Contribution Analysis

MA – L2 – Q70 – Performance analysis

Calculate the impact of three strategies on annual profit for Kumasi Ventures Ltd, each implemented independently.

Question

Kumasi Ventures Ltd manufactures and sells a single product. Its budget for the next financial year is as follows:

Sales (80,000 units at GH₵600 per unit)	GH₵000
	48,000
Production costs: materials and labour	16,000
Other production costs	8,000
Marketing and distribution costs	12,000
Administration costs	10,000
Total costs	46,000
Profit	2,000

Materials and labour costs in production are 100% variable, and 25% of other production costs are variable. All administration costs are fixed costs and two-thirds of marketing and distribution costs are also fixed.

The directors of Kumasi Ventures Ltd are dissatisfied with the budgeted profit, and believe that annual profits should be at least double the size of the budgeted profit.

Three strategies have been proposed to improve profitability.

(1) Strategy 1. Increase sales by opening a new sales office in a neighbouring country. It is expected that this would increase annual sales by 5,000 units, but would add GH₵1.2 million to annual fixed costs.

(2) Strategy 2. Re-design the product by adding several additional features that should add value for the customer. This would have no effect on annual sales volume in units, but the company would be able to raise the sales price to GH₵625. The additional costs of producing the new product design would be GH₵1.5 million each year (all fixed costs).

(3) Strategy 3. Implement a cost reduction exercise throughout the company. It is expected that the planned exercise would reduce all variable costs by 20%, but would add to annual fixed costs by GH₵3.5 million.

Required:
(a) Calculate the effect of each individual strategy on annual profit, assuming that the strategy is implemented on its own, without the other two strategies.

(b) Show whether the three strategies, if they are all introduced together, will close the profit gap between the budgeted profit and the target profit that the directors would like to achieve.

Answer

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Tags: Contribution Analysis, Cost Management, Financial analysis, fixed costs, Profit improvement, Sales strategies, variable costs
Level: Level 2

Topic: Performance Analysis

MA – L2 – Q64 – Transfer Pricing

Evaluate transfer pricing objectives and calculate company contribution for Keta Fitness Ltd's divisions.

Question

KETA FITNESS LTD
(a) Objectives of Transfer pricing include the following:
(i) Goal congruence
(ii) Performance evaluation
(iii) Divisional authority
(iv) Tax minimisation
(v) Motivation
(b) The company’s contribution as a whole

	DIVISION A	DIVISION B	COMPANY
Selling price	GH₵ 20,000	GH₵ 30,000	GH₵ 30,000
Incremental Cost (A)	(12,000)	(20,000)	(12,000)
Incremental Cost (B)	–	(15,000)	(15,000)
Contribution	8,000	(5,000)	3,000

(i) Should Division A transfer to Division B or sell as an intermediate product?
(ii) If there is excess capacity of 200 units, what would be the total contribution and the range of transfer prices for the excess capacity?

Answer

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Tags: Contribution Analysis, Divisional performance, goal congruence, Internal Transfers, Motivation, Performance Evaluation, transfer pricing
Level: Level 2

Topic: Transfer pricing

MA – L2 – Q52a – Relevant Cost and Revenue

Advise whether Okonku Enterprises should discontinue Double bed production based on contribution and profit impact.

Question

Okonku Enterprises produces Single, Double, and King size beds for sale to hotels in West Africa. Its manufacturing plant is located in Keta and is currently producing at 100% capacity. Below is the annual output and sales for each product and the associated costs.

Product	Single bed	Double bed	King Size
Units sold	5,000 units	3,500 units	4,000 units
Sales	GH₵ 2,500,000	GH₵ 2,800,000	GH₵ 3,800,000
Cost
Material cost	750,000	1,400,000	1,520,000
Labour costs	600,000	1,050,000	1,200,000
Manufacturing O’head	200,000	650,000	300,000
Administrative cost	200,000	100,000	200,000
Total cost	1,750,000	3,200,000	3,220,000
Profit /Loss	750,000	(400,000)	580,000

The Director of Okonku is of the view that the product Double bed is not doing well and must not be produced any longer. The following additional information has been provided.
(i) 40% of the labour cost for all bed types are fixed costs.
(ii) 50% of the manufacturing overhead is variable costs for all products.
(iii) 80% of the administrative cost is fixed.

Required:
(a) Advise whether the company should shut down the production of Double beds.

(b) Should the company accept the new order assuming Double beds will still be produced?

