Adapted trom ROBERT S KAPLAN INCOM Company The decline in our profits has become
ID: 2601756 • Letter: A
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Adapted trom ROBERT S KAPLAN INCOM Company The decline in our profits has become intolerable The severe price cuming in pumps has dropped ourpre-ta margin to less than 3%, far below our histoncal 10% margins. Fortunately, our competitors are overlooking the opportunities for profit inflow controllers. Our recent 10% price increase in that line has been implemented without losing any businets. Robert Johnson, president of the INCOM Company, was discussing operating results in the latest month with Ahmed Khan, his controller, and John Scott, his manufactring manager. The meeting among the three was taking place in an atmosphere tinged with apprehension because competitors had been reducing prices on pumps, INCOM's major product line. Since pumps were a commodity product, Johnson had seen no altemative but to match the reduced prices to maintain volume. But the price cuts had led to declining company profits, especially in the pump line (summary operating results for the previous month March 2016, are shown in Exhibits 1 and 2). INCOM supplied products to mamfacturers of water purification equipment. The company had started with a unique design for valves that it could produce to tolerances that were better than any in the incustry Johnson quickly established a loyal customer base because of the high quality of its manufactured valves. He and Scott realized that INCOM's existing labor skills and machining equipment could also be used to produce pumps and flow controllers, products that were also purchased by its customers. They soon established a major presence in the high-volume pump product line and the more customized flow controller line. INCOMs production process started with the purchase of semi-finished components from several suppliers. It machined these parts to the required tolerances and assembled them in the company's modern manufacturing facility. The same equipment and labor were used for all three product Lines, and production rms were scheduled to match customer shipping requirements. Suppliers and customers had agreed to just-in-time deliveries, and products were packed and shipped as completed. Valves were produced by assembling four different machined components (2 components of L12 and 2 of L15). Scott had designed machines that held components in fixtures so that they could be machined automatically. The valves were standard products and could be produced and shipped in large lots. Although Scott felt several competitors could now match Johnson's quality in valves, none had tried to gain market share by cutting price, and gross margins had been maintained at a standard 35%. The manufacturing process for pumps was practically identical to that for valves. Five components G components of L12 and 2 of L14) were machined and then assembled into the final product. The pumps were shipped to inchustrial product distibutors after assembly. Recently, it seemed as if each month brought new reports of reduced pnces for pumps. INCOM had matched the lower prices so that it would not give up its place as a major pump supplier. Gross margins on pump sales in the latest month had fallen below 20%, well below the company's planned gross margin of 35%. Flow controllers were devices that controlled the rate and direction of flow of chemicals. They required more components and more labor, than pumps or valves, for each finished unit. Each Flow controller required 4 components of L16, 5 components of L12 and 1 component of L21. Also, there was much more variety in the types of flow controllers used in industry, so many more production runs and shipments were performed for this product line than for valves. NCOM had recently raised flow controller prices by more than 10% with no apparent effect on demand.Explanation / Answer
[(X*1.05)+(Y*1.05)]={X+Y)*1.05
WHERE X AND Y ARE COST OF MATERIAL X AND MATERIAL Y CONSUMED
CALCULATING THE REVISED COSTS:
VALVES
PUMPS
FLOW CONTROLLERS
MATERIALS PER UNIT
$16*1.05= $16.80
$20*1.05= $21
$22*1.05= $23.10
DIRECT LABOUR COST
10
12.5
10
MANUFACTURING OVERHEAD
30
37.5
30
STANDARD UNIT COSTS (A)
56.80
71
63.10
PLANNED GROSS MARGIN (B)
35%
35%
35%
TARGET SELLING PRICE (A)/(B)
85.71
107.14
85.71
(2)
CONTRIBUTION MARGIN INCOME STATEMENT FOR MARCH 2016
VALVES
PUMPS
FLOW CONTROLLERS
MATERIALS PER UNIT
16
20
22
DIRECT LABOUR COST
10
12.5
10
OVERHEAD COST( AS CALCULATED BELOW)
16.01
19.78
48.59
TOTAL VARIABLE COST (A)
42.01
52.28
80.59
TARGET SELLING PRICE(B)
86.15
107.69
95.38
CONTRIBUTION
(B)-(A)
44.14
55.41
14.79
OVERHEAD COSTS PER UNIT
TOTAL
% VARIABLE
VARIABLE COST $
COST DRIVER
UNITS OF COST DRIVER
COST PER UNIT OF COST DRIVER
MACHINE RELATED EXPENSES
336000
80%
268800
MACHINE HOURS
11200
24
SETUP LABOUR
40000
0%
0
PRODUCTION RUNS
160
0
RECEIVING AND PRODUCTION CONTROL
180000
90%
162000
PRODUCTION RUNS
160
1012.50
ENGINEERING
100000
0%
0
HOURS OF ENGINEERING WORK
1250
0
PACKAGING AND SHIPPING
150000
50%
75000
NUMBER OF SHIPMENTS
300
250
GENERAL, SELLING AND ADMIN. EXP.
