Decision making with contribution per limiting factor.

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GROUP MEMBERS
ROHIT PANCHAL 1131 PANDEY 1132 PAPIA 1133 AKSHAY 1134

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Decision making is a key function of managers which involves choosing between alternatives. There are various types of decisions faced by managers. examples: a) Make or buy a product b) Accept or reject an order c) Shutdown or continue operations of a plant d) Introduce a new product or not

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Decision making costs: The following are the different types of decision making costs:

TYPE OF COST Outlay cost Notional cost

DEFINITION

Relevancy

Costs which involve actual outflow of Relevant. funds. Costs which do not involve outflow Relevant. of funds Example: Rent paid on own land.

Opportunity cost Profit foregone by not choosing the Relevant. next best alternative. Sunk cost / Historical cost Costs that are already incurred. Irrelevant.

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Limiting factor:
Ascarce resourcewhich restricts the output generated or sales volume achieved is called a limiting factor. Limiting factors could be raw material, labor hours, machine hours, money etc. In decisions involving limiting factors contribution approach can be used i.e. contribution per unit of the limiting factor. For instance a unit making multiple products has limited availability of machine hours; the product mix is made based on the contribution per machine hour of the products.

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Summary

The Case Study is about Merrion Products Ltd, which was incorporated and commenced to trade in 20x1. Its several shareholders consisted of members of the Carroll family. The business was devoted to the import of a raw material. substance which was slightly refined 8/28/12 to Irish tastes and sold to various

After the success of A product. Merrion Ltd decided to introduce new products based on the same raw material but refined in different ways. In 2003, product "B" was introduced and product "C" was added the following year. In fact demand for all products

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Problem in Case

In 2007political instability in the exporting country resulted in a severe restriction on the availability of this raw material. Michael Carroll made direct contact with our usual supplier and he indicated that he will be unable to delivery more than 72,000 Euros of raw materials per quarter until conditions improve and that's not going to be for some time. The basic problem, Exporter tells the Michael Carroll is that the material is simply not available in his own country due to the current political situation. Michael Carroll enquiries regarding possible 8/28/12 alternative suppliers of the same raw material in

Una Interruption

I expect that our budgets for the next quarter shall have to be revised downwards and our profits shall be considerably depressed as a result." She circulated the previously agreed budget. It supporting schedules for the forthcoming quarter to participants (Exhibits 1 and 2).
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EXHIBIT 1 Budget for the quarter ending 31 March 20x7

Euros Budget sales Cost of production Gross margin Administration expenses 19,900 200,000 149,500 50,500

Distribution expenses 5,700 Sales commission Financial expenses Budgeted Net Profit 8/28/12 20,000 800 46,400 4,100

EXHIBIT 2 Schedule of Revenue and Production Costs per Product. C Product A B D

Sales price 20 40 16 4 5 2,000 30 13 6 6 2,000 20 10 4 5 1,500 Direct material (imported) 7 Direct labour and packing Production overhead Budget sales (units) 3 4 1,500

NOTE: Production overhead includes both fixed and variable expense. The estimated fixed overhead for the forthcoming quarter amounts to 20,000 euros and has been apportioned to each product on the basis of total anticipated sales revenue for each product. 8/28/12

Michael Carroll accepted that the point was valid. After much discussion all family members agreed that maximum sales value of each product at current prices
Product A B C D Euros 60,000 88,000 63,000 40,000

Michael Carroll : I recommend that we produce a minimum of 1,000 units of each product during the forthcoming quarter. Una Carroll : If you feel that there is a single, best way to utilise our production facilities in these circumstances now is the ideal time . let us know. 8/28/12

Requirements
1.

Prepare a statement showing the most profitable production plan for Merrion Products Ltd. for the forthcoming quarter. Prepare a detailed profit and loss account to accompany your recommendation. Explain your workings.

2. Calculate the firm's break-even 8/28/12 point for the forthcoming quarter.

SOLUTION. 1 Most Profitable Production Plan

Merrion Products Ltd. has their budgeted sales as well as production and net profit for the first quarter of year 2007. Basic criteria raw material available up to 72000 Euros only; definite limit over the sales; and minimum production of 1000 units for each 8/28/12 product.

To draw out the new plan, we start first by identifying profitable production and their priority as Product A C D well. B
Sales price 20 7 3 4 1,500 30,000 0.300 40 4 5 2,000 80,000 0.375 0.938 30 6 6 2,000 0.167 0.385 20 10 4 5 1,500 0.050 0.100 Direct material (imported) Direct labour and packing Production overhead Budget sales (units) Budget sales revenue Contribution over each euro of sales 16 13

60,000 30,000

Profit generated over each euro of 0.857 imported raw material

Priority of utilization contribution 2 1 3 4 and imported raw materials The fixed production overhead is estimated to be 20,000 euros and been apportioned to each product based on total anticipated sales revenue for each product. This concludes that the firm has been using 8/28/12 Absorption Costing

we stop using the absorption costing and impose marginal costing method. For that purpose, we identify and reverse apportion the fixed production costing as below.
Product Budget sales (units) Budget sales revenue Production overhead (absorption) Total Production overhead Fixed Production overhead A 1,500 30,000 4 6,000 3,000 B 2,000 80,000 5 10,000 8,000 1 C 2,000 60,000 6 12,000 6,000 3 D 1,500 30,000 5 7,500 3,000 3

Production overhead (marginal) 2

Now, we take the new production overhead cost into count and reconstruct the most profitable product table once again. This will increase the level of contribution and utilization of raw material for each of the product line

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the same priority of most profitable product

Product Sale price Direct Material ( Imported ) Direct labour and packaging Production overhead Budget sales (units) Budget sales revenue Contribution over each euro of sales Profit generated over each euro of imported raw material A 20 7 3 2 1,500 30,000 0.400 1.143 B 40 16 4 1 2,000 80,000 0.475 1.188 1 C 30 13 6 3 2,000 60,000 0.267 0.615 3 D 20 10 4 3 1,500 30,000 0.150 0.300 4

Priority of utilization contribution 2 and imported raw materials

Now we construct the new plan. But start with the condition applied by the board of members 8/28/12

we must produce at least 1000 units for each product line.

Product Sales Price Direct Material ( Imported ) Direct labour and packaging Production overhead Sales (units) Sales revenue A 20 7 3 2 1,000 20,000 B 40 16 4 1 1,000 40,000 16,000 C 30 13 6 3 1,000 30,000 13,000 D 20 10 4 3 1,000 Total 110 46 17 9 4,000

20,000 1,10,000 10,000 46,000

Consumed raw material 7,000

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Product

* We revise the sales of product B to maximum sales value as it is the first most profitable product. (88000/40 = 2200 units maximum sales)
A B C D Total 1,000 20,000 2,200 1,000 1,000 5,2000 88,000 30,000 20,000 1,58,000

Sales (units) Sales revenue

Consumed raw material 7,000 35,200 13,000 10,000 65,200 * We revise the sales of product A to the maximum of available raw material resources and it is the second most. (Floor((7200065200)/7)=971 units additional sales) Product A B C D Total Sales (units) Sales revenue 1,971 39420 2,200 1,000 1,000 6171 88,000 30,000 20,000 177420 35,200 13,000 10,000 71997

Consumed raw material 13797

Finally, we conclude our findings as in this quarter; buy and consume imported raw material up to 71,997 Euros, we will need to sell 6171 units of products, and over the sales we will make 177,420 Euros. Now we present the final statement together the profit and loss account. 8/28/12

Most Profitable Production Plan

Product Sales Price Direct Material ( Imported ) Direct labour and packaging Production overhead Sales (units) Cost of sales Sales revenue A 20 7 3 2 1,971 B 40 16 4 1 2,200 C 30 13 6 3 1,000 D 20 10 4 3 1,000 Total 110 46 17 9 6,171

23,652 46,200 39420 88,000

22,000 17,000 1,08,852 30,000 20,000 177420

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Profit and Loss Account Statement

Budget sales Cost of production Gross margin Less: Fixed production overhead Administration expenses Distribution expenses Sales commission Financial expenses Budgeted Net Profit 8/28/12 19900 5,700 17742 800 44142 4,426 177420 108852 68568 20000 48568

Break even point:

Thebreak-even point(BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain.

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POINT
Merrion Products Ltd is having multiple product line. Therefore, before calculating the break even point, we need to assume some criteria such as:

1. The price of the each product is constant. This means the product A should not be sold at price 10 Euros to customer A and 20 Euros to customer B. They should be constant either 10 Euros or 20Euros to both customer A and B. 2. Cost is linear. When production 8/28/12

This results to variables cost of every product to rise by 10% and contribution reduces. Total Product A B C D
Sales Price Cost of sales contribution Contribution (after commission) Sales (units) Sales revenue 20 12 8 6 1,971 40 21 19 15 2,200 30 22 8 5 1,000 20 17 3 1 1,000 110 72 38 27 6,171

39,420 88,000 30,000 20,000 177420

Sales cost = 22.22% 49.60% production overhead *Fixed weight Expenses - Commission + Fixed 16.91% 11.27% 100.00% = 44142-17742+20000 = 46400 Break even point in sales revenue = Fixed cost / Weighted average P/V ratio = 46400 27 / 110 = 189,037 Euros sales Break even point in sales unit = Fixed cost/Weighted average contribution margin per unit =46400/27 8/28/12 =1,719 units of product

OPPORTUNITY COST:

Opportunity costis the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among severalmutually exclusivechoices.

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Solution 3. OPPORTUNITY COST

There is an opportunity for the decision of If we produce minimum of units for each product line. producing 1000 1000 units for each product line:
Product Sales Price Direct Material ( Imported ) Sales (units) Consumed raw material A 20 7 1,971 13797 B 40 16 2,200 C 30 13 1,000 D 20 10 Total 110 46

1,000 6,171

35,200 13,000 10,000 71997

Sales revenue 39420 88,000 30,000 20,000 177420 If we are not restricted to minimum of 1000 units for each product Product A B C D Total line: Sales Price Direct Material ( Imported ) Sales (units) Consumed raw material 8/28/12 Sales revenue 20 7 3,000 40 16 2,200 30 13 1215 20 10 0 110 46 6415 71997 184450

21,000 35,200 15,795 0 60,000 88,000 36450 0

Opportunity cost = Sales

without minimum 1000 - Sales with minimum 1000 = 184450- 177420 = 7030 Euros

Conclusion= Merrion Products Ltd

forgoes 7030 Euros due to the decision of producing minimum 1000 units per product line. This is their opportunity cost.

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Solution 4. INFLUENCE OF PRICE

When the price increases by 7 Euro for each product, this will impact the analysis. The reason is, we had designed the plan based on most profitable product whereas Product B is first and followed by Product A, C and D. Most profitable product refers to 8/28/12 products that make the firm earn

.
Product Sale price Direct Material ( Imported ) Direct labour and packaging Production overhead Total variable cost Total contribution A 27 7 3 2 12 15 B 47 16 4 1 21 26 0.556 1.625 2 C 37 13 6 3 22 15 0.405 1.154 3 D 27 10 4 3 17 10 0.370 1.000 4

Contribution over each euro of sales 0.556 Profit generated over each euro of imported raw material Priority of utilization contribution and imported raw materials 8/28/12 2.143 1

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THANK YOU
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