Sample Report On Mendel Paper Company

Report to the management of Mendel Paper Company

Contribution margin analysis
At the initial estimates, all the four product lines will have a positive contribution margin. Material costs constitute a larger percentage of the total variable cost for each of the four product lines. Variable overhead cost is allocated on the basis of the number of hours. Given the information on the number of units produced per hour, computer line will have a variable overhead cost of $1.50 per unit. The variable cost per unit for Napkins, Placemats and Poster board will be $0.60, $2.40 and $0.50 respectively. The computer line has the highest contribution margin while Napkins line has the lowest contribution margin per unit. However, the Napkins line has the highest total contribution since its expected sales are the highest among the four lines.
If the cost of material for computer stock increases to $7, the contribution margin per unit will decline from $6.50 to $5.50. Total contribution for computer line will decrease by $2,500 to $192,500. The increase in material cost for placemats will also cause a decline in its contribution margin from $6.00 to $5.60. The total contribution for the line will also fall to $252,000 from the initial $270,000. The overall effect of these revisions will be a decline in the total contribution from $1,133,000 to $1,120,000.

Break-even analysis

If the company operates at the initial estimates, it will break-even if it sells a total of 130,583 units. This implies that the firm will only suffer a total loss if it sells less than 130,583 units. Given the estimated sales volume for the next fiscal year, the company will have a margin of safety of 52.52%. The margin of safety is very high indicating that the risk of the company’s sales falling to a level that it will suffer losses is very low (Weetman, 2010). The company will have to sell 14,247 units of the computer product line and 56,986 units of napkins in order to break-even. In addition, it will only need to sell 21,363 units of place mats and 37,987 units of poster board to start making profits.
The revised estimates include an increase in the material cost for both computers and place mats. For computers, the rise in material cost is leverage by the increase in expected sales for the next fiscal quarter by 5,000 units. The contribution margin will decline by $1 per unit. Similarly, the increase in material cost of place mats will lead to a reduction in its contribution margin per unit to $5.60. All other factors held constant, and these changes will increase the break-even point for the two products as well as the total break-even point. However, a reduction in plant fixed cost to $378,000 from $420,000 makes things better. This will improve the company’s profitability as long as the cut in fixed cost does not affect the operations of the firm. Therefore, the total revised fixed cost for the next quarter will be $496,000.
At the new rates and the revised fixed cost, the total break-even point will be 124,840 units. This gives a margin of safety of 55.4%, an increase from the 52% provided by the initial estimates. Computer Product Line will break-even at 19,395 units, which is an increase from the initial 15,753 units. The margin of safety is higher since the product line will experience an increase in sales by 5,000 units. On the other hand, the break-even point for Place Mats will fall to 20,062 units from the initial figure of 21,363 units. The decline is attributed to the fall in fixed cost despite the rise in variable cost per unit.

Recommendations

As shown in the above analysis, an increase in the material cost for place mats and computer stock will lead to a decline in the contribution margins of both product lines. This is a legitimate concern since the company’s profits will fall if cost reduction measures are not put in place. The primary concern is on the Placemats line since the company does not expect an increase in its sales volume from the initial estimate of 120,000 units. The analysis also indicates that if the company reduces its plant fixed cost to $378,000, the break-even points will decline thereby increasing the total profit as well as the margin of safety for each product.
The company should, therefore, concentrate on measures to enhance efficiency in order to reduce its total fixed cost. Some of these measures include training employees, employing modern and appropriate technology in production, strengthening supervision, outsourcing some operations, mainly administrative duties, among other measures (Kinney & Raiborn, 2013). So long as the contribution margins for the product lines is positive, reducing fixed cost will enhance the profitability of the firm.
On the issue of variable cost for place mats, the firm should put measures to increase its sales. The increase in variable cost can be offset by an increase in sales volume as this will lower the fixed cost per unit. This will be possible since the contribution margin per unit of place mats is positive. Aggressive advertising and sales promotion will enable the business achieve this goal (Hansen & Mowen, 2013). The firm is currently operating below its capacity since the expected sales will use a total of 46,000 hours while the company’s capacity is 60,000 hours. In addition, the management can reduce variable cost by entering into agreements with suppliers to offer the materials at a lower cost.

References

Hansen, D., & Mowen, M. (2013). Cornerstones of cost management. Mason, OH: South-Western Cengage Learning.
Kinney, M., & Raiborn, C. (2013). Cost accounting. Cincinnati: South-Western CENGAGE Learning.
Weetman, P. (2010). Management accounting. Harlow, Essex, England New York: Financial Times/Prentice Hall.
APPENDICES
Contribution analysis at original estimates
Contribution analysis with the proposed revisions
Break-even analysis: Initial estimates
Break-even point
Total expected sales volume = 275,000
Sales mix and contribution margins
Average contribution margin = [0.1091 × 6.50] + [0.4364 × 1.90] + [0.1636 × 6.00] + [0.2909 × 5.50]
= 0.7092 + 0.8292 + 0.9816 + 1.600
= 4.12
Total fixed cost = 420,000 + 118,000 = 538,000
Break-even point(total) = Total fixed costAverage contribution margin = 538,0004.12 = 130,583
BEP for Computer line = 130,583 × 0.1091 = 14,247 units
BEP for Napkins line = 130,583 × 0.4364 = 56,986 units
BEP for place mats line = 130,583 × 0.1636 = 21,363 units
BEP for Poster board line = 130,583 × 0.2909 = 37,987 units
b) Margin of safety
Margin of safety = expected sales – Break-even point sales
Total margin of safety = 275,000 – 130,583 = 144,417 units = 52.5%
Margin of safety for Computer line = 30,000 – 14,247 = 15,753 units = 52.5%
Margin of safety for Napkins line = 120,000 – 56,986 = 63,014 units = 52.5%
Margin of safety for Place mats line = 45,000 – 21,363 = 23,637 units = 52.5%
Margin of safety for Poster Board line = 80,000 – 37,987 = 42,013 units = 52.5%
Break-even analysis: revised estimates
Break-even point
Average contribution margin = [0.125 × 5.50] + [0.4286 ×1.9] + [0.1607 ×5.6] + [0.2857 × 5.50]
= 0.6875 + 0.8143 + 0.8999 + 1.5714
= 3.973
Total fixed cost = 378,000 + 118,000 = 496,000
Break-even point(total) = Total fixed costAverage contribution margin = 496,0003.973 = 124,840
BEP for Computer line = 14,840 × 0.125 = 15,605 units
BEP for Napkins line = 124,840 × 0.4286 = 53,506 units
BEP for place mats line = 124,840 × 0.1607 = 20,062 units
BEP for Poster board line = 124,840 × 0.2857 = 35,667 units
b) Margin of safety
Margin of safety = expected sales – Break-even point sales
Total margin of safety = 280,000 – 124,840 = 155,160 units = 55.4%
Margin of safety for Computer line = 35,000 – 15,605 = 19,395 units = 55.4%
Margin of safety for Napkins line = 120,000 – 53,506 = 66,494 units = 55.4%
Margin of safety for Place mats line = 45,000 – 20,062 = 24,938 units = 55.4%
Margin of safety for Poster Board line = 80,000 – 35,667 = 44,333 units = 55.4%