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Mendel Paper: Production Costs and Selling Prices

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Mendel Paper: Production Costs and Selling Prices
Table of Contents
  1. Introduction
  2. Contribution Margins
  3. Break Even Point
  4. Margin of Safety
  5. Recommendations
  6. References

Introduction

The Mendel Paper company has four products in its portfolio. These are Computer Papers, Napkins, Place Mats and Poster Boards. Each of these products has different production costs and selling prices. There are two potential scenarios for Mendel. The first is the original estimates made for the quarter, while the second involves some changes to the cost structure and sales mix.

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Standard costs are estimates of the cost of creating a product or providing a service under normal conditions. They are established by considering historical data and motion studies. Standard costs assist companies in planning for production expenses. Whenever Standard Costs differ from the actual cost of production, Management Accountants report variances. Mendel Paper Company has established the standard costs for the four products in their portfolio.

Contribution Margins

Computer Paper Napkins Place Mats Poster Board
Variable overhead per hour 9 6 12 8
Units per hour 6 10 5 4
Variable Overhead per unit 1.5 0.6 2.4 2

The contribution margin indicates the amount of money Mendel gains from selling each unit. This is the money available to cover fixed costs. It is computed by deducting all the variable costs from the expected sales revenue. The table below shows Contribution Margin by product and per unit for the original assumptions. Computer paper has the highest margin at $6.5 per unit while Napkins have the lowest contribution margin at $ 1.9 per unit.

ORIGINAL ASSUMPTIONS
Computer Paper Napkins Place Mats Poster Board
$ $ $ $
Sales Revenue 420,000.00 840,000.00 540,000.00 680,000.00
Less: direct materials 180,000.00 540,000.00 162,000.00 200,000.00
Less: other variable cost 45,000.00 72,000.00 108,000.00 160,000.00
225,000.00 612,000.00 270,000.00 360,000.00
Contribution 195,000.00 228,000.00 270,000.00 320,000.00
Per Unit 6.50 1.90 6.00 4.00

The revised scenario involves an increase in the direct material cost of Place Mats and Computer Paper. It also involves an increase in the sales volume of computer paper. This results in a reduction of the contribution margins for both products. Secondly, the changes made result in Place Mats having the highest contribution margin. This means that the increase in raw materials price is not covered by the increase in sales volume thus diluting the Marginal Contribution.

REVISED SCENERIO
Computer Paper Napkins Place Mats Poster Board
$ $ $ $
Sales Revenue 490,000.00 840,000.00 540,000.00 680,000.00
Less: direct materials 245,000.00 540,000.00 180,000.00 200,000.00
Less: other variable cost 52,500.00 72,000.00 108,000.00 160,000.00
297,500.00 612,000.00 288,000.00 360,000.00
Contribution 192,500.00 228,000.00 252,000.00 320,000.00
Per Unit 5.50 1.90 5.60 4.00

Mendel aims at making higher contribution margins in order to cover its fixed costs. Thus, the original scenario remains the most desirable option in terms of contribution margins (Kline, Liao & Schiff 2013).

Break Even Point

Mendel’s Break Even point refers to the level of sales at which the company earns no profit and makes no losses. The Break Even point is computed by considering both the variable and fixed overheads. Selling price is also included in the formula (Kline, Liao & Schiff 2013).

First, the Contribution Margin percentage is computed for the chosen sales mix. The average contribution margin per unit is divided by the average selling price per unit. The tables below show the results for each of the two scenarios (Kline, Liao & Schiff 2013).

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ORIGINAL SCENERIO
Computer Paper Napkins Place Mats Poster Board Total mix
$ $ $ $
Sales Revenue 420,000.00 840,000.00 540,000.00 680,000.00 2,480,000.00
Less: direct materials 180,000.00 540,000.00 162,000.00 200,000.00 1,082,000.00
less: other variable cost 45,000.00 72,000.00 108,000.00 160,000.00 385,000.00
225,000.00 612,000.00 270,000.00 360,000.00 1,467,000.00
Contribution 195,000.00 228,000.00 270,000.00 320,000.00 1,013,000.00
Per Unit 6.50 1.90 6.00 4.00 4.60
Number of units 30,000.00 120,000.00 45,000.00 80,000.00 275,000.00
Average SP per unit 14 7 12 8.5 9.02
CM % 51.01

Next, the total Fixed Costs are computed. The original scenario has higher fixed costs at $538,000. This figure helps to compute the Break Even Point (Schneider 2012).

Fixed Costs
$
Fixed Overhead 420,000.00
Administrative expenses 118,000.00
Total 538,000.00

The Break Even Point is now computed by dividing the Fixed Costs by the Contribution Margin percentage (Schneider 2012).

BEP=FC/CM% $
Fixed costs 538,000.00
CM% 51.01
BEP 1,054,735.18

The table below shows the revised scenario Breakeven Point. The new BEP is $ 156,088 higher than the original scenario. This clearly indicates that Management should stick to original plan (Schneider 2012).

REVISED SCENERIO
Computer Paper Napkins Place Mats Poster Board Total mix
$ $ $ $
Sales Revenue 490,000.00 840,000.00 540,000.00 680,000.00 2,550,000.00
Less: direct materials 245,000.00 540,000.00 180,000.00 200,000.00 1165000
Less: other variable cost 52,500.00 72,000.00 108,000.00 160,000.00 392500
297,500.00 612,000.00 288,000.00 360,000.00 1557500
0
Contribution 192,500.00 228,000.00 252,000.00 320,000.00 992500
Per Unit 5.50 1.90 5.60 4.00 4.25
Number of units 35,000.00 120,000.00 45,000.00 80,000.00 280,000.00
Average selling price per unit 14 7 12 8.5 10.375
CM % 40.96
Fixed Costs
$
Fixed Overhead 378,000.00
Administrative expenses 118,000.00
Total 496,000.00
BEP=FC/CM%
Fixed costs 496,000.00
CM% 40.96
BEP 1,210,823.53

A higher Break Even Point in the second scenario indicates that Mendel Paper Company needs to sell more units in order to cover its fixed and variable expenses (Kline, Liao & Schiff 2013).

Margin of Safety

Mendel’s Margin of Safety in the original scenario is computed by deducting the Break Even Point sales from the Expected sales (Schneider 2012). The table below shows the result. The Margin of Safety is higher in the first scenario than the revised scenario. This indicates that the first scenario is the better option for Mendel Paper Company. The second Margin of Safety is lower due to the higher BEP (Kline, Liao & Schiff 2013).

Mendel’s Margin of Safety in the original scenario is computed by deducting the Break Even Point sales from the Expected sales (Schneider 2012). The table below shows the result. The Margin of Safety is higher in the first scenario than the revised scenario. This indicates that the first scenario is the better option for Mendel Paper Company. The second Margin of Safety is lower due to the higher BEP.

Margin of Safety – Original Scenerio
$
Expected Sales 2,480,000.00
Less: Break Even Point 1,054,735.18
1,425,264.82
Margin of Safety- Revised Scenario
$
Expected Sales 2,550,000.00
Less: Break Even Point 1,210,823.53
1,339,176.47

Recommendations

Herbert should not be alarmed about the variable cost of the Place Mats. This is because even with the new price, the Place Mats have a high contribution Margin. The product management should be worrying about is the Napkins (Schneider 2012). They have an extremely low contribution margin. If there is any price increase on the raw materials, the Napkins will be a loss-making product. The overall recommendation would be to maintain the original sales volume while reducing the fixed costs (Schneider 2012). Fixed costs reduction will result in better financial returns for Mendel Paper Company (Kline, Liao & Schiff 2013).

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References

Kline, S., Liao, W. & Schiff, A. (2013). Cost accounting for managerial planning, decision making and control. Sydney: Cognella Academic Publishing.

Schneider, A. (2012). Management accounting. Mason, Ohio: Thomson/South-Western.

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