Accounting Business Reporting for Decision Making

460 Accounting: Business Reporting for Decision Making

in an increase in variable marketing and administrative costs by $4 per unit, and would reduce

fixed marketing and distribution costs by $100 000.

i. Calculate the number of units required to break even if management implemented the

changes.

ii. Would you suggest management pursues the changes? Explain.

d. ‘CVP analysis is useful because it is so accurate.’ Comment on this statement.

Decision-making activities

10.58 Nardeb Company is a software producer and sales company. Currently, it pays all sales staff

on a fixed base salary. Recently, management has been considering switching sales staff across

to an incentive-based reward system. Nardeb’s chief accountant Polly Xu has prepared some

summarised numbers (see below) for senior management to consider.

Michael Day comments that he cannot see the difference, as the sales level and profit are

unchanged. Xu argues that it is the difference in cost structure that matters. She argues that the

entity is better off staying with the current structure, because the increase in profit is greater

when sales levels increase than it would be with the incentive rewards.

With fixed

rewards

With incentive

rewards

Sales

Variable costs

$2 500 000

1 500 000

$2 500 000

2 000 000

Contribution margin

Fixed costs

1 000 000

750 000

500 000

250 000

Profit $ 250 000 $ 250 000

Required

a. Explain the basis of Polly Xu’s argument.

b. Calculate the contribution margin ratio under each alternative.

c. If sales were to increase by 10 per cent, which alternative would produce the highest increase

in profit?

d. Prepare a statement of profit or loss for each alternative.

10.59 You are the adviser of a Junior Achievement group in a local high school. You need to help the

group make a decision about fees that must be paid to sell gardening tools at the Home and

Garden Show. The group sells a set of tools for $20. The manufacturing cost (all variable) is

$6 per set. The Home and Garden Show coordinator allows the following three payment options

for groups exhibiting and selling at the show.

a. Pay a fixed booth fee of $5600.

b. Pay a fee of $3800 plus 10 per cent of all revenue from tool sets sold at the show.

c. Pay 15 per cent of all revenue from tool sets sold at the show.

Required

a. Compute the break-even number of tool sets for each option.

b. Which payment plan has the highest degree of operating leverage?

c. Which payment plan has the lowest risk of loss for the Junior Achievement group?

Explain.

10.60 Spa Company produces plunge pools. Currently, the company uses internally manufactured

pumps to power water jets. Spa Company has found that 40 per cent of the pumps have failed

within their 12-month warranty period, causing huge warranty costs. Because of the company’s

inability to manufacture high-quality pumps, management is considering buying pumps from a

reputable outside supplier who will also bear any related warranty costs.