Management Application of Accounting
Management accounting plays an integral role in shaping, defining and directing management decision making. This is made possible through the application of managerial decision-making tools such as budgets, break-even analysis, contribution margin and variance analysis. In this regard, this report employs the managerial decision-making tools to help the managers of an established cookies business make strategic managerial decisions.
Contribution Margin & Break-even Analysis
Chocolate Chip
Sugar
Specialty
Total
Units Sold
1,500,000
980,000
300,000
2,780,000
Sales
$ 1,875,000
$ 882,000
$ 1,050,000
$ 3,807,000
Less: Variable Costs
$ 690,000
$ 205,800
$ 81,000
$ 976,800
Contribution Margin
$ 1,185,000
$ 676,200
$ 969,000
$ 2,830,200
Less: Common Fixed Costs
$ 125,000
Profit
$ 2,705,200
Per item Contribution Margin
0.79
0.69
3.23
Weighted Average Contribution Margin
1.018
Break-even point in units
122,783
The contribution margin is the amount of sales revenue that remains after the variable cost has been paid. It therefore represents that amount that a company can use to pay fixed cost (Maheshwari, Maheshwari,& Maheshwari,2021). This analysis is important in ascertaining the profitability of a product or service as such it helps in making managerial decisions such as dropping a product from the product line or making against buying from the supplier. According to the above analysis the contribution margin per unit of the Cookies business shows that the specialty product contributes highly to the overall profitability of the business. In this regard the company should focus on production and marketing of its specialty product since it’s the company’s cash cow.
The break-even analysis is another managerial decision-making tool that has been used to evaluate the performance of Cookies business. According to the results above the Cookies business will start earning profit when its sales 122,783 units of Cookies. This means that at any given level of production the business must make more than the break-even units as it guarantees profits for the business.
Full &Variable Costing
Full (absorption) costing :
Full cost per unit
$ 2.05
Ending Inventory Full (absorption) costing
$ 369,000
Variable costing :
Variable cost per unit
$ 2.00
Ending Inventory Full (absorption) costing
$ 360,000
Full costing considers total cost of a product as the sum of the variable cost and the fixed manufacturing overheads. As a result of this the full costing method results in high product cost as well as the value of ending inventory (Maheshwari, Maheshwari & Maheshwari,2021). In this regard the full cost per unit of Cookies is $ 2.05 resulting in the $ 369000 as the value of ending inventory. This makes full costing as the most appropriate method for financial reporting as it considers both variable and fixed manufacturing overhead as the cost of the product. On the other hand, variable costing considers only the variable cost as the product cost. As such the variable cost per unit of Cookies is $ 2 which results in lower cost ending inventory.
Special Order
Revenue for special order
$ 2,750
Costs for special order:
Design cost
$ 500
Tool cost
$ 100
Net increase (decrease) in profit
$ 2,150
The profit obtained from the special order is less that the profit that a company can get by selling the product at the normal price. Based on the calculation above the company can only get $ 2150 from the special order against the a profit of $ 3150. In this regard the owner of the Cookies business should not consider the special order.
IRR of the Project
Purchase of new equipment
$ 250,000.00
Expected annual increase in sales
$ 48,017.50
Time frame
7
years
Acceptable rate needed
9%
Calculate the Internal Rate of Return:
PV of annuity factor
5.206
Internal rate of return
8%
Accept or reject
Reject
The IRR is the break-even rate of return that evaluates the profitability as well as the viability of a project. According to this investment technique a project is considered viable if the IRR is higher than the acceptable rate. As such the planned purchase of equipment to help in the running of the Cookies business should not be implemented because the IRR of the project is less than the acceptable return. Despite the project promising annual cash flow of $ 48,017.50 the project should not be implemented.
Cash Budget
Estimated cash receipts
January
February
March
Last month’s sales
$ 50,000
$ 25,000
$ 60,000
Current month’s sales
$ 100,000
$ 240,000
$ 72,000
Total
$ 150,000
$ 265,000
$ 132,000
The cash budget is important for the Cookies business as it help the managers to decide on the credit terms of the business (Eldenburg, et al.2020). The monthly cash requirements for the business is $ 150,000 as such for the business to operate effectively it must collect $ 150,000 and above. According to the cash budget above the business attains the monthly cash requirements in the month of January and February with decline in the third month. As such in order for the business to attain the monthly cash requirements in March the excess amount collected in February should be saved to cover the shortfalls in the next month. Another strategy could be to revise the cash collection plans from 80% in the month of sale to 60% and 20% in the subsequent month to 40%.
Variance Analysis
Amount
Favorable/ Unfavorable
Calculate Materials Variances:
Materials Price Variance
7452
Unfavorable
Materials Quantity Variance
-7252
Favorable
Calculate Labor Variances:
Labor Rate Variance
-1.375
Favorable
Labor Efficiency Variance
1.875
Unfavorable
The material price variance evaluates the actual cost of raw material against the budgeted (Eldenburg, et al.,2020). According to the above results the actual cost of Cookies raw material was higher than the budgeted leading to unfavorable results. Besides the material price variance, the material quantity variance is favorable implying that the business used material than budgeted thus leading to saving. This means that the business was efficient in resources management.
The labor rate variance is critical in controlling the cost of labor and reducing the production cost. According to the above results the labor rate variance is favorable meaning that the business was efficient in managing the wages and salaries to the employees. On the other hand, despite control of labor the labor efficiency variance is unfavorable indicating that the employees of the business are not working efficiently to produce more Cookies. This means that the business should focus on encouraging the employees to increase profitability.
Conclusion
The analysis of the operations of Cookies business shows that the business should focus on the production of the special cookies as it results in high contribution margin of $ 3.23. More specifically, the analysis has shown that the material price variance of the business is unfavorable as such the business should control the cost of raw material to increase profitability. Over and above the business should re-evaluate its receivable collection strategy to ensure it gets enough cash for the monthly expenses. In this regard, if the business collects 60% of sales in the month of sale and 40% in the following month the monthly cash requirement of $ 150,000 will be attained across the year.
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