Management Accounting

Executive summary

This report addresses your concerns that the current production mix doesn't make enough net profit to company budget, thus, was used excel and others management accounting techniques that will help increase future net profit. My recommendation would be to use option which offers to change production mix and buy 250 engines from outside supplier for no more than 500 pounds per each engine. This option would be the best choice to increase company's net profit and future success.

Introduction

In September 2011, "Aberdeen HighTech" chief executive officer (CEO) conveys her dissatisfaction with financial performance for the previous quarter. For that reason, was made analysis of current product mix with aim to increase net profit.

Analysis of the previous quarter income statement

The previous quarter income statement is shown below (Table 1). During previous quarter were produced only two products EX1001 and EX1002 which makes 9,850 and 10,100 contribution respectively. Contribution calculated as selling price minus total variable cost per unit. Higher contribution means higher profit from that product. Total contribution for both products shows how much revenue is collected from both products. It's nevertheless true that this is not amount of money which goes directly to producers 'pocket', you need to take away total fixed cost and then you will get net profit which shows the final profit which goes directly to producers 'pocket'. However, previous quarter "Aberdeen HighTech" manufacturer earned zero net profit. This means that company neither make a profit nor losses. According to "Aberdeen HighTech" CEO, company was operating at maximum capacity. In this situation there are two options: the first one is to increase selling price which will increase contribution but probably will reduce demand of the goods. The other one option is to change current production mix to optimum production mix if not already producing at the optimum production mix. Graph 1 below shows graphically how current production mix looks.

Table 1: Income statement with old product mix

EX1001 EX1002 Total

Selling price 40,000 38,000

Less Variable cost per unit:

Direct material cost per unit 24,000 20,000

Direct labour cost per unit 1,050 950

Machining cost per unit 2,100 2,750

Variable OH per unit 3,000 4,200

Total variable cost per unit 30,150 27,900

Contribution per unit 9,850 10,100

Units produced 1,000 1,500

Total contribution 9,850,000 15,150,000 25,000,000

Less Fixed Cost 25,000,000

Net Profit 0

Optimum production capacity

Optimum production capacity should help to increase maximum profit which is possible to get with current constraints. According to information which was given (Table 2), company has 4 departments and each department has constraint machine hours: Engine assembly 4,000, metal stamping 6,000, EX1001 assembly 5,000 and EX1002 assembly 4,500 available machine hours. Moreover, is also known that product EX1001 and EX1002 have maximum demand constraints, 3,500 and 3,000 respectively.

Table 2: Resource requirement for production

Machine hours required per unit Labour hours required per unit Total machine hours available (per quarter)

Department EX1001 EX1002 EX1001 EX1002

Engine assembly 1 2 4 2 4,000

Metal stamping 2 2 3 3 6,000

EX1001 assembly 2 0 4 0 5,000

EX1002 assembly 0 3 0 6 4,500

Thus, was used Microsoft Excel program which helped to solve products mix problem. Table 3, which is below shows optimum production mix and all relevant information which is needed to get it. Hence, from table we see that with new capacity two departments reach their constraints - Engine assembly and metal stamping. This means that company could not produce any more units of products. Hence, optimum production mix with current constraints is 2,000 units of product EX1001 and 1,000 units of product EX1002.

Table 3: Optimum production mix

PRODUCTS TOTAL CONSTRAINT BINDING OR

EX1001 EX1002 LHS VALUE NOT BINDING

Objective: Max contribution 9,850 10,100 29,800,000

SUBJECT TO:

Engine assembly constraint 1 2 4,000 <= 4,000 BINDING

Metal stamping constraint 2 2 6,000 <= 6,000 BINDING

EX1001 assembly constraint 2 0 4,000 <= 5,000 NOT BINDING

EX1002 assembly constraint 0 3 3,000 <= 4,500 NOT BINDING

Demand constraint EX1001 1 0 2,000 <= 3,000 NOT BINDING

Demand constraint EX1002 0 1 1,000 <= 3,500 NOT BINDING

PRODUCT MIX SOLUTION: 2,000 1,000

Changes in net profit

New production mix will generate higher net profit. As we see from income statement with new product mix (Table 4) which is below, company will earn 4,800,000 pounds per quarter. Comparing with old product mix, now net profit is 4,800,000 pounds instead of zero net profit. Graph 1 below shows graphically how optimum production mix looks.

Table 4: Income statement with new product mix

EX1001 EX1002 Total (£)

Selling price (£) 40,000 38,000

Less Variable cost per unit:

Direct material cost per unit 24,000 20,000

Direct labour cost per unit 1,050 950