sales You are required to: i. Compute the sales mix. ii. Compute the unit contribution margin for each brand of Motor King. iii. Compute the weighted average unit contribution. iv. Compute break even sales in volume and in sales. v. How many motor kings should be sold to earn target profit of GHC208,800

17 17 Question 1 Zumah Ltd manufactures and sells two complimentary products: Hyline and Glycerin in the ratio 3:2. The result for the just ended period showed the following: Product Hyline Glycerin Selling price (GH ) Contribution/sales ratio Profit/ (loss) (GH ) 97,200 (3,600) Joint fixed cost of GH 180,000 are apportioned in proportion to the number of units of each product sold. The company is in the process of preparing the budget for the coming year, and is desirous of improving the performance of Glycerin. Therefore the following proposals are being considered for implementation: i) Increase the price of Glycerin by 25% in expectation that the quantity demanded will reduce by 10%; Or ii) Retool the production process which will result in a reduction of joint fixed costs by 15% and an increase in variable costs of each product by 10%; or iii) Introduce proposals 1 and 2. Required: a) Determine the units of each product sold, and hence, prepare the profit statement for the just ended period; and (7 marks) b) Advise the management of Zumah Ltd as to which proposal to implement with the view of optimizing profits. (8 marks) (Total: 15 marks) Nov 2017

18 Question 2 Anima Ventures want to start a new bakery at Bodwease in Ashanti Region. She plans to rent a store room for her operations under the following terms and conditions. Option 1 Option 2 Fixed Rent Charge GH 5,000 GH 3,000 Variable Rent - 10% of selling price of each loaf The following data are also relevant for her business: GH GH Selling Price 5.00 Material cost: Flour 0.80 Margarine 0.70 Labour cost 0.50 Required: i) Determine the break-even point in units under each option. (2marks) ii) Calculate the degree of operating leverage (DOL) for the two options if 10,000 loaves of bread are to be sold in the current year. (4marks) iii) What would be the expected operating income if sales increase by 25% next year? (4marks) iv) Which of the two options would you recommend to Anima Ventures and why? (3marks)

19 Question 3 ATM Ltd specializes in the production of tables. The following is the company s estimated profit statement for next year, prepared using marginal costing principles. 1. Chief Executive s Suggestion: I think cheaper materials could be used, which will reduce the total material cost to GH 40,000. However, this will mean additional fixed costs of GH 12,000 to cover inspection of the cheaper materials. GH GH Sales 220,000 Less variable costs: Materials 51,000 Labour 70, ,000 Contribution 99,000 Less fixed costs: Administration 20,000 Others 25,000 45,000 Profit 54,000 Two suggestions have been made in an attempt to improve profit next year. 2. Marketing Director s Suggestion: He suggested that an intensive advertising campaign can increase sales volume by 20% over the estimated amount above. Variable cost as a percentage of revenue will be unaffected by this option, but extra fixed costs of GH 22,500 will be incurred in order to cover the advertising campaign. Requirements: (a) For each of the original estimates, the Chief Executive s suggestion and the Marketing Director s suggestion, Calculate: (i) The company s breakeven points (ii) The margin of safety as a percentage. (9 marks) 19

20 20 LIMITING FACTOR DECISIONS

21 21 A limiting factor is described as resources that are in scarce supply and places ceiling on the organisation s volume of activity. An organisation might have more than one limiting factor other than sales demand or two or more resources (labour, materials, machine capacity). The most pressing limiting factor is called a binding constraint. Linear programming is used for solving scenarios that involve more than one limiting factor. For the purposes of our discussion, we will assume only one limiting factor, aside sales demand. Other assumptions are as follows: Management will decide to use its scarce resources in such a way that will maximize total contribution Fixed cost are the same whatever the selected sales mix Variable costs are the only relevant cost In establishing the contribution maximum product mix with a single limiting factor, product must be ranked in order of contribution they earned

22 22 For exams purposes, candidates are expected to draw up optimum production plans subject to a constraint. The following steps are helpful: 1. Determine the binding constraint by comparing requirement of each resource available with resource requirement to meet effective sales demand. 2. Determine the contribution per unit for each of the products 3. Ascertain contribution per limiting factor by dividing contribution per unit by limiting factor per unit of each product 4. Rank the output from step 3 in descending order. 5. Draw up the production plan by utilizing the limiting factor in the order of rankings (take note if there are reserved minimum production units for each/any of the products. In such case, the reserved units will be prioritized first before using the rankings to ration). 6 Based on the question requirement, you may want to prepare profit statement using the optimum production plan arrived at.

