- 15 Marks
Question
Boasiako Ltd manufactures high-quality coffee biscuits that are sold to hotels and restaurants in Koforidua. Two months ago, it had prepared a budget for the forthcoming financial year.
Details of the budget are presented below:
| Sales | GH¢6,000,000 |
| Less: | |
| Direct materials | GH¢2,080,000 |
| Direct labour | GH¢1,160,000 |
| Variable overheads | GH¢840,000 |
| Fixed overheads | GH¢972,600 |
| Total costs | GH¢5,052,600 |
| Profit | GH¢947,400 |
The budget above has been prepared on the assumption that sales will be 800,000 packets of biscuits. However, due to changing economic conditions, the sales forecast for the year is now 720,000 packets of biscuits. It is expected that the selling price per unit, direct costs per unit, and variable overhead cost per unit will not change from those budgeted. It is also expected that fixed overheads will be the same as those budgeted.
Management is now considering a number of options to improve profitability for the forthcoming financial year:
Option 1:
Decrease the selling price by 20%. It is anticipated that this would increase sales volume by 25% on the forecast sales for the current year.
Option 2:
Decrease all variable costs by 10% and decrease fixed costs by 10%. This is not expected to have any impact on the sales level.
Option 3:
Decrease the selling price by 10% and decrease fixed costs by 5%. This is expected to increase sales volume by 25% on the forecast sales for the current year.
Required:
a) Calculate the expected profit for the current year (forecast sales). (2 marks)
b) Based on the forecast activity for the year, calculate:
i) The breakeven point in packets of biscuits.
ii) The margin of safety in percentage terms.
iii) The sales revenue required to earn a profit of GH¢1,440,000. (6 marks)
c) Evaluate the profitability of the three options and recommend the option that Boasiako Ltd should adopt. (7 marks)
Answer
a) Expected Profit for the Current Year (Forecast Sales):
| Per Unit (GH¢) | Total (GH¢) | |
|---|---|---|
| Sales | 7.50 | 5,400,000 |
| Less: Variable Costs | ||
| Direct materials | 2.60 | 1,872,000 |
| Direct labour | 1.45 | 1,044,000 |
| Variable overheads | 1.05 | 756,000 |
| Total Variable Costs | 5.10 | 3,672,000 |
| Contribution | 2.40 | 1,728,000 |
| Less: Fixed Overheads | 972,600 | |
| Profit | 755,400 |
(2 marks)
b) CVP Analysis:
i) Breakeven Point (BEP) in Packets of Biscuits:
BEP (in units) = Total Fixed Costs / Contribution per unit
= GH¢972,600 / GH¢2.40
= 405,250 packets
ii) Margin of Safety in Percentage Terms:
Margin of Safety (%) = (Actual Sales – BEP Sales) / Actual Sales * 100
= (720,000 – 405,250) / 720,000 * 100
= 43.7%
iii) Sales Revenue Required to Earn a Profit of GH¢1,440,000:
Required Sales Revenue = (Total Fixed Costs + Target Profit) / Contribution to Sales Ratio
= (GH¢972,600 + GH¢1,440,000) / 0.32
= GH¢7,539,375
(6 marks evenly spread using ticks)
c) Evaluation of Profitability of the Three Options:
| Option 1 (SP -20%, Volume +25%) | Option 2 (VC -10%, FC -10%) | Option 3 (SP -10%, FC -5%, Volume +25%) | Current Situation | |
|---|---|---|---|---|
| Units | 900,000 | 720,000 | 900,000 | 720,000 |
| Sales | 5,400,000 | 5,400,000 | 6,075,000 | 5,400,000 |
| Less: Variable Costs | ||||
| Direct materials | 4,590,000 | 3,304,800 | 4,590,000 | 3,672,000 |
| Contribution | 810,000 | 2,095,200 | 1,485,000 | 1,728,000 |
| Less: Fixed Costs | 972,600 | 875,340 | 923,970 | 972,600 |
| Profit | (162,600) | 1,219,860 | 561,030 | 755,400 |
Recommendation:
The company should consider adopting Option 2 as it provides the highest profit among the options, with a profit of GH¢1,219,860.
- Tags: Break-Even Point, CVP Analysis, Decision Making, Margin of Safety, Profit Calculation
- Level: Level 2
- Topic: Cost-Volume-Profit (CVP) Analysis
- Series: MAY 2019
- Uploader: Kwame Aikins