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Herrestad Company, managerial accounting

Herrestad Company managerial accounting
Introduction
Module 1-SLP
Question One responses
(A) Contribution margins
Contribution Margin refers to the accounting concept that a firm to determine the profitability of individual products. It is normally obtained by finding the discrepancy between the difference between total sales revenue and total sales variable cost hence, contribution margin is also refered to gross profit (Davis,& Davis, 2012)..From the above situation contribution margin may be computed as follows:
Computation for contribution margin.
Sales    (8,000units×$ 250)                                                                                                $ 2,000,000
Less (-) variable expenses
Direct materials (8,000units×$100)                                   $800,000
Direct labor         (8,000units×$50)                                    $400,000
Variable overheads (8,000units×$30)                              $240,000
Variable selling and administrative (8,000unit×$10)       $80,000   ($1,520,000)
Contribution Margin                                                                                             $ 480,000
(-)Less fixed expenses
Fixed manufacturing overheads                                                   $200,000
Fixed selling and administrative                                                  $100,000   ($300,000)
Net operating Income                                                                                             $180,000
 
Contribution margin as a percentage is computed as = (contribution margin ÷ sale price)                  × 100
Contribution Margin as a percentage = ($480,000 ÷ $ 2000,000) × 100
=$  24%
Additionally Contribution margin ratio (CR ratio) may be calculated as follows:
Contribution Margin Ratio= (Unit Contribution margin ÷ Unit selling price) × 100
Unit contribution margin=revenue per unit – variable expenses per unit
=$250-$190
=$60
Unit selling price =$250
Therefore, contribution Margin ratio CR (ratio) = ($60÷$250) × 100
=24%
Interpretation
Based on the above computation, after subtracting total variable cost from our sales, we obtained an annual contribution ratio of 24% this means that, for each dollar of sales there is 24% that is left to contribute towards direct cost and profits. Additionally, the contribution margin of 24% will help towards covering the variable cost and will also give a net operating income. In above connection; the 24% margin will enable decision makers to compute the break even points for the above product. This will be important because managers will be able to know how many units the company should sell and produce in order to make profits.
Second version whereby selling price per unit is 280
Cost of goods sold =opening stock inventory + purchases-closing stock
Cost of goods sold=$1,600,000
Selling and administrative expenses=fixed selling and administrative expenses + unit                                                                    sold × variable selling and administrative cost
Selling and administrative expense=$100,000+ (8,000 ×$10)
=$180,000
 
 
Herrestad Company
Adjusted Absorption Income Statement
For the year ending 31st December, 2011
Sales   (8,000×$280)                                 $2,240,000
Cost of goods sold                                         1600,000
Gross Profit (Margin)                                       $640,000
Less (-) selling and administrative expenses   (180,000)
Net Income                                                     $460,000
After the adjustment whereby, the selling price per unit changed from $250 to $ 280, net operating income increased from $220,000 to $460,000 a difference of $240,000.The above situation indicates that, when the selling price is increased the company is able to meet the cost of sale as well as the selling and administrative charges and hence, more profits will be made.
 
Contribution margin when unit selling price is $280 will be as follows:
Sales   (8,000units×$ 280)                                                                                                $ 2,240,000
Less (-) variable expenses
Direct materials (8,000units×$100)                                   $800,000
Direct labor         (8,000units×$50)                                    $400,000
Variable overheads (8,000units×$30)                              $240,000
Variable selling and administrative (8,000unit×$10)       $80,000   ($1,520,000)
Contribution Margin                                                                                             $ 720,000
(-)Less fixed expenses
Fixed manufacturing overheads                                                  $200,000
Fixed selling and administrative                                                  $100,000   ($300,000)
Net operating Income                                                                                                 $420,000
 