23 23 Illustration: Unity Company Ltd is preparing for next seasons operations. The company has provided the following information relating to its three products. Product TO GE DA Selling Price Material Cost GH per kg) Labour cost GH 2.2 per labour hr) Annual Demand (Units) 2,150 3, The company can only make available a total of 18,560 hours in the short run. Required: a. Provide the optimal production plan for Unity Ltd for the ensuing period. b. What is the total incremental benefit of producing DA instead of GE, assuming available resources can only meet demand of DA? Source: (CA, May 2016)

24 24 Shadow prices refer to the maximum amount an organisation should rationally pay for an additional unit of a limiting factor. Shadow price is usually computed as the additional contribution that will result from having an additional unit of a limiting factor. For instance, in our previous example, demand for product DA was not fully met due to scarcity of labour hours. If the entity procure an additional 1hour of labour, it can produce an extra units (1/3.5) and earn an extra GHC0.40 (1.4 contribution per unit x extra units). This GHC0.40 represents the shadow price, maximum amount to pay for an extra unit of a limiting factor. Slack on the other hand refer to unused limiting factor, even in a situation of a constraint. In a situation of a single limiting factor, slack result when a remaining limiting factor is incapable of producing a full unit of a product. In context of multiple limiting condition, slack results when other limiting factors are unused as a result of unavailability of a binding limiting factor.

25 25 The supplier of raw materials to Vim Ltd has also been adversely affected by the recent climate change who has promised to supply 60,000 units of the materials monthly. Details on the products are as follows: A B C D Demand (Units) 10,000 6,000 12,000 8,000 Direct materials required per unit (kg) Direct labour hours required per unit 3kg 2kg 2kg 3kg 5hrs 4hrs 4hrs 6hrs GHS GHS GHS GHS It is the company s policy to produce and sell at least 3,000 units of each product every month. Required: a. Advise management on the most profitable production mix and ascertain the most optimum profit expectation if the fixed costs of the month amount to GHS240,000. (12 marks) b. Explain two advantages and two disadvantages of marginal costing (4 marks) c. Explain four characteristics that differentiate services from products (4marks) Selling price per unit Direct materials cost unit Direct Labour cost unit Variable overhead

26 26 Taking the decision to price a particular product or services is often the most important to make. Theoretically, price of products are premised on cost information. In recent times, a myriad of factors, other than cost information affect pricing decisions and strategies. Factors that influence pricing decisions Aside cost, the following factors influence pricing decisions: Quality of the product, relative to competitive product offering Economic conditions such as inflation, exchange rate and interest rates Stage of the product: The various stages; introductory, growth, maturity and decline; influence pricing decisions Level of competition in the market place price perception of customers: this includes price sensitivity of customers Bargaining power of suppliers Demand for a product/service: very key factor when making price decisions.

27 27 There are a number of pricing strategies which are discussed as follows; Cost-plus pricing strategy: thus adding a percentage mark-up for profit to the full cost of the product. Marginal cost-plus pricing: thus adding a profit margin to the variable cost of the product Market skimming pricing: This strategy usually apply to new products. It involves charging high prices when products are launched in order to maximize short-term profitability Market penetration: pricing is a policy of low prices when product is first launched in order to obtain strong demand. Complementary product pricing: It is a pricing policy for complementary goods (thus goods which are used together). A company can decide to sell the complementary product at high prices or low prices or at a loss leader (thus charging one lower to influence higher demand that will affect the other products demand). Product line pricing: It is a pricing policy for a group of product which are closely related to one another. Price discrimination strategy: A strategy that involves selling at different prices across varying customer groups.

28 28 Cost-volume-profit analysis feature prominently in almost every exams diet. Examiners test both computation skills and decision making capability of students. Candidates were largely caught unprepared when the examiners feature break-even analysis for multiple product in an exam diet. Candidates should also master the assumptions and limitations of break-even analysis. On decision making front, candidates should be conversant with scenario planning and assessment of production plans when cost components are varied. Questions on limiting factor in past exams decision have been straight forward. Candidates should however be mindful when the examiner present a question that looks like a multiple limiting factor problem; while in actual fact, it has only one binding constraint For pricing, questions so far requested for pricing strategies and qualitative factors that shape pricing decisions Undoubtedly, this topic is a must-know for any candidate who intend passing the management accounting paper.

29 29 DECISION MAKING TECHNIQUES Relevant Cost Decisions Make or buy decisions Other decisions

30 30 Candidates are also expected to assemble relevant cost for specific decisions. More importantly, candidates should be able to assemble quantitative cost and revenue figures in making make or buy decisions, accept or reject, and shut down decisions. Lets work through some essentials now.

31 31 These are usually decisions needed to be made during a period of one year or less which involves deciding on idle capacity, fixed factors of production. When such a decision has to be taken and the concern is whether the decision will increase profit or not, relevant costs are used. Relevant costs are future cash flows (incremental costs) resulting as a direct consequence of a decision. Relevant cash flows can be considered for different type of costs like, machine costs, labour costs, material costs and opportunity costs (value of benefit sacrificed) Relevant cost for machine is when a decision involving the use of the machine to perform a task. The already purchased price, depreciation or committed cost of the machine cannot be considered as relevant cost (thus they are sunk cost) but only the incremental cost that will arise as a consequence of using the machine. If labour has an alternative use, the relevant cost is the variable cost of the labour and associated variable overheads plus the contribution forgone from using the labour at the best next alternative

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33 Relief, a car repair company, has been invited to tender for a big job which is outside its regular activities, and since there is surplus capacity, the executives are keen to quote as low price as possible. A low price will not have any negative impact on Batosa Ltd s regular work. The under listed cost estimate has been prepared on the basis of a study made by the Estimating Department. GH Direct material and components: 4000 units of Alfa at GH 25 per unit 100, units of Beta at GH 10 per unit 4,000 Other material and components to be bought 25,000 Direct labour: 1400 hours of skilled labour at GH 3.50 per hour 4, hours of unskilled labour at GH 2 per hour 3,400 Overhead: Department A (250 hours at GH 25 per hour 6,250 Department B (450 hours at GH 20 per hour) 9, ,550 The following information is obtained: Material Alfa: This is a regular stock item. The stock holding is more than sufficient for this job. The material currently held has an average cost of GH 25 per unit but the current replacement cost is GH 20 per unit. Material Beta: A stock of 4,000 units of Beta is currently held in the stores. This material is slow-moving and the stock is the residue of a batch bought ten years ago at a cost of GH 10 per unit. Beta currently costs GH 24 per unit but the resale value is only GH 18 per unit. A foreman has pointed out that Beta could be used as a substitute for another type of regularly used raw material which costs GH 20 per unit. Direct labour: The work force is paid on a time basis. Skilled workers are frequently moved to jobs which do not make proper use of their skills. The wages included in the cost estimate are for the mix of labour which the job ideally requires. It seems likely if the job is obtained, most of the 4400 hours of direct labour will be performed by skilled staff receiving GH 3.50 per hour. Overhead Department Alfa: Department Alfa is the one department of Batosa Ltd that is working at full capacity. The department is treated as a profit centre and it uses a transfer price of GH 25 per hour for charging out its processing time to other departments. This charge is computed as follows: GH Estimated variable cost per machine hour 10 Fixed departmental overhead 8 Department profit 7 Department Alfa s facilities are frequently hired out to other firms and a charge of GH 30 per hour is made. There is a steady demand from outside customers for the use of these facilities. Overhead: Department Beta: Department Beta uses a transfer price of GH 20 for charging out machine processing time to other departments. This charge is calculated as follows: Required: Estimated variable cost per machine hour 8 Fixed department overhead 9 Department profit 3 25 GH a) Compute the relevant costs of the job and briefly justify each of the figures you state. [State any assumptions] (12 marks) b. State three qualitative factors that can influence firms decision to outsource production (3 marks) 20

34 34 Make or buy decisions is deciding between making items in-house or purchasing them form an external supplier. When there are no limiting factor, the relevant cost are the differential costs between the two options. When there is a limiting factor, the company rank the in house production base on the highest extra cost of saving a limit factor or buy externally base on the lowest extra cost of saving a limit factor Outsourcing decisions is deciding to use external suppliers for finished goods, components or services which are non-core activities to the company. Basically the relevant cost is the differential costs between the two options.

35 35 Dolow produces computer component A for sale at GH47 per unit to a Manufacturer of computers. The company currently produces 15,000 units of the component per annum. Total cost of production and unit cost are as follows: Direct materials Direct labour Variable production cost Fixed manufacturing overhead Share of non-production overhead Production Cost GHC 210, ,000 30, , , ,000 Unit Cost GHC A supplier has offered to supply 15,000 units of the components per annum at a price of GHC39 per unit over a four-year period without any change in price If Dolow accepts the offer, the following are the effects on current operation. 45 Direct labour will be redundant but at a redundancy cost of GHC5,000. Direct materials and variable production cost will be avoidable Fixed manufacturing cost will be reduced by GHC18,750 per annum Share of non-production overhead cost will stay as it is. Assuming further that, the extra capacity for accepting the contract offer from the supplier can be used to produce and sell 15,000 units of component Z at a price of GHC43 per unit with the following assumptions: All of the labour force required to manufacture component A will be used to make component Z. Variable manufacturing overhead will remain same. The fixed manufacturing overhead will remain same. Non-manufacturing overhead will be the same. The materials for component A will not be needed but additional materials at a cost of GHC15 per unit will be required for production. Required: a. Should Dolow make or buy component A b. Should Dolow accept the offer and use the available space to manufacture component Z? (Total: 20 marks)

36 36 Sometimes, a client may offer to buy at a price below normal selling prices In making decisions whether to accept such offers, the company must assess both quantitative and qualitative factors Quantitative: Contribution?, Idle capacity or full capacity? Qualitative: sustainability, effect on current client decisions, etc

37 37 SNA Limited produces cement which can be used both locally and abroad. The company is currently operating at 80% capacity for the local market. Results under the capacity (80%) are as follows: Either to; Reject the order and continue with the local sales only or, Accept the order and split capacity between overseas and local sales and reject excess local demand; or GH Sales 6,400,000 Direct materials 2,000,000 Direct labour 800,000 Variable overheads 400,000 Fixed overheads 2,600,000 A company from Benin has placed an order that would utilize 50% of the capacity of the factory. The order when taken will attract 15% below the normal local price and cannot be split but should be taken in full. Management of SNA Company has the following available options: Increase capacity to accept the export order and still maintain the local sales by; Acquiring an equipment that will increase capacity by 10% which will result in an increase of GH 200,000 in fixed costs, and start working overtime to meet balance of required capacity. Labour will then be paid at one and a half the normal wage rate. Required: Prepare a Statement of profitability for each of the three (3) options columnally and recommend the best option. (16 marks) (NB: Show working) b) State four (4) qualitative factors that you will consider in accepting the foreign order. (4 marks)

38 38 Shut down decisions is whether to close down an operation or stop making a product and sell a particular product or service. With respect to shutting down a product line, the rule of thumb is that we do not shut down a product line that yields positive contribution. Before taking a product line shut down decision, rearrange all relevant information in line with marginal costing format. Decision should be based on contribution as opposed to profit. In short-term decision making, not only the financial benefits should be considered. The qualitative factors are as well important and they include; The impact of the decision on employees, the society, the environment The signal of the decision to affected stakeholders The reaction by stakeholders How the connected stakeholders like customers, suppliers will be affected An organisation may consider shutting down its operation if its entire business line ceases to make economic sense. In making such decisions, the firm may consider implication of various shutdown timelines.

39 39 El-classico Ltd manufactures and sells a small range of kitchen equipment. Specifically the product range contains a dishwasher (DW), a washing machine (WM) and a tumble dryer (TD). The TD is of a rather old design and has for some time generated negative contribution. It is widely expected that in one year s time the market for this design of TD will cease, as people switch to a washing machine that can also dry clothes after the washing cycle has completed. El-classico Ltd is trying to decide whether or not to cease the production of TD now or in 12 months time when the new combined washing machine/drier will be ready. To help with this decision the following information has been provided: 1. The normal selling prices, annual sales volumes and total variable costs for the three products are as follows: DW WM TD Selling price GHC200 GHC350 GHC80 Material cost per unit GHC70 GHC100 GHC50 Labour cost per unit GHC50 GHC80 GHC40 Contribution per unit GHC80 GHC170 -GHC10 Annual sales 5,000 units 6,000 units 1,200 units 2 It is thought that some of the customers that buy a TD also buy a DW and a WM. It is estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced. 3. All the direct labour force currently working on the TD will be made redundant immediately if TD is ceased now. This would cost GHC6,000 in redundancy payments. If El-classico waited for 12 months the existing labour force would be retained and retrained at a cost of GHC3,500 to enable them to produce the new washing/drying product. Recruitment and training costs of labour in 12 months time would be GHC1,200 in the event that redundancy takes place now. 4. El-classico operates a just in time (JIT) policy and so all material cost would be saved on the TD for 12 months if TD production ceased now. Equally, the material costs relating to the lost sales on the WM and the DW would also be saved. 5. The space in the factory currently used for the TD will be sublet for 12 months on a short-term lease contract if production of TD stops now. The income from that contract will be GHC12, The supervisor (currently classed as an overhead) supervises the production of all three products spending approximately 20% of his time on the TD production. He would continue to be fully employed if the TD ceases to be produced now. Required: (a) Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12 months (ignore time value of money).16 marks (b) Explain two pricing strategies that could be used to improve the financial position of the business in the next 12 months assuming that the TD continues to be made in that period (4 marks)

40 40 This topic is one of the most prominent aspects of the syllabus. From May, 2010 exams sittings, questions relating to this topic has appeared in more than 10 sittings out of the total of 16 exam diets. It is one also one of the areas that candidates cannot assume mastery. Like real life organisation level decision, the scope of questions are extremely unpredictable. We will advise our candidates to explore questions from the following exam diets: Year May, 2010 May, 2011 May, 2012 May, 2013 Nov 2016 May, 2017 May, 2017 Area of exams question Make or buy decisions, Shut down decisions, Qualitative factors to be considered when making short term decisions Relevant costing, Processing further decision making Accept or refuse order decisions, CVP analysis Make or buy decision, Limiting factor analysis Further processing decision, Relevant costing Relevant costing Outsourcing decisions

41 41 END