Intermediate Management Accounting
Preliminary Analysis Brown Boot Company
Sales and manufacturing costs from the preliminary analysis have been continuously rising to an extent to which Brown Boot Company (BBC) cannot realize the budget for 20X5. From Exhibit-3 it is evident that sales have been declining from an initial 1,274,500 to 1,197,500 for three years. This indicates declining percentage variance. The Brown Boot Company needs to cut costs in its sales and manufacturing sections. The budgeted selling and administrative costs per pair were pegged at $4.90 but the actual selling and administrative costs per pair in the Year 20X4 were $6.76 which is approximately 38.0% higher than the planned budget. This indicates a dwindling performance which shows low growth rate in the Brown Boot Company. Based on this performance, BBC’s president is right in relation to eroding performance in the Brown Boot company and the issues need addressing with immediate effect.
Budget estimates for the year 20X5 cannot be realistic since the Brown Boot Company is experiencing increases in sales and manufacturing costs. The company needs to review its mechanism for combating high costs in sales to ensure profitability required to enhance its manufacturing operations. A decrease in per-capita beef consumption increases the price of hides due to low supply and high demand for hides. Given the high price of hides, BBC’s management needs to find a solution to remedy this situation.
Brown Boot Company’s Operations Manager concern about Exhibit 2 is based on the issue raised by customer service regarding the impact of boot quality on the price of boots both in variable costs and administrative costs. As a result, BBC needs to come up with a fixed selling price that includes a profit margin as presently, its total cost of manufacturing a pair is at $ 65.26. Accordingly, variance reports should be produced regarding the prevailing business conditions for adequately documenting the company’s progress. This entails fixing discrepancies between unit costs and efficient use of direct materials to promote the growth in the performance of the company.
Analysis of budgeted sales for a pair of shoes in 20X2, 20X3, 20X4, and 20X5 began to decline from 20X3 to 20X5. However, sales surpassed projected figures though budgeted variable costs remain constant. Also, selling prices declined from 20X3 to 20X5 to attract more demand for BBC’s products. Subsequently, this trend should be reversed for the company to improve its operations. Exhibit 3 indicates changes of over 4% that can assist BBC’s management focus on areas of poor performance (less than 4%) and build on areas that are above this figure for the past three years. By using this analysis, the company can isolate the factors responsible for poor performance as well as create a mechanism for resolving these challenges. Additionally, management will know how to plan and implement policies necessary for boosting the firm’s growth.
Computation of Fixed cost allocations and Overhead allocation rates
Overhead application rate =
|Robie Reid Hiking Boot||Iron Horse Company per Boot|
|Total budgeted overhead cost||4.28||12.9745|
|The expected value of direct hour||0.26||0.77|
|Overhead application rate||16.46153846||16.85|
|Planned production||Units Budgeted for Sale||Produced|
|Iron Horse per pair||Total|
|cost per unit||1175000|
|Robie Reid per pair|
|Cost per Unit||total cost|
|Robie Reid Units of Boots|
|calculation of (b)|
|Application overhead rate||Total value|
|Units for Iron horse boots||1097000||16.85||18484450|
|Units for Robie Reid boots||127000||16.46||2090420|
- The purpose of effective application rate
It is useful in calculating the full cost of a product manufactured by a company. Often, manufacturing companies allocates all direct material costs, labor costs, and direct expenses on a per-unit basis.
- BBC should use an overall application rate to determine the cost and price of their products since this approach factor in all absorption rates in determining the final price of a product and the profit margin as well. To effectively do so, the company should use a departmental application rate before introducing a new product as it takes into consideration the costs incurred by each department. On the other hand, the company should use an overall application rate after the introduction of a new product. However, the company should use an overall application rate following the introduction of a new product and before a product is sold the to gain profit to cover any costs incurred in the production of a product. The rate applied considers underutilized sections to gain full profit from the productions. Moreover, the company will do well by considering the unutilized economic value of a commodity.
- Activity-based costing is an accounting approach that identifies and assigns profit costs to overhead activities in the company and then transfers these costs to a product. Even so, it is challenging assigning costs such as the cost of management and staff salaries to a product. However, this approach is appropriate for manufacturing industries since a product’s actual cost can be determined.
