Re: Decision making with contribution per limiting factor


S

simo

--
Mohamed el Faghloumi
simo said:
Would anybody help solve this case: (for school) ....awfull thanks!

Key topics: Decision making with contribution per limiting factor

Merrion Products Ltd. 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 to Irish tastes and sold to various customers around the
country. During the initial years of production, product "A" was the only
product manufactured and the profits were adequate to satisfy the family
shareholders. During the 20x0's it was decided to introduce new products
based on the same raw material but refined in different ways. In 20x3,
product "B" was introduced and product "C" was added the following year.
Both products were an immediate success and the entire production output for
both products was sold by the end of the year. In fact demand for all
products constantly outstripped production. Encouraged by this success,
product "D", based on the same raw material was introduced into the product
range last year after extensive research on customer tastes. It was
considered by all family members to be as equally successful as the other
three products.

According to the audited financial statements Merrion Products Ltd. was a
profitable company with an excellent cash flow. The various family members
concentrated mainly on the administrative and selling side of the business.
Each family member was entitled to a basic salary which was supplemented by
a share of total sales commission. The sales commission was calculated at
the rate of 10% of sales price on every unit sold. Thus each family member
would participate in the overall success of his firm. The Carroll family
believed that the company's profitability was mainly attributable to two
factors. First, was the high quality of its products with guaranteed
delivery dates. Michael Carroll, the managing director of the firm, often
boasted that the number of customer complaints in any one year could be
counted on the fingers of one hand. The second reason was due to subtle
marketing and presentation so that each product was perceived by the public
as different and was sold to different types of customer. In other words the
products were not considered complementary and had their own unique brand
loyalty. Thus the sales of one product could fluctuate without affecting the
sales of the other products, or the refusal of orders for one product would
not lead to the cancellation of orders for the others.

Each product was produced from the same basic raw material which was
imported from abroad. Until recently this raw material was available in
unlimited quantities and was purchased by Merrion quarterly in advance as
required. However recent political instability in the exporting country
resulted in a severe restriction on the availability of this raw material. A
recent fact finding visit to the exporting country only served to confirm
the restricted availability of the imported raw material in the forthcoming
year. On his return home Michael Carroll called a directors meeting to
discuss the problem and its impact on the budget for the forthcoming
quarter.

Una Carroll, the only daughter in the family, filled the role of company
accountant. After obtaining a business studies degree at college she
immediately joined the family firm. She was mainly concerned with
maintaining the basic financial accounting records and keeping control over
accounts receivable and payable. She also monitored progress towards agreed
budget targets. However the budget setting process for each quarter was
unsophisticated in that output levels were determined by amiable consensus
among family members. Preference was usually given to the highest price item
since this procedure maximised sales commission for the family members. Una
tried to persuade the other members of the family that there was a more
scientific method available to determine best production plans. However
whenever she mentioned the phrase "profit maximisation" in discussion her
family always retorted "But that's only theory Una and has got nothing to do
with practice". Being the youngest in the family Una felt she lacked a great
deal of authority and credibility.

The Carroll family felt that the business did not need a management
accountant since they considered the overall operations to be fairly simple.
Neither did they require the services of a production manager or a marketing
manager since they could virtually sell everything they produced. Una knew
from experience that as long as budgeted profit was higher than last year
then everyone was happy. Generally, the actual financial performance met the
budget targets pretty well.

At the start of the meeting Michael Carroll relayed to participants details
of his foreign trip. He explained, "Unfortunately our worst suspicions have
been confirmed. I saw things at first hand and also had discussions with our
Embassy officials. I 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, he tells me is that the material is simply
not available in his country due to the current political situation. Since
my return home I have made extensive enquiries regarding possible
alternative suppliers of the same raw material in other countries. There
just isn't any which we could tap at this short notice. Like many simple
problems, its insoluble in the short-term. We've just got to accept it for
now!"

Una interrupted: "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 and supporting
schedules for the forthcoming quarter to participants (Exhibits 1 and 2).

EXHIBIT 1 Budget for the quarter ending 31 March 20x7

Euros

Budget sales 200,000

Cost of production 149,500

Gross margin 50,500

Administration expenses 19,900

Distribution expenses 5,700

Sales commission 20,000

Financial expenses 800 46,400

Budgeted Net Profit 4,100

EXHIBIT 2 Schedule of Revenue and Production Costs per Product.

Product
A
B
C
D

Sales price
20
40
30
20

Direct material (imported)
7
16
13
10

Direct labour and packing
3
4
6
4

Production overhead
4
5
6
5

Budget sales (units)
1,500
2,000
2,000
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.

Una continued "In my opinion there is no scope for any reduction in costs.
We can't change, at least in the short term, our direct material costs.
Neither can we change our packaging costs. Our direct labour consists of the
part-time assembly workers which we need in order to produce. Likewise
variable overheads will be incurred if we want to produce and our fixed
overheads are already down to an absolute minimum. Commission is the only
thing that we could effectively cut."

Michael Carroll interjected. "No, I recommend that the sales commission be
left alone. We're all in this venture together and I reckon we're going to
have to sell our way out of our problems. We need to retain the incentive to
sell and keep our selling prices intact."

Everyone agreed. Patrick Carroll, the eldest member of the family, who was
chiefly responsible for sales, raised the possibility of maximum sales
levels of each product. He said, "We must take into

consideration that there is a definite limit on the amount of goods which we
can sell at existing prices next quarter."

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 for the forthcoming quarter would be as follows:

Product Euros

A 60,000

B 88,000

C

63,000
D 40,000



Subsequently everyone at the meeting realised that due to the definite
shortage of raw materials it was not possible to produce simultaneously all
these quantities. Michael Carroll added "I think we shall have to be more
selective in what we produce in future. However, I recommend that we produce
a minimum of 1,000 units of each product during the forthcoming quarter.
This would, at least, keep the company's products in the minds of the public
and satisfy our major customers. Its important to do this. Any remaining
materials should be used in the most profitable manner. Una, now is the
ideal time to put some of that theory of yours into practice. If you feel
that there is a single, best way to utilise our production facilities in
these circumstances now is the ideal time to let us know."

Requirements

1. 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. 2. Calculate the firm's break-even point for the
forthcoming quarter. What fundamental assumptions have you made?

3. 3. What is the "opportunity cost", if any,
associated with the minimum production of 1,000 units of each product?

4. 4. Assuming it was possible to increase all
selling prices by 7 euros per unit without influencing demand, would this
price increase effect your analysis. Explain.
 
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Joined
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I have the same question, and dont know how to solve this problem. Do you know the answer?
Thank you
 

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