Cost and Decision-Making Analysis

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Cost and Decision-Making Analysis

Jazmine Newsome

Managerial Accounting

Argosy University

Dr. Denel Pierre

Cost and Decision-Making Analysis

Company Costing plays a very vital role in managerial decision making by determining how an organization reaches its goals. Costs levels have a great impact on the finances of the business that must be thoroughly analyzed and managed. Legitimate data of actual costs is the primary element in business operations so that the organizations are able to accomplish their goals and ultimately reach their projected targets (Markgraf, n.d.). This cost decision-making analysis will cover three segments, the break-even point in total sales, break-even point per unit analysis, and a costing system evaluation for Piedmont Fasteners Corporation.

Break-Even Point in Total Sales Analysis

The break-even analysis is conducted to discover the volume of sales at which the

business earns zero dollars. The contribution margin that is earned is what is needed to cover

the fixed costs of the organization. The contribution margin is the outcome of all variable expenses subtracted from the total organization revenue. The break-even point has been reached when the contribution margin on each individual sale matches the total fixed costs amount that is in incurred in a reporting period. All of the sales above the break-even point are direct

contributions to organization profits (Bragg, 2015)

Overall Break-Even Sales Analysis for Piedmont Fasteners Corporation

 
       
Product Units Sold Selling Price Per Unit Sales
Velcro 100,000 $1.65 $165,000.00
Metal 200,000 $1.50 $300,000.00
Nylon 400,000 $0.85 $340,000.00
Total Sales     $805,000.00
       
   
       
Product Variable Cost Per Unit Units Sold Variable
Velcro 1.25 100,000 $125,000
Metal 0.7 200,000 $140,000
Nylon 0.25 400,000 $100,000
Total Variable     $365,000
       
 
       
  Total Sales Total Variable Total
Contribution Margin $805,000 $365,000 $440,000

Formula: CM Ratio = Contribution margin/sales

  Contribution Margin Sales Total
CM Ratio $440,000 $805,000 .5466

Formula: Dollars sales to break even = Fixed expenses/CM ratio

  Total Sales CM Ratio Total
Dollar sales to break even $400,000 .5466 $732,000

Break-Even Point Per Unit Analysis

The prime issue with calculating the break-even point is figuring out how to incorporate the common fixed costs for each individual unit. The most effective and efficient approach to this is not include the common fixed costs. The break-even points will be inflated for each individual unit which can result in managers deciding to drop certain products that actually reflect profits.

Overall Break-Even Unit Analysis for Piedmont Fasteners Corporation

Break-even point for each unit is calculated using the contribution margin method:

  Velcro Metal Nylon
Unit selling price $1.65 $1.50 $0.85
Variable costing per unit $1.25 $0.70 $0.25
Unit contribution margin (A) $0.40 $0.80 $0.60
Product fixed expenses (B) $20,000 $80,000 $60,000
Unit sales to break even (B)/(A) $50,000 $100,000 $100,000

Using the calculations above with the exact break-even quantity of each product, the company

would take a net loss of $240,000. (See results below)

  Velcro Metal Nylon Total
Unit sales $50,000 $100,000 $100,000  
Sales $82,500 $150,000 $85,000 $317,500
Variable expenses $62,500 $70,000 $25,000 $157,500
Contribution margin $20,000 $80,000 $60,000 $160,000
Fixed expense       $400,000
Net operating income       -$240,000

The results above may seem a bit unsettling for managers and might not make much sense. The

total sales by the individual unit break-even results are only $317,500 whereas the overall break-

even results were $732,000. A resolution to this issue is to allocate the common fixed costs that

are associated with the products before actually calculating the break-even point per individual

unit.

Allocated Fixed Costs Expenses Based on Sales Revenue:

  Velcro Metal Nylon Total
Unit sales $165,000 $300,000 $340,000 $805,000
Total sales percentage 21% 37% 42% 100%
Allocated common fixed expenses $49,193 $89,441.00 $101,366.00 $240,000
Products fixed expenses $20,000 $80,000 $60,000 $160,000
Allocated common fixed and product fixed expenses (A) $69,193 $169,441 $161,366 $400,000
Unit contribution margin (B) $0.40 $0.80 $0.60  
Units sold break-even point (A)/(B) 172,983 211,801 268,943  

If the company is able to sell the above break-even point calculation totals shown above, they

would in fact break-even overall. The conflict however, that two of the products which are the

Velcro and Metal product break–even points are actually higher than the normal average of annual sales.

Based off of these results, it would be understandable for managers to make the decision of

discontinuing both products and concentrate on the Nylon product. (See figure breakdown

below)

  Velcro Metal Nylon
Normal average sales $100,000 $200,000 $400,000
Annual break even sales $172,983 $211,801 $268,943
Management Decision Discontinue Discontinue Continue

Even though discontinuing the Velcro and Metal products appears to be a logical decision based off the outcomes above, consequently this would actually be a long-term mistake. Managers basing their decision off the above figures would in fact show a lost of $60,000. (See results below)

  Velcro Metal Nylon Total
Unit sales Discontinued Discontinued $340,000 $340,000
Variable expenses     $100,000 $100,000
Contribution margin     $240,000 $240,000
Fixed Expenses       $300,000
Total net income       -$60,000

By dropping both the Velcro and Metal product lines only reduces the fixed expenses from

$400,000 to $300,000. The Velcro and Metal product was contributing $100,000 towards the

organization profits and the total fixed expenses. Even though the annual break even sales

outweighed the normal average sales results, keeping all of the current products in production

did in fact produce a profit of $40,000 verses dropping the Velcro and Metal products resulting

in a net loss of $60,000. (See results below)

  Velcro Metal Nylon Total
Unit sales $165,000 $300,000 $340,000 $805,000
Variable expenses $125,000 $140,000 $240,000 $365,000
Contribution margin $40,000 $160,000 $240,000 $440,000
Product fixed expenses $20,000 $80,000 $60,000 $160,000
Product segment margin $20,000 $80,000 $180,000 $280,000
Common fixed expenses       $240,000
Total net income       $40,000
Velcro + Metal Contributions   $100,000    

Costing Systems Evaluation

A process-costing system is an accounting method developed to allocate manufacturing

costs equally to each product that is being produced. Organizations that benefit from this

method usually produce a mass amount of either similar or identical products on a consistent basis. The job-costing method is another accounting method used to allocate manufacturing costs which are assigned to each individual product. This method is generally adopted by companies interested in analyzing the variation of manufacturing costs that are associated with different products and services they offer (Brewer, Garrison, and Noreen, 2012).

Job-order costing would be the most beneficial option for Piedmont Fasteners Corp. based upon three different determinations. Since the organizations products are not similar in nature and the costs vary, this type of method would be recommended for the organization to consider. Secondly, costs at the organization are not accrued by a department, but are accrued by each product individually. Thirdly, costs are not calculated by department they are calculated per job on the job-costing sheet (Brewer, Garrison, and Noreen, 2012).

References

Brewer, P.C.,Garrison, R.H., & Noreen, E.W. (2012). Managerial Accounting 14th ed.

McGraw-Hill Irwin. New York, NY.

Markgraf, B. (n.d.). Importance of costing in managerial decision making. Small Business

Chron. Retrieved from http://smallbusiness.chron.com/importance-costing-managerial-decision-making-51739.html




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