- Analysis of the profitability of adding Robie Hiking Boot BBCs product Mix
|Iron Horse Boot||Robie Reid Boot||BBC Mix|
|20X5 pairs of shoes||1,097,000||125,000||1,222,000|
|Selling Price per pair||$96.50||$50.00|
|Production expense per pair||$70.47||$33.21|
|Number of pairs sold||1,097,000||125,000|
|Total production cost||77,307,235.5||4,150,750||81,457,985.5|
|less overhead cost||$14,238,000||$5,932,800||$20,170,800|
|Net profit for both||$10,481,715|
Computation of Break-even points
Break-even points =
Iron Horse Boot Break-even Point
|Sales price per Unit||96.5|
|Variable cost per unit||6.5|
Iron Horse Boot Company needs to sell 195,556 boot pairs to cover up production costs. Selling this amount of boots will help the company determine in advance the number of boots to sell to meet the cost of manufacturing boots per annum.
Robie Hiking Boot Break-even Point
|Sales price per Unit||$50|
|Variable cost per unit||$1.50|
Robie Hiking Boot Company needs to sell 7,423 units to cover up the costs of manufacturing costs. In this way, it can determine in advance how much it needs to sell to meet the cost of manufacturing boots per annum.
Break-even of the Products Combined
|Iron Horse Boot||Robie Hiking Boot||Total|
|Sales price per Unit||96.5||$50||$147|
|Variable cost per unit||6.5||$1.50||$8|
Similarly, BBC needs to sell 129,675 units to cover up manufacturing costs as well as determine the number of boots to sell to meet the manufacturing costs each year. The phrase margin of safety refers to the difference between the value of the stock and its market price. Alternatively, it can be defined as the difference between the expected profit and the break-even point.
Margin of Safety = × 100%
The margin of safety for the Iron Horse Boot is computed as follow.
|Iron Horse Boot margin of safety|
|20X5 sales units||1,097,000|
|sales per unit||96.5|
|Margin of safety||0.998152701|
The margin of sales used by the organizations determines their budget forecasts and investments. In this case the margin of safety is .99815 x 100% = 9.982%
The margin of safety for Robie Hiking Boots is computed as follows:
Margin of safety for Robie Hiking Boot
|20X5 sales units||125000|
|sales per unit||50|
|Margin of safety||0.99881232|
The margin of safety for Robie Hiking company is calculated as 0.9988×100% = 9.988%. This margin of safety is depicted above.
The margin of safety for the combined products
|Margin of safety for both companies|
|Iron Horse Boot||Robie Hiking Boot|
|20X5 sales units||1,097,000||125,000||12,22,000|
|sales per unit||96.5||50||146.5|
|Margin of safety||0.998152701||0.99881232||0.998189474|
The margin of safety = 0.9982 x 100% = 9.982%
Service department cost allocations
The purpose of allocating cost to operating departments are outlining below as follow:
- It helps in decision making concerning the final product, reduces wastes, and assists in determining the price of the product.
- Step method in the allocation of service costs against department costs and office cost allocations is shown below.
Step method for allocation of service costs to department costs
|Office Service||Operating Department|
|Allocations per depart||$3,000,000||$1,200,000|
|stitching depart (manual)||$876,000||$442,961.17||$177,184.47|
|stitching depart (automated)||$472,800||$239,077.67||$95,631.07|
Use of the reciprocal method is computed through a reverse of the above method.
Reciprocal method for allocation service costs to department costs
|allocation to department||$3,000,000||$1,200,000|
|stitching depart (manual)||$876,000||0.147653722||0.147653722|
|stitching depart (automated)||$472,800||0.079692557||0.079692557|
- Discussion to address the following points:
- The direct method is the best among the three for allocating service costs to departmental costs as it is convenient, easy to comprehend, and use. It is recommended that BBC should use this method as it is very convenient and easy to implement.
- A difference of 4% in the method is due to the use of different procedures used to compute the final value. Obtained differences occur due to accounting discrepancies inherent when solving the cost allocation calculations.
- The operation manager should pick one method and use it in allocating the service costs to department costs to avoid cases of confusion. Accordingly, the best method to use is the direct method.