Question

A department at Venta Technology has prepared the following report for 2020. This department has recently faced severe competitive pressures, which has resulted in falling sales and profits over the last 3 years. Summarised data from the management accounts Budgeted profit and loss account for 12 months £ Sales (80,000 units) 5,600,000 Cost of goods sold (see notes 1 and 2) 4,800,000 Gross profit 800,000 Selling general & administrative overheads (see note 3) 800,000 Profit before tax DI 0 A new customer has placed an order for 10,000 units at £60 per unit. The current capacity of the factory is 90,000 units. Note 1. Cost of goods sold includes fixed costs of £500,000. All other costs are variable. Note 2. If the order is accepted there will be additional fixed costs of £50,000. Staff will receive a bonus of £10,000 if the order is completed on time. Note 3, Sales commission is 10% of sales and is included in the total cost of £800,000. The sales commission on the new order is only 5%. All other costs are fixed Required: i. Advise managers whether or not the order will increase the department's profits. ii. Calculate the minimum price the company should accept for the order. Assume that the company will lose 10% of current sales if the order is accepted. What is the lost contribution if the company loses 10% of current sales? iv. Identify and evaluate what additional information management need about existing and potential customers before finally accepting or rejecting the order.

Answer 1

Hi,

I have solved this question by using the Relevant Costing Method, in which the cost which is incurred for the new proposal is considered. Any fixed cost incurred already in existing production not consider as a sunk cost.

Answer 1) Evaluation of Proposal Particulars Amount (£) Sales ( 10,000 units @ 60 per unit) 600,000 Total Sales 600,000 Less :- Cost of Goods Sold Variable cost Variable cost ( 10,000 units @ 53.75 per unit) Bonus to Staff Fixed Cost Fixed Cost (W.N.-d) Additional Fixed Cost 537,500 10,000 50,000 Selling general & Administrative Overheads 30,000 Sales Commission ( 5% of 600,000) Fixed Cost Total Cost Profit before tax (W.N.- d) 627500 -27,500 Working Note :- a Company has additional capacity of 10,000 units, which means existing Production not have effect. 10,000 units ( 90,000 - 80,000) b Calculation of Variable Cost per unit in Cost of Good Sold Existing Production Cost of Goods Sold Less :- Fixed Cost Variable Cost Units Cost per unit 4,800,000 500,000 4,300,000 80,000 53.75 c Calculation Selling general & administrative Overheads Existing Production Selling general & administrative overheads Less :- Sales Commission ( 10% of 5,600,000) Fixed Cost 800,000 560,000 240,000

d Fixed Cost already incurred in existing production, therefore considered as sunk cost. Will not create an impact on new offer. Conculsion Manager should not accept the new offer, as acceptance of offer will give loss of -£ 27,500. 2) Calculation of Minimum Price the company should accept for the Order. Cost incrred for new offer = 627,500 Minimum Price Charged = Cost of New offer Total Units 627,500 10,000 62.75 per unit 3) Calculation of lost contribution due to lose of 10% of current Sales Amount (£) 5,600,000 Particulars Sales Less :- Variable Costs Cost of Goods Sold Selling general & administrative overheads Contribution 4,300,000 560,000 740,000 Lost Contribution = 10% of 740,000 = £74000

4) Identification and evaluation of additional information management needed about existing and potential customer. a Is customer satisfied with product and any improvement required. b Expectation of customer about product from company. c Class of Customer buying product, so that management can increase price to earn profit. Without effecting sales quantity. d Upcoming tread in the industry, any modification required in product.