Contribution margin as a percentage is computed as = (contribution margin ÷ sale price)                   × 100
Contribution Margin as a percentage = ($720,000 ÷ $ 2240, 000) × 100
=$  32.14%
Additionally Contribution margin ratio (CR ratio) may be calculated as follows:
Contribution Margin Ratio= (Unit Contribution margin ÷ Unit selling price) × 100
Unit contribution margin=revenue per unit – variable expenses per unit
=$280-$190
=$90
Unit selling price =$280
Therefore, contribution Margin ratio CR (ratio) = ($90÷$280) × 100
=32.14%
An interpretation for the above Contribution Margin Ratio
From the above computation, after subtracting total variable cost from our sales, an annual contribution of 32.14% will be obtained. This means that, for each dollar of sales there is 32.14% that is left to contribute towards direct cost and profits. Additionally after an increment in unit selling cost, the percentage contribution margin increased from 24% to 32.14% this indicate that, the company power to offset variable cost is increasing substantially. Contribution margin therefore, is a vital tool in the sense that, it can help corporate managers to determine whether to keep or drop certain aspects of the business .For example if there is a positive contribution margin like in this case, the margin should be maintained even if it result to negative profits. On the contrary, if the contribution margin is negative it should be drop because it would make the company to suffer losses for each unit it produces (Hermanson, Edwards, J.D., & Invacevich, 2011). Therefore, in the above case, the contribution margin should be maintained because it results to profits for each unit of commodity the company produces. In above connection the managers of Harvested Company can be able to compute the break even point more easily and target the income sales and make better decisions on whether to add or subtract a product line.
(A)Computation of the number of units the company must sell to break even for the year:
Break even points refers to the number of units that must be sold in order to make a company to meet its operating. At break-Even point a company is only able to meet its operating cost without making profits or losses. Any point above the break-even point the company starts making profits. On the contrary any point below the break even point the company starts making losses (Maher, Stickney & Weil, 2012).
At break even, total revenues (sales) – total cost =zero profits
The formula for computing break-even points is as follows.
Break Even Point= Fixed Cost ÷ (Selling price-Variable Cost).
Break Even Computation when selling price is $250
Fixed cost
 

Fixed manufacturing overheads                                                   $200,000
Fixed selling and administrative Cost                                          $100,000
Total fixed cost                                                                                $300,000
Variable Cost
Direct material                                                                                 $100
Direct labor                                                                                     $50
Variable Overheads                                                                        $30
Variable selling and administrative cost                                         $10
Total Variable Cost                                                                       $190
Therefore, break even point = $300,000÷ ($250–$190)
= 5000 Units
 
Harvested Company
Annual Profit and Loss Statement
Year Ended 31st December 2011
Sales
Gross Sales                                      ($250×5000)             $1,250,000
Less (-) Cost of goods Sold            ($190×5000)                        ($950000)
Net Sales                                                                                                        $300,000
Less (-) Expenses
Fixed manufacturing Overheads                                      $200,000
Fixed and Administrative expenses                                 $100,000                   ($300,000)
Net Profit                                                                                                                            $0
 
An analysis for the above Break-even Point
To break even, the company must sell 5000 Units per annum. In above connection, the annual financial statement of Harvested Company clearly indicate that, at break even point, the company will be making zero profits($0).This means that, the company is neither making profits nor losses and hence, the company is only able to meet its operating cost without making profits (Davis & Davis, 2012. Additionally, if the Harrested Company starts producing any units above 5000units, the company will start making profits. On the contrary, if the Harrested Company starts making any units below 5000units, the company will start operating at a loss. Therefore, break-even point plays a very vital role because it act as an important tool that help decision makers to know which measure should be put in place so that the company can continue making profits. Connectively, the company will be in a position of taking advantage of already available opportunities for investment. Additionally, managers will be able know at which point the company start operating at a loss and hence necessary measures are put in place to arrest the adverse situation that may occur.
 
 
(C)Computation of Break-even Points given the assumption that, direct material cost increased from $ 100 to $ 120.
Break Even Computation when selling price is $250
Fixed cost
 

Fixed manufacturing overheads                                                   $200,000
Fixed selling and administrative Cost                                          $100,000
Total fixed cost                                                                                $300,000
Variable Cost
Direct material                                                                                 $120
Direct labor                                                                                     $50
Variable Overheads                                                                        $30
Variable selling and administrative cost                                         $10
Total Variable Cost                                                                       $ 210
Therefore, break even point = $300,000÷ ($250–$210)
= 7500 Units
 
 
Harrested Company
Annual Profit and Loss Statement
Year Ended 31st December 2011
Sales
Gross Sales                                      ($250×7500)             $1,875, 000
Less (-) Cost of goods Sold            ($210×7500)                        ($1,575,000)
Net Sales                                                                                                        $300,000
Less (-) Expenses
Fixed manufacturing Overheads                                      $200,000
Fixed and Administrative expenses                                 $100,000                    ($300,000)
Net Profit                                                                                                                            $0
Interpretation
After the direct material cost increasing from $ 100 to $ 120 the company must produce 7500 unit to break even. At this juncture, the company is neither making profits nor losses. But if this company tends to lower its production units below 7500units, the company will start operating at a loss. Additionally, if this company tends to produce above 7500 units the company will start making profits. The above change indicates that, if the cost of direct material cost is increased, the company must produce more additionally units to be at the break even point. Additionally, if the company managers think that the company may not make substantial profits when producing 7500 units, the managers should ensures that, they reduce the fixed cost. This may be done by trying to carry out necessary reduction on both fixed manufacturing overheads and administrative expenses. Connectively, corporate managers may try and see how they can reduce variable cost by finding less expensive suppliers who can supply direct materials at a subsidized price (Warren, Reeve & Duchac, 2012). Finally, the corporate managers may further the selling price of product A and product B. But prior to the increment in selling prices of the two products, the managers should analyze other prices within the same market they are operating. This will be important because, it will help to avoid losses that may arise as a result of lack of customers who may be willing to purchase the products at predetermined prices.
Module 2-SLP
Activity Based Costing (ABC) also known as activity based costing. This type of costing assumes that activities causes cost and that cost objects create the demand. On the contrary, conventional costing systems assume that, products cause cost. There had been controversies’ of whether activity based costing have been able to overcome deficiencies of tradition costing. Some of those deficiencies include inability to successfully incorporate capital intensive methods of production and rather fully relying on labor intensive. There are three major discrepancies between activity based costing and traditional costing. Traditional costing assumes that, cost objects consume resources while on the other hand, activity based costing assumes that, cost objects consume activities. Another discrepancy is that, traditional costing utilizes volume related allocation bases while activity based costing utilizes drivers at various levels. Additionally, traditional costing is structure directed while activity based costing is process oriented (Bradtke, 2007). Therefore, because of important insight that activity based costing delivers, this costing is going to be applied in the allocation of cost to product A and product B. Some of those advantages of using Activity based costing in cost allocation include; It eliminate product cross subsidies inherent in cost accounting, it is able to reveal the causes of losses that lead to a fall in profitability of the company. Finally, it acts as an enzyme or a catalyst for decision affecting profitability of the firm (Bradtke, 2007).
 
Herrestad Company
Segmented Income Statement
Year ended 31st December 2011
                             Product A                           Product B          Totals
Sales                                       $920,000              $1,080,000               $2,000,000
Less (-) Variable Cost  
Direct Material          $560,000                   $240,000                 $800,000
Direct labor                $100,000                    $300,000                 $400,000
Variable overhead     $90,000                    $150,000                 $240,000
Variable selling &
Admin.Expenses       $26,000 ($776,000)   $54,000 ($744,000) $80,000     ($152,000)
Contribution Margin                 $144,000                   $336,000              $1848, 000
Less (-) Fixed Costs
Fixed manufacturing
Overheads                $200,000                 $200,000                   $200,000
Fixed selling and
AdminOverheads     $100,000                 $100,000                       $100,000
Production runs         $130,000 ($430,000) $210,000 ($510,000 $800,000 ($1100, 000)
Net operating Income/loss     $(286,000)                ($174,000)                   $748,000
Comments
The above results indicate that, the company is doing well irrespective of having a negative net operating income for individual products this is because, the contribution margin is positive (Bradtke, 2007). Therefore, the company should continue producing the product but increase the production units for product B. The above results further indicate that, more loess are incurred to produce and sell product A unlike the losses made on product B. In order for this company to reduce the above losses the following need to be carried out: The Company should reduce abnormal losses by reducing unit losses as well as the value losses that the company is susceptible to incur.
Module 3-SLP
Relevant Cost those are cost which are used for decision making. Those costs are some times referred to cost appropriate to aid the making of specific managerial decisions. For a cost to affect a decision the cost must have the following attributes: incremental, future and cash flows. Incremental means that expenditure which can be incurred and can be avoided as a result of decision making, such cost would be incurred whether or not the decision made are not said to be incremental to the decision.Fure means that, past cost are not relevant as they can not be affected by the current decision and are usually common to all the alternatives that may be chosen (Warren, Reeve & Duchac, 2012). Finally, Cash flow in this particular context means that, expenses such as depreciation are not cash flows and are therefore not relevant.Additionally,book value for existing equipment are irrelevant but on the contrary, disposal value is relevant.Therefore,relevant cost will be the sum of   avoidable cost outlay and opportunity cost.avodable cost outlay are those cost that can be incurred if only the book project will be approved on the contrary, opportunity cost are benefits forgone for choosing a particular alternative instead of another. Below are the assumptions of relevant cost cost behavior pattern are known. This means that, if a department is closed down the associated cost savings will be known. The amount of fixed cost, unit cost, demand and sales are known with a lot of certainity.The short term profits are the major objectives for decision making in this scenario.Additionally,the information upon which the decision is based is complete and reliable (Davis,& Davis, 2012).
(a). List of expenses and amount that are relevant
Direct Material
Direct labor
Variable Overheads
Below is the computation for relevant cost for product C in Herrestad Company
Product C                                                          
Selling price per unit                                                       $150
Direct Material (40-12)                   $28
Direct labor                                         $50
Variable Overheads                         $25
Total relevant Cost                                                          ($106)
Contribution Margin                                                             $44
Units produced                                                            1000 units
Total Contribution margin                                                                  $44,000
The relevant cost is the variable selling and administrative costs which in this case are not going to be incurred. All other variable costs are sunk, since the units have already been produced. The fixed costs would not be relevant, since they will not be affected by the sale of leftover units. Sunk cost is those cost which have already been incurred and can not be recovered. Unlike other cost, sunk cost is independent from any event that may occur in the future because they had already been incurred. In this case our sunk cost is direct material, direct labor and variable overheads.
 
(b)If the company only pays $140 per unit, the following will happen
Selling price                                                     $150
Total relevant cost per unit                             ($140)
Contribution margin                                         $10
Units produced                                                1000units
Total Contribution margin                               $10,000
The total contribution Margin will substantially fall by $33,000 as result of increase in variable cost, this trend will be unsuitable for the company and therefore the company will need to change its decision with regard to production of product This further means that, if the company continues with this trend, substantial losses will be made and this will in turn leads the company to go under.
(c)       If I am the manager for Herrestad Company, in the short run, I will accept the order because my company contribution margin will still be positive. This means that, my company will be able to meet its operating cost even if it is not able to make enough profits. However, in the long run, I would not accept the order because even if my company is able to make some profits, contribution margin is compromised. This means that in the long run my company will have a negative contribution margin and it will start operating at a loss (Maher, Stickney & Weil, 2012).. Therefore as a portfolio manager, I will accept the order in the short run as I look for other investment portfolios to diversify the anticipated risk which might accrue in the long run.
 
Conclusion
The above paper had captured the computation of contribution margin in the first module whereby, the contribution margin and contribution margin ratios have been computed and necessary interpretations for the outcomes were made with regard to how they affect the profitability derived from each individual product. Additionally, the section has captured the computation of adjusted income statements of Herrestad Company as well as calculations and interpretation of break even points. In the second module, The Activity Based costing has been applied to allocate cost to product A and Product B. Finally, the last module had captured the computation and analysis of relevant cost for Herrestad Company.

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