Profitability Analysis of “bobby Bully”

1. Objective

The objective of this report is to analyze the profitability potential of “Bobby Bully” and evaluate several decisions made by the Controller of the Company.

1. Profitability analysis of “Bobby Bully”

2.1 Sales unit projections to U.S. purchasers

Schedule of expected sales provided by the marketing department assumes 70% of sales to domestic purchasers and 30% to U.S. purchasers. BML has fairly recently escalated its sales in the U.S. to the extent that almost 30% of its sales, up from 5% the preceding year. Such growth in sales is reasonably foreseen in the near future. The assumption made by the marketing department appears conservative. The total sales in units to U.S. purchasers should be more than estimated if incorporate the fact market share in U.S. will continue growing.

2.2 Sales unit projections using expected values

In calculation of projected sales in units, the sales unit projections corresponding to the highest probability of occurrence are used in the Controller’s profitability analysis. This assumption tends to overestimate the projections. A more appropriate method of predicting a discrete random variable is to use the expected value, the probability-weighted average of all possible values. Under this method, the projected sales in units is 12,000 if the selling price is $20, 18,500 if $18, 22,500 if $16, and 43,000 if $15.

2.3 Reclassification of supervision expenses

One assembly line and, therefore, one supervisor, can produce up to 20,000 units. Therefore, supervision cost should be classified as a step fixed cost of $25,000 for each 20,000 units of volume increase.

1. Breakeven analysis

The new breakeven volumes are calculated using the updated information as described above. Detailed calculations are shown in Exhibit C. Given the analysis, “Bobby Bully” will break even under the first and second proposed scenarios. Under the second scenario where the selling price is set as $18 per unit, the total sales volume is projected to be 18,500 units (see Exhibit C). BML needs only produce and sell 15,833 units to breakeven, and will make a profit of $16,000 if produce and sell all 18,500 units (see Exhibit A). It is, therefore, recommended to proceed with production of “Bobby Bully” and conduct further research to determine the optimal price that generates the highest possible profits.

1. Accounting treatment of leased equipment

3.1 Decision to purchase or to lease

3.2 Current accounting treatment of leased equipment

Currently, BML is treating the lease as operating lease. In an operating lease, the lease expense is treated as an operating expense in the income statement and the lease does not affect the balance sheet. This gives the Controller incentive to record the lease as operating lease to avoid any negative effect on debt convent ratios.  

3.3 IFRS classification of leased equipment

The accounting treatment of leases is coved in section IAS 17 of CICA Handbook. According to paragraph IAS 17.10, a lease is classified as capital lease if certain criteria are met (see Exhibit D). BML’s lease of equipment should be classified as a capital lease as BML has been offered an option to purchase the equipment at a "bargain price" at the end of the lease term. Such option is considered as reasonable assurance that ownership will transfer to lessee at end of lease term assuming that bargain purchase option will be exercised by BML.