559650
10%
55965
NUMBER OF UNITS
24000
2.33
ALLOCATION OF OVERHEAD
VALVES
PUMPS
FLOW CONTROLLERS
MACHINE RELATED EXPENSES
3750*24=90000
6250*24=150000
1200*24=28800
RECEIVING AND PRODUCTION CONTROL
10*1012.50=10125
50*1012.50=50625
100*1012.50=101250
PACKAGING AND SHIPPING
10*250=2500
70*250=17500
220*250=55000
GENERAL, SELLING AND ADMIN. EXP.
7500*2.33=17475
12500*2.33=29125
4000*2.33=9320
TOTAL
120100
247250
194370
NO. OF UNITS
7500
12500
4000
COST PER UNIT
16.01
19.78
48.59
(3)
INCOME STATEMENT FOR MONTH OF APRIL
ASSUMPTIONS: THERE IS NO OPENING AND CLOSING STOCK
THE SELLING PRICE IS TAKEN IS TARGET SELLING PRICE
VALVES
PUMPS
FLOW CONTROLLERS
TOTAL VARIABLE OVERHEAD COST
PER UNIT
TOTAL
PER UNIT
TOTAL
PER UNIT
TOTAL
UNITS
7600
12000
4200
SALES (A)
86.15
654740
107.69
1292280
95.38
400596
2347616
DIRECT LABOUR EXPENSE
10
76000
12.5
150000
10
42000
268000
DIRECT MATERIALS EXPENSE
16
121600
20
240000
22
92400
454000
MANUFACTURING OVERHEADS -VARIABLE COSTS
16.01
121676
19.78
237360
48.59
204078
563114
TOTAL VARIABLE COSTS (B)
1285114
CONTRIBUTION MARGIN (A)-(B)
1062502
FIXED COSTS (AS CALCULATED BELOW)
803885
OPERATING INCOME
258617
CALCULATION OF FIXED COSTS
TOTAL COST
% FIXED
FIXED COST
MACHINE RELATED EXPENSES
336000
20%
67200
SETUP LABOUR
40000
100%
40000
RECEIVING AND PRODUCTION CONTROL
180000
10%
18000
ENGINEERING
100000
100%
100000
PACKAGING AND SHIPPING
150000
50%
75000
GENERAL, SELLING AND ADMIN. EXP.
559650
90%
503685
TOTAL
803885
(4)
INCOME STATEMENT FOR MARCH 2016 AS PER MARGINAL COSTING APPROACH
VALVES
PUMPS
FLOW CONTROLLERS
TOTAL VARIABLE OVERHEAD COST
PER UNIT
TOTAL
PER UNIT
TOTAL
PER UNIT
TOTAL
UNITS
7500
12500
4000
SALES (A)
86
645000
87
1087500
105
420000
2152500
DIRECT LABOUR EXPENSE
10
75000
12.5
156250
10
40000
271250
DIRECT MATERIALS EXPENSE
16
120000
20
250000
22
88000
458000
MANUFACTURING OVERHEADS -VARIABLE COSTS
16.01
120075
19.78
247250
48.59
194360
561685
TOTAL VARIABLE COSTS (B)
1290935
CONTRIBUTION MARGIN (A)-(B)
861565
FIXED COSTS
803885
OPERATING INCOME
57680
NOTE: THE DIFFERNCE IN OPERATING INCOME AS GIVEN IN QUESTION AND AS CALCULATED ABOVE IS DUE TO ROUNDING UP OF PER UNIT FIGURES
NOW,
CONTRIBUTION MARGIN (IN %) = 861565/2152500= 40% APPROX
SO, BREAK EVEN POINT IN SALES = 803885/40% = $2009713
THE RATIO OF PRODUCTS IN BREAK EVEN SALES CAN BE GIVEN AS UNDER
VALVES = 645000*2009713/2152500= $ 602213
PUMPS = 1087500*2009713/2152500= $1015360
FLOW CONTROLLERS = 420000**2009713/2152500= $392139
VALVES
PUMPS
FLOW CONTROLLERS
MATERIALS PER UNIT
$16*1.05= $16.80
$20*1.05= $21
$22*1.05= $23.10
DIRECT LABOUR COST
10
12.5
10
MANUFACTURING OVERHEAD
30
37.5
30
STANDARD UNIT COSTS (A)
56.80
71
63.10
PLANNED GROSS MARGIN (B)
35%
35%
35%
TARGET SELLING PRICE (A)/(B)
85.71
107.14
85.71
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