Accounting Business Reporting for Decision Making

434 Accounting: Business Reporting for Decision Making

(continued)

Lunch provided @ $30 per player Contract lunch @ $1200 per tournament

Contribution margin

($60 per player)

Less: Fixed costs

$2 400

1 800

Contribution margin

($90 per player)

Less: Fixed costs

($1 800 + 1 200)

$3 600

3 000

Profit $ 600 Profit $ 600

The statement of profit or loss show that at a sales level (number of players) of 40, Nicholas at ATC

would be indifferent to either lunch strategy as profits are identical. However, if the sales level changed,

ATC’s preference would change due to the difference in the contribution margin offered by each option.

For example, if sales (number of players) fell below 40, ATC would prefer to go with the per player

lunch option as profits would fall by only $60 per player due to the lower contribution margin. However,

beyond 40 units (or players), ATC would prefer the contract lunch option as profits would increase by

$90 per unit (player) due to the higher contribution margin. The change in profit is able to be explained

by the change in contribution margin.

The reality check ‘Cost structure at General Motors’ highlights the issues in relation to high operating

leverage due to high fixed cost structure. For General Motors to grow profits, high volumes of output were

necessary and unfortunately General Motors was unable to use nearly a third of its production capacity.

REALITY CHECK

Cost structure at General Motors

The demise of General Motors (GM) had been expected for some time. While the global financial crisis

impacted heavily on industries and companies around the world, it brought to a head the problems con-

fronting the motor vehicle industry and in particular those confronting GM. GM was placed into bank-

ruptcy protection in the United States in June 2009 triggering the largest industrial bankruptcy in history.

At the time, GM had assets of US$82.2 billion and liabilities of US$172 billion. While a range of factors

were used to explain the demise of GM, a number of observations can be made which are relevant to

issues in this chapter.

The initial plan for GM was to emerge from bankruptcy after eliminating 14 factories, 2400 dealers,

21 000 hourly-paid jobs, 8000 white-collar jobs and US$79 billion in debt. Government monetary assis-

tance was necessary to facilitate this. These significant actions suggest that over the years GM (along

with other car manufacturers) had added levels of capacity and bureaucracy that were unsustainable

in the longer term. Combined with what appears to have been a focus on wide-of-the-mark car design,

changing market conditions and a dynamic competitive environment, GM had a cost structure that made

it difficult to generate profits at any level of production, which highlights the operating leverage problem.

The industry needed to downsize. At the time of the GM bankruptcy, it was estimated that there was

enough global capacity in the industry to produce 90 million vehicles per year; yet annual demand was

around 60 million vehicles. Much of this oversupply in capacity was likely to be represented in the form of

fixed costs. Consequently, as demand fell there was relatively little alteration in costs. GM had to reduce

its break-even point. GM’s chief financial officer stated, ‘We do need to bring down our break-even level’.

By 2010 and 2011, GM was able to generate profits of US$4.7 billion and US$7.6  billion respec-

tively. Parts of its operations (e.g. Europe) were still unprofitable, but its outlook was brighter, and it

was hoping to achieve profits again in Europe by 2016. Today, GM continues to address challenges

associated with its cost structure. The company, which is still owned 32 per cent by the US government,

appears to be on the right track to recovery — at least for now.

Sources: Adapted from Buckley, C 2009, ‘General Motors losses hit $6bn as cash burn grows’, Times Online, 7 May,

http://www.timesonline.co.uk; The Economist 2009, ‘The decline and fall of General Motors: Detroitosaurus wrecks’, 4 June,

http://www.economist.com; The Economist 2009, ‘A giant falls: the bankruptcy of General Motors’, 4 June, http://www.economist

.com; Reed, J & Bond, B 2012, ‘GM earnings hit record $7.6bn in 2011’, Financial Times, 16 February, http://www.ft.com;

‘GM posts its best U.S. October sales since 2007’, GM media release, October 2014, media.gm.com/media/us/en/gm/

news.detail.../1001-gm-plan.html.