Question

Question 3 Ming Fai Electronics Company (Ming Fai) is a well-known semiconductors and microchip manufacturer. The company developed ‘Thor’, a new chipset used in the mobile phone industry, and planned to launch the product to market in 2020. Tony Chan, the CEO of Ming Fai, appointed you as the management accountant to help him to establish a business plan for selling ‘Thor’, especially on the determination of selling price. You are given the following budgeted cost data for Thor in 2020: Direct materials $5 per unit Direct labour $3 per unit Variable manufacturing overhead $2 per unit Marketing expense $1 per unit sold Product design and licensing $300,000 Fixed manufacturing overhead $200,000 General and administration costs (all fixed costs) $100,000 Tony anticipates manufacturing and selling 200,000 units of Thor in 2020, with no inventory at the end of the year. Based on the current market condition, the sales director advises Tony that Ming Fai can sell ‘Thor’ successfully for $18. Ming Fai requires a target operating income for all its products at 30% of revenue.

Required

(a) Compute the target full cost of producing and selling 200,000 units of Thor in 2020. Comment on whether the current cost budget can meet Ming Fai’s target operating income. If not, what is the gap with the target cost? Show your calculations.

(b) As a proposal for value engineering, the production manager suggests to replace a special component part in the product with an equivalent component part to be supplied by a new supplier in Mainland China. This would reduce the direct materials costs by 50% but an additional reengineering charge of $100,000 is required to make the change and ensure that all original features of the product are not affected. With this proposal, will Ming Fai achieve its target operating income of 30% of revenue? Show your calculations.

(c) Tony is having hesitation to reengineer the product. In fact he has been advised by his sales director to launch a big-scale marketing campaign to promote ‘Thor’ in 2020. He believes that with the campaign Ming Fai can sell the product at a price of $25 without losing any sales. The additional cost of the marketing campaign is estimated to be $500,000. With this proposal, will Ming Fai achieve its target operating income of 30% of revenue? Show your calculation.

(d) What short-term and long-term issues, both quantitative and qualitative, might Tony consider when deciding between the proposals under requirement (b) and (c)?

Answer 1

Answer a.

Calculation of operating profit:

Sales/Revenue 200,000 ×$18 =$3,600,000.

(Variable costing) 200,000 × $11 = ($2,200,000.)*

Contribution Margin = $1,400,000

(Fixed costs ) =($600,000)**

Operating Profit = $800,000.

1. Full costs of production will be $2,800,000 total of variable and fixed costs or sales minus operating profits.

Working

* variable costs = direct material $5 + direct labour $3 + variable overhead $2 + marketing overhead $1 (all cost per unit ) total variable costs $11 per unit.

** fixed costs = Proudct design and licensing $300,000 +manufacturing cost $200,000 + General and administrative cost $100,000.

2. Now target operating profit will be 30% of revenue that is 30% of $36,00,000 =1,080,000.

But as per current cost budget operating income will be lower than target operating income by $280,000.( Amount of gap ). TARGET WILL NOT BE ACHIEVED

Answer b.

Calculating operating profit by taking into account new proposal.

Sales / revenues $3,600,000. (Same as above)

(Variable costing) 200,000 × $8.5 = ($1,700,000)*

Contribution Margin = $1,900,000.

(Fixed costs )= ($7,00,000)**

Operating profits = $1,200,000

As target operating profit is $1,080,000 ( 30% of $3,600,000) the proposal of value engineering will ACHIEVE THE TARGET.

* variable cost = 50% reduction in direct material $5 ×50% $2.5 + direct labour $2 + variable overhead $2 + marketing expense $1 it all per unit so total variable cost $7.5

** fixed costs product design and licensing costs $400,000 (increased by $100,000 ) + fixed manufacturing overhead $200,000 + general and administrative costs $100,000 total fixed costs = $700,000.

Answer c.

Calculation of operating profit by taking into account big scale promotion strategy

Sale price will rise by $25 per unit

Additional Marketing campaign will be $500,000 remaining costs are as per ANSWER a.

Sales 200,000 ×$25 = $5,000,000.

(Variable costs) = ($2,200,000) refer answer a.

Contribution Margin =2,800,000

( Fixed costs ) = ($1,100,000) ($600,000 refer answer a. + $500,000 additional marketing campaign cost )

Operating profit = $1,700,000.

Target operating profits =30% of revenue that is $1,500,000 (30% of $5,000,000).

In given proposal also TARGET WILL BE ACHIEVED

Answer D.

Discussing short and long term issues in proposal b & c

While considering proposal b

The most significant qualitative factos maintaining relationship with existing suppliers as we are planning to reduce purchase of material by 50% and we also have ensure timely delivery from China of component part and all access level of dependence on Chinese suppliers.

In quantitative factors like storage of currently purchased inventory and consider increase the price of component with increase import duty for long term consideration.

While considering proposal c

Key factor here is increasing selling price without adding additional functions. We are increasing the price to recover the additional costs of market campaign then management has consider long term impact of such practice whether it is sustainable or not  

Qualitative factors like arranging the successful market campaign and ensuring the marketing campaign reaches to target customer for that there must be well planned and implemented marketing campaign strategies