Paul Pecos decision rule

Contribution at the present price set:

Selling Price                             $300 per unit

Direct Materials                       $125 per unit

Direct Labor                              $50 per unit

Variable Overheads                   $30 per unit

Contribution                              $95 per unit

From the contribution figure determined above, the organization can sustain a lower selling price of the product marketed.  However, one has to bear in mind that a positive contribution does not mean an overall profit.  The company is also required to cover the fixed costs in order to attain an overall net profit.  In case of idle capacity yet, a lower selling price is acceptable since a greater contribution will be made in such a stance, which will also enhance the profitability.

Evaluation of Ms. Goodpersons SaleContribution per unit                            $95

Fixed Cost per unit                              $45

Margin of Safety                                  $50

Minimum price set by Paul Pecos         $300

Margin of Safety                                  $  50

Actual minimum selling price                $250

Paul should be more careful in how to communicate with employees, especially in the case of Ms. Goodperson’s sale, since the price charged would still attain a profit.  Before trading drastic decisions it is important that financial information is sought.  For instance, in this case the selling price agreed by Ms. Goodperson will still generate a positive contribution, because it is higher than the $250 minimum selling price determined from the calculations above.

Contribution Margin Income StatementsPaul Pecos Decision

Contribution Margin Profit Statement$Sales Revenue (see note 1)286,500Variable Costs:Direct Materials ($125 x 925)115,625Direct Labor ($50 x 925)46,250Variable Overheads ($30 x 925)27,750Contribution96,875Fixed Costs450,000Net (Loss)(353,125)

Note 1 – Sales Volume and Revenue

DetailsSelling Price

$VolumeSales Revenue

$Sam Smoothtalk

  Offer 1

  Offer 2

310

305

200

150

62,000

45,750Harry Hustler

  Offer 1

  Offer 3

  Offer 4

305

300

330

50

100

75

15,250

30,000

24,750Gary Giftofgab

  Offer 1

  Offer 3305

325250

100

76,250

32,500925286,500

According to lowest selling price of $250

Contribution Margin Profit Statement$Sales Revenue (see note 2)578,000Variable Costs:Direct Materials ($125 x 1,925)240,625Direct Labor ($50 x 1,925)96,250Variable Overheads ($30 x 1,925)57,750Contribution183,375Fixed Costs450,000Net (Loss)(266,625)

Note 2 – Sales Volume and Revenue

DetailsSelling Price

$VolumeSales Revenue

$Glenda Goodperson

Offer Taken290700203,000Sam Smoothtalk

  Offer 1

  Offer 2

  Offer 3310

305

295200

150

30062,000

45,750

88,500Harry Hustler

  Offer 1

  Offer 3

  Offer 4305

300

33050

100

7515,250

30,000

24,750Gary Giftofgab

  Offer 1

  Offer 3305

325250

10076,250

32,5001,925578,000Recommendations to the Situation at Hand

Presently the organization is incurring substantial losses.  If the 20,000 targeted units sales are reached, the company would still incur losses.  However, such aim is appropriate since the losses will diminish.  However, an organization cannot remain active if recurring losses are incurred.  Thus the firm should adopt remedial actions that boost its profitability.  For example, the present machinery the firm holds could be used to manufacture other profitable products and thus enhance its profits.  Cost control measures should also be undertaken in order to control costs and remove expenditure that is not adding value to the organization.

Reference:

Drury C. (1996). Management and Cost Accounting. Fourth Edition. New York: International Thomson Business Press.