May 2019 Q4
Boasiako Ltd manufactures high quality coffee biscuits that are sold to hotels and restaurants in Koforidua. Two months ago it had prepared a budget for the forthcoming financial year.
Details of the budget is presented below:
. GH¢
Sales 6,000,000
Less:
Direct materials 2,080,000
Direct labour 1,160,000
Variable overheads 840,000
Fixed overheads 972,600
Total costs 5,052,600
Profit 947,400
The budget above has been prepared on the assumption that sales will be 800,000 packets of biscuits. However, due to changing economic conditions, the sales forecast for the year is now 720,000 packets of biscuits. It is expected that selling price per unit, direct costs per unit and variable overhead cost per unit will not change from those budgeted. It is also expected that fixed overheads will be the same as those budgeted.
Management is now considering a number of options so as to improve profitability for the forthcoming financial year:
Option 1:
Decrease the selling price by 20%. It is anticipated that this would increase sales volume by 25% on the forecast sales for the current year.
Option 2:
Decrease all variable costs by 10% and decrease fixed costs by 10%. This is not expected to have any impact on the sales level.
Option 3:
Decrease the selling price by 10% and decrease fixed costs by 5%. This is expected to increase sales volume by 25% on the forecast sales for the current year.
Required:
a) Calculate the expected profit for the current year (forecast sales). (2 marks)
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b) Based on the forecast activity for the year, calculate: (6 marks)
i) The breakeven point in packets of biscuits.
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Breakeven points in packet of Biscuits, Margin of safety in % and revenue required to earn a profit of GH¢1,440,000
ii) The margin of safety in percentage terms.
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iii) The sales revenue required to earn a profit of GH¢1,440,000.
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c) Evaluate the profitability of the three options and recommend the option that Boasiako Ltd should adopt. (7 marks)
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Recommendation:
The company should consider option 2 as this gives a higher profit.