Answer

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Tags: Contribution Analysis, decision making, fixed costs, Hotel Industry, Manufacturing costs, Product Discontinuation, Profit Impact, Relevant Cost, Short-Term Decisions, variable costs
Level: Level 2

Topic: Relevant cost and revenue

MA – L2 – Q48 – Decision Making Techniques

Determine if BHIL should manufacture Zeta internally or buy it, given material constraints and government orders.

Question

Blue Horizon Industries Limited (BHIL) produces and markets three products viz. Alpha, Beta, and Gamma. Following information is available from BHIL’s records for the manufacture of each unit of these products:

	Alpha	Beta	Gamma
Selling price	GH₵ 66	GH₵ 106	GH₵ 124
Material-A (GH₵ 4 per kg)	GH₵ 8	GH₵ 12	GH₵ 12
Material-B (GH₵ 6 per kg)	GH₵ 12	GH₵ 24	GH₵ 24
Direct labour (GH₵ 10 per hour)	GH₵ 25	GH₵ 25	GH₵ 30
Variable overhead based on:
– Labour hours	GH₵ 1.8	GH₵ 1.5	GH₵ 1.8
– Machine hours	GH₵ 1.4	GH₵ 1.2	GH₵ 1.2
Total	GH₵ 3.2	GH₵ 2.7	GH₵ 3.0
Other data:
Machine hours	7	6	6
Maximum demand per month (units)	3,000	3,000	5,000

Additional information:
(i) BHIL is also engaged in the trading of a fourth product Zeta, which is very popular in the market and generates a positive contribution. BHIL currently purchases 600 units per month of Zeta from a supplier at a cost of GH₵ 40 per unit. In-house manufacture of Zeta would require: 2.5 kg of material-B, 1 hour of direct labour, and 2 machine hours.
(ii) Materials A and B are purchased from a single supplier who has restricted the supply of these materials to 22,000 kg and 34,000 kg per month respectively. This restriction is likely to continue for the next 8 months.
(iii) BHIL has recently accepted a Government order for the supply of 200 units of Alpha, 300 units of Beta, and 400 units of Gamma each month for the next 8 months. These quantities are in addition to the maximum demand stated above.
(iv) There is no beginning or ending inventory.

Required:
Determine whether BHIL should manufacture Zeta internally or continue to buy from the supplier during the next 8 months.

Answer

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Tags: Contribution Analysis, fixed costs, Government Order, Make or Buy, Manufacturing, Material Scarcity, Production Planning, Profit Maximization, Resource Constraints, variable costs
Level: Level 2

Topic: Decision making techniques

MA – L2 – Q47 – Decision Making Techniques

Establish production plan to maximize profit with steel limited to GH₵250,000, prioritizing a major customer's order.

Question

An engineering company has been experiencing problems with restricted availability of resources. The company manufactures a variety of casings. It makes four types of casing. Each casing requires the same bought-in component and some high-grade steel. The standard costs for the four types of casing are as follows:

Casing	A	B	C	D
	GH₵	GH₵	GH₵	GH₵
Steel	250	500	190	390
Bought-in component	50	50	50	50
Direct labour	60	60	50	100
Variable production costs	40	50	40	50
Fixed production costs	180	240	150	270
Selling and administration costs	145	225	120	215
Profit	35	55	30	55
Selling price	760	1,180	630	1,130

All the selling and administration costs are fixed and the same single component is used for each of the four products. Direct labour is paid GH₵8 per standard hour and each member of the workforce is capable of producing any of the casings.
The company’s main customer has ordered 30 units of Casing A, 20 units of B, 30 units of C, and 20 units of D for production and delivery in the next month. Senior management have agreed that this order should be treated as a priority order and that these casings must be manufactured and delivered to the customer next month. This is necessary to maintain the goodwill of the customer. It is estimated that this order represents 10% of the total demand next month for each type of casing.
The company operates a just-in-time system, and has no inventories of steel, components, or finished goods.
Required:
If the aim is to maximise profit for the month, establish the production and selling plan for the company next month in the following situation:
(a) Situation 1. Supplies of steel are limited to GH₵250,000.

(b) Situation 2. Only 400 bought-in components are available from suppliers.

(d) Situation 4. A labour dispute restricts available productive labour hours in the month to 2,125; but the manufacture of any quantities of the four casings could be sub-contracted to an outside supplier. The cost of buying the casings externally would be GH₵475, GH₵705, GH₵380, and GH₵640 for Casing A, Casing B, Casing C, and Casing D respectively. In addition, it should be assumed that the major customer insists that its order is completed by the company itself and the manufacture should not be subcontracted.

Answer

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Tags: Contribution Analysis, fixed costs, Manufacturing, Priority Orders, Production Planning, Profit Maximization, Resource Constraints, Shortages, Steel Limitation, variable costs
Level: Level 2

Topic: Decision making techniques

MA – L2 – Q42 – Decision Making Techniques

Determine optimal production mix for four liquids with a contract obligation, maximizing profit within labour hour constraints.

Question

NexGen Ltd. manufactures four liquids: A, B, C, and D. The selling price and unit cost details for these products are as follows:

	Liquid A	Liquid B	Liquid C	Liquid D
	GH¢ per litre	GH¢ per litre	GH¢ per litre	GH¢ per litre
Selling price	100	120	120	110
Costs:
Direct materials	24	30	21	18
Direct labour (GH¢6/hour)	18	15	24	12
Direct expenses	0	0	0	0
Variable overhead	12	10	18	12
Fixed overhead (note 1)	24	20	36	24
Total cost per litre	78	75	102	66
Profit per litre	22	35	18	44

Note 1: Fixed overhead is absorbed on the basis of labour hours, based on a budget of 1,600 hours per quarter (three months).
During the next three months, the number of direct labour hours is expected to be limited to 1,345 hours. The same labour is used for all products.
The marketing director has identified the maximum demand for each of the four products during the next three months as follows:

Liquid A: 200 litres
Liquid B: 150 litres
Liquid C: 100 litres
Liquid D: 120 litres
No inventories are held at the beginning of the period that could be used to satisfy demand in the period.

Required:
(i) Determine the number of litres of liquids A, B, C, and D to be produced and sold in the next three months in order to maximise profits.
(ii) Calculate the profit that this would yield.

(B) Suppose that a contract has been made before the beginning of the period by NexGen Ltd. and one of its customers, PrimeCorp. NexGen Ltd. has agreed to supply PrimeCorp with 20 litres of each A, B, C, and D during the three-month period.
This sales demand from PrimeCorp is included in the demand levels shown above in part (a) of the question.

Required:
(i) Given the contract with PrimeCorp, determine the number of litres of liquids A, B, C, and D to be produced and sold in the next three months in order to maximise profits, if the maximum number of labour hours remain 1,345 hours for the period.
(ii) Calculate the profit that this would yield.

Answer

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Tags: Contract Obligations, Contribution Analysis, Labour Hours, Limiting Factors, Production Planning, Profit Maximization
Level: Level 2

Topic: Decision making techniques

Tag (SQ): Contribution Analysis

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MA – L2 – Q70 – Performance analysis

Calculate the impact of three strategies on annual profit for Kumasi Ventures Ltd, each implemented independently.

MA – L2 – Q64 – Transfer Pricing

Evaluate transfer pricing objectives and calculate company contribution for Keta Fitness Ltd's divisions.

MA – L2 – Q52a – Relevant Cost and Revenue

Advise whether Okonku Enterprises should discontinue Double bed production based on contribution and profit impact.

MA – L2 – Q48 – Decision Making Techniques

Determine if BHIL should manufacture Zeta internally or buy it, given material constraints and government orders.

MA – L2 – Q47 – Decision Making Techniques

Establish production plan to maximize profit with steel limited to GH₵250,000, prioritizing a major customer's order.

MA – L2 – Q42 – Decision Making Techniques

Determine optimal production mix for four liquids with a contract obligation, maximizing profit within labour hour constraints.

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MA – L2 – Q70 – Performance analysis

Calculate the impact of three strategies on annual profit for Kumasi Ventures Ltd, each implemented independently.

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MA – L2 – Q64 – Transfer Pricing

Evaluate transfer pricing objectives and calculate company contribution for Keta Fitness Ltd's divisions.

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MA – L2 – Q52a – Relevant Cost and Revenue

Advise whether Okonku Enterprises should discontinue Double bed production based on contribution and profit impact.

You're reporting an error for "MA – L2 – Q52a – Relevant Cost and Revenue"

MA – L2 – Q48 – Decision Making Techniques

Determine if BHIL should manufacture Zeta internally or buy it, given material constraints and government orders.

You're reporting an error for "MA – L2 – Q48 – Decision Making Techniques"

MA – L2 – Q47 – Decision Making Techniques

Establish production plan to maximize profit with steel limited to GH₵250,000, prioritizing a major customer's order.

You're reporting an error for "MA – L2 – Q47 – Decision Making Techniques"

MA – L2 – Q42 – Decision Making Techniques

Determine optimal production mix for four liquids with a contract obligation, maximizing profit within labour hour constraints.

You're reporting an error for "MA – L2 – Q42 – Decision Making Techniques"

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