This is the second year that your class has successfully bid for a stall in the Lunar New Year Fair in Victoria Park. Last year the trading results were just slightly better than breakeven, the target for this year is to make further improvement. The strategy is the same as last year to sell one licensed product (Model A) and two types of hand-made products (Models B and C) created by your class.
Based on experience in last year and the current sourcing of materials,
Chairman of the class committee produces a drafted income statement as
follows:
TopicA09: Cost Accounting for Decision-making Student Worksheet p.2
Draft Income Statement
Model A
(2,000 units)
Model B (1,000
units)
Model C (700 units)
Total
$ $ $ $
Sales 40,000 30,000 35,000 105,000
Less: Cost / Expenses
Purchase cost 17,000 -- -- 17,000
Materials -- 26,000 18,200 44,200
* Materials for fixing and decorating the whole stall
1,000 1,000 1,000 3,000
Royalty charge of $2.5 per unit sold
5,000 -- -- 5,000
One set of special loose tools
-- 1,000 -- 1,000
Hire charge of a special equipment
-- -- 4,800 4,800
* Transportation expense 1,600 1,600 1,600 4,800
* Rental of the stall 7,000 7,000 7,000 21,000
31,600 36,600 32,600 100,800
Net Profit / (Loss) 8,400 (6,600) 2,400 4,200
* Expenses for the entire operation are apportioned equally among the three
models.
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Activity 1: Discussion
The class committee executive team had a meeting today to discuss the above statement. A member raised the point that since Model B incurs a net loss of
$6,600, if the class is not to sell this model and to save all costs, the total net profit can be more than $4,200.
Discuss in your group whether all costs of Model B can be eliminated in case this model is dropped. Write your opinion in the table below.
Cost item of Model B Cost can be eliminated if Model B is dropped
(Yes or No)
Explanation
Materials ($26,000)
Materials for fixing and decorating the whole stall ($1,000)
One set of special loose tools ($1,000)
Transportation expense ($1,600)
Rental of the stall ($7,000)
Hint: Does the class still need to pay the costs concerned if Model B
is not sold?
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Activity 2: Discussion
As some costs of Model B cannot be eliminated even by dropping the model, it may be unwise to decide not selling Model B at this moment. The Treasurer is requested to revise the income statement drafted by the Chairman. He prepares an income statement under marginal costing to reflect the true picture of the trading results of the three models.
Consider which of the following income statements will be selected by the Treasurer to cause a drop out decision of Model B.
Format 1 Model A
$
Model B
$
Model C
$
Total
$
Sales 40,000 30,000 35,000
Less: Variable cost Expense A Expense B
xx xx
xx xx
xx xx
Contribution xxx xxx xxx xxxx
Less: Fixed cost Expense C Expense D Expense E Expense F Expense G Expense H
xx xx xx xx xx xx
Net profit / (loss) xxx
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Format 2 Model A
$
Model B
$
Model C
$
Total
$
Sales 40,000 30,000 35,000
Less: Variable cost Expense A Expense B
xx xx
xx xx
xx xx
Contribution xxx xxx xxx
Less: Specific fixed cost Expense C Expense D Expense E
xx
xx
xx Contribution after
specific fixed cost
xx xx xx xxx
Less: General fixed cost Expense F Expense G Expense H
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Activity 3: Preparation of Income Statement to facilitate Drop Out Decision of Model B of the Lunar New Year Stall Case
Task 1
Classify the following costs on the income statement on P.2 into variable costs, specific fixed costs and general fixed costs. This classification of costs will facilitate the preparation of the revised income statement.
Purchase cost of Model A
Material cost of Models B and C
Material cost for fixing and decorating the whole stall
Royalty charge of Model A
Special tools for Model B
Hire charge of a special equipment for Model C
Transportation expense
Rental of the stall
Variable cost
Specific fixed cost
General fixed
cost
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Task 2
As if you are the Treasurer, prepare a revised income statement to present the trading results of the three models. Then, give your recommendation on the drop out decision of Model B.
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Further discussion about The Lunar New Year Sales – the selling of additional product, Model D
Activity 4 – Costs of Materials of Model D
As Model B earns a positive contribution after specific fixed costs of $3,000, the class committee executive team decides that the model should not be dropped. However, the team hopes to raise profit by $4,200. Some members suggest that another hand-made product, Model D, be introduced during the Lunar New Year sales to potentially produce a profit.
To make the decision on whether to sell Model D, its costs have to be estimated by the Treasurer. The product requires Material X and Material Y. The following information is about the costs of these two materials:
1. No need to purchase Material X because there is $20,000 of material still
available from last year’s Lunar New Year Fair. If the material is not used, it
will be discarded by the end of the academic year.
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2. Leftovers of Material Y purchased at $ 22,000 for Last year’s Lunar New Year is just enough to make Model D. However, Material Y is a popular material and used frequently by various class activities. If material is unavailable, then a new $23,000 purchase must be initiated.
Required: Identify the material costs which are relevant to the sales decision making of Model D.
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Activity 5 – Additional charges of general fixed costs arising from the sales of Model D
Following the introduction of Model D in Lunar New Year sales, the general fixed costs are examined using the following data:
1. Material costs for fixing and decorating the stall
In order to highlight Model D, instead of using the original material which costs $3,000, special material will be purchased for decorating the stall. The new materials cost $4,000.
2. Transportation expense
The original transportation expenses of $4,800 represent hiring a van for transporting the products of Model A, Model B and Model C from school to the event.
As an additional Model D product must be delivered to the New Year sales stall, a bigger van must be hired. But the hiring fee is too expensive.
Fortunately, the other class which has also successfully bid for a sales stall offers a free transport of Model D for your class. The transportation van fee of $7000 will be paid by the other class.
Required: Identify the incremental costs of decoration materials and
transportation expenses on the assumption that Model D is to be
sold at the event.
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Activity 6 – Selling of Model D in Lunar New Year Fair
A class committee meeting is held to make a decision on whether to sell Model D in Lunar New Year Fair. In the meeting, the Treasurer reports his estimated costs e.g material costs, for the model. Furthermore, he estimates 1,500 units of Model D to be sold in the Lunar New Year sales. Sales revenue of $22,500 will then be earned.
Required:
Advise whether Model D should be sold in Lunar New Year Fair.
(Hint: 1. If the sales of Model D can bring in a profit, it is worthwhile to add it in the Lunar New Year Fair. Profit means that the sales revenue of Model D, $22,500, exceeds its costs.
2. Refer to the cost estimations in activity 1 and activity 2)
