Accounting for Managers: Interpreting accounting information for decision-making

422 ACCOUNTING FOR MANAGERS

Table A2.13

Manufacture 100 Purchase 100

Direct labour 20,000

Direct material 60,000

Variable overhead 10,000

Supplier price 100,000

Total 90,000 100,000

10.7
An alternative format for these figures is as in Table A2.14.
This format shows the contribution, whichbased on the contribution after deducting
material is in fact highest for Franklin. However, calculating the contribution per labour
hour (by dividing the contribution by the numberof hours, i.e. labour cost divided by £100
per hour) verifies the lower contribution by Franklin per unit of the limiting factor, i.e.
labour capacity. This is reflected in the rate of gross profit being the lowest of the three
main customers.
The issues that arise from these figures are:

1 Labour is in effect a fixed cost given the circumstances of the business and its allocation to
different products is questionable, other thanin terms of determining the most profitable
utilization of the limited capacity.
2 Can the high labour cost for Franklin bereduced by mechanization given that Franklin
contributes almost 17% of total sales (£1, 000 , 000 /£6,000,000) with the highest contribution
margin of 75%?
3 While Engineering Partners and Zeta are the most profitable customers in the accountant’s
report, the revised format shows the highest contribution per labour hour from the ‘other’
customer segment. Zeta, which on the accountant’s figures appears more profitable than
Engineering Partners, is using the revisedformat, less profitable per labour hour.
4 Do the corporate overheads, presently allocated arbitrarily in proportion to sales volume
(30% of sales), accurately reflect the different cost structure of each segment of the business
in terms of space utilization (rent), capital investment in production processes (depreci-
ation), non-production salaries, selling and administration expenses? An activity-based
approach may lead to more meaningful allocation of costs and a different decision as to
the profitability of different business segments.

Table A2.14

Franklin

Industries

Engineering

Partners

Zeta PLC Other

customers

Total

(average)

Sales 1,000,000 1,500,000 2,000,000 1,500,000 6,000,000
Cost of materials 250,000 600,000 750,000 750,000 2,350,000

Contribution 750,000 900,000 1,250,000 750,000 3,650,000
% 75% 60% 62.5% 50% (60.8%)
Cost of labour 300,000 200,000 300,000 75,000 875,000

Gross profit 450,000 700,000 950,000 675,000 2,775,000
% 45% 46.7% 47.5% 45% (46.25%)
No. of hours (labour/£100) 3,000 2,000 3,000 750 8,750
Contribution per labour hour £250 £450 £417 £1,000 (£417)