QUESTION 3 – Polokwane Pliers Pty Ltd [40 Marks]

a)
POLOKWANE PLIERS (PTY) LTD
VARIABLE COSTING STATEMENT OF PROFIT AND LOSS
R

Sales 29 600 000 [1P]

Variable manufacturing costs (10 360 000)
Opening inventory [R7 x 140 000] 980 000 [1P]
Direct material 6 000 000 [1P]
Direct labour 1 500 000 [1P]
Variable production overheads (c2) 3 000 000
Closing inventory (R7 x 160 000) (1 120 000) [1P]
Variable non-manufacturing costs
Sales commission (R3 642 000 – R1 658 800) (1 983 200) [1]
Contribution [1] 17 256 800
Fixed Manufacturing overheads (7 x 1 600 000) (11 200 000) [1P]
Fixed non-manufacturing costs
Sales commission (1 658 800) [1P]
Administration, distribution & others expenses (4 398 000) [1P]
Profit before tax Nil

Comments:
• The report given in the scenario is prepared using absorption costing
approach (1) which although is consistent with the external reporting
standards, it is not suitable for decision making purposes (1);
• Variable costing approach is preferred for decision making purposes and
this approach is consistent with important decision making tools such as
CVP analysis (1). While on the other hand, absorption costing report
currently reflects that the company is operating above breakeven point by
reflecting a profit of R140 000 for the period (1), the variable costing
correctly reflects that the company is operating at breakeven point by
reflecting a nil profit or loss (1) for the period.
• The profit merely reflects the movement in inventory as the absorption
costing allows the current reported profits to be distorted by movement in
inventory. For example, inventory pilled from 140 000 to 160 000 units (1),
the profit reflects fixed costs associated with the additional units of inventory
i.e. R7,00 x 20 000 = R140 000 (1P), variable costing approach wrote these
costs off as period cost.

C1: Number of units and variable costs per unit

Budgeted sales 1 490 000

Less: shortfall of actual sales on budgeted sales (10 000)
Actual number of units sold 1 480 000 [1]
 Units
Opening inventory 140 000 [1/2]
Production* (balancing figure) 1 500 000 [1P]
Closing (160 000) [1/2]
Sold units (as above) 1 480 000 [1/2P]

*Cost per unit produced = R2 240 000/160 000 = R14 [1]

Therefore, fixed cost per unit (R14(1P) – R7(1)) R7

C2:
Variable cost per unit including labour and material R7 [1]
Less: Labour and material (6 000 000 + 1 500 000)/1 500 000 (R5) [1P]
R2
Therefore, total variable overheads (R2 x 1 500 000) R3 000 000 [1P]

Max [25]
b)
Fixed costs
Production overhead budgeted 11 200 000
Administration, distribution & other expenses 4 398 000
Sales commission 1 658 800
Total 17 256 800 [1P]

Actual contribution margin (