The Plasma Department have iced out that there is a need to look at the costs of Plasma panels. According to report, Plasma B is not doing well and dragging the performance of the whole department. The Microelectronic Department are deciding whether to buy a new machine for the production Of controller 457 or to outsource the production. This report will aim to examine and evaluate the number of sales of each individual circuit board, evaluate the sales and costs of Plasma B and finally evaluate the pros and cons of prod icing controller 457 on our own and ultimately deciding whether or not to outsource the production. . 0 Analysis 1: Target Sales Currently, the selling price for Advanced, Boosted and Custom’s circuit board were set at $185. 00, $450. 00 and $610. 00 respectively. The sales mix has been consistent at 60%, 30% and respectively for the 3 products. To solve the problem, we got to use the Cost Volume Profit (CAP) analysis. Products Selling price/ Unit Variable cost/ Unit Unit contribution margin Advanced $222. 00 $185. 00 $37. 00 Boosted $540. 00 $450. 00 $90. 00 Custom $732. 00 $610. 00 $122. 00 Figure 1 The contribution margin which is revenue minus the variable expense reflects a company’s profitability.
A contribution margin analysis shows how much a many should sell. Because of the complexity of the matter whereby there are many products, the sales mix has to be consistent and there is a target net profit of $2,800,000 to be met, there is a need to find out the weighted average unit contribution margin. Using the following accounting formula, we can find out the total units required to be sold. After calculations (See Appendix 1), the total units to be produced was found to be 77,850 units.
By applying the sales mix into the total units to be produced, the total units to be sold by each individual products is found as seen from Figure 2 below. Recommendation: The total number of each units shown below to be sold to hit the net profit target Products Number of unit to be produced 46,710 23,355 7,785 Figure 2 2. 1 Importance of Tax Tax is important in the calculations of the number of units sold to hit the target profit because it directly takes a chunk off the net profit. If a desired net profit is wanted, there is a need to increase the desired amount by the tax amount.
As we can see from the formula below, if tax wasn’t taken into considerations to calculate the required number of units to be sold, the required total number of units would take a dip. But because of the presence of tax, a larger amount of required units to be sold is needed to offset the tax amount. 2,2 Underlying Assumptions of CAP analysis When doing the CAP analysis, many assumptions are made. 1 . We assume that the behavior of the total revenue is linear which actually means that the selling price per unit will not change as sales volume changes within the relevant range. 2.
We assume that the behavior of total costs is liner over the relevant range which then leads to 3 more specific assumptions: I) Fixed costs remains constant even during sales volume changes ii) Labor productivity do not change ii) No capacity additions during the period under consideration 3. We assume that sales volume is the ONLY cost driver for the fixed and variable costs. 4. We assume that the sales mix will always be constant over the relevant range 5. We assume that there is no beginning and end inventory I. E the number of units produced equals the number of units to be sold. 3. Analysis 2: Plasma B Figure 3 As shown by Figure 3, Plasma B is currently experiencing a net loss of $200,000 for the first quarter of xx. The department manager of the Plasma Department has taken note of this and recommended shutting down Plasma B because it is dragging down the performances of the other Plasma product. However, it is wrong to just look at the Quarterly Income Statement and assume plasma B is making a loss. TO effectively calculate the cost Of the product, the relevant costs has to be taken into consideration. In management accounting these are costs that are relevant with respect to a particular decision.
A relevant cost for a particular decision is one that changes if an alternative course of action is taken. And as shown in Figure 1 , Plasma B is making a loss of $200,000 because many irrelevant costs are awaken into consideration. For instance, Corporate Overhead and Divisional Overhead should not be taken into consideration when evaluating the net income/loss of Plasma B. Corporate Overhead and Divisional overhead remains unaffected by the closure of Plasma B, which means to say it IS a fixed cost and thus it remains inconsequential when evaluating the net income/loss.
For fixed cost, because there is no feasible way to effectively trace the cost back to the product, it is unfair to allocate and equally distribute the costs to the products. However for fixed overhead, it contains a variable portion in it. In the event where Plasma B closes down, the fixed overhead will be reduced by 50%. Therefore, 50% of the fixed overhead is fixed and the other 50% is the variable portion which can be traced back towards Plasma B. Therefore, 50% of the fixed overhead should be included in the calculation.
And of course, since in the event of the closure of Plasma B, the 4 employees will no longer be required, the fixed wages should be included as a cost for Plasma B. Therefore the more accurate way to measure the net profit/loss of Plasma B will be, Plasma B Revenues Cost of Sales $768,000 Gross Margin 482,000 Fixed Wages- Traced $84,000 Fixed Overhead- Traced $82,000 Net Income/(loss) $316,000 Figure 4 As from the new way of calculation which only involves the relevant costs, it can be seen from Figure 4 that Plasma B is in fact making a profit of $31 6,000 instead of the loss of $200,000 originally calculated.
Recommendation: I will recommend Plasma B to be kept because of its profitability. 4. 0 Analysis 3: Controller 457 Controller 457 is a new product which our company do not have any expertise in producing. But with some training of our employees, it is possible for us to produce them. The cost based on the current calculation is SSL 00. 50 per unit if we were to produce it on our own and therefore the manager of the Microelectronic Department has recommended for the company to outsource the job to BAG Technology who agreed to supply us the product at $68. 0 per unit. Figure 5 Figure 5 shows the current form of calculation for the total cost to produce 10,000 units on our own and thereby infer that the current cost per unit is $100. 50 (See appendix 3). However the mistake here is the same as the calculation of net profit/loss for Plasma B which is taking too many irrelevant sots into consideration when evaluating the cost to build. As discussed in the previous analysis, Corporate and divisional overhead shouldn’t be taken into consideration because it’s a fixed cost whether or not we produce the product on our own.
As for the overhead cost, we should take into consideration the variable side of it as it is directly related to the cost. Overhead Costs is actually 150% of labor costs and the variable side of it takes up a third of the Overhead Costs while the Fixed Costs takes up the other two-third of it, and therefore we should only count the a third of the overhead cost as part Of the relevant cost. We do need to take depreciation into consideration because each time each product is being made, the machine depreciates and the depreciation is directly and solely caused by the production of Controller 457.
Therefore, depreciation should be included when calculating the cost. Needless to say, because labor and material costs are also directly and solely for the production of Controller 457, we’ll have to include it in the cost. Depreciation $22 per unit Labor Cost $18 per unit Material Cost $21 per unit Overhead Cost (Variable Side) $9 per unit Total Cost $70 per unit Figure 6 From Figure 4, we can see the new cost per unit should we produce Controller 457 on our own. The new cost of $70 per unit is still higher than the agreed price of $68 if we outsource it with BAG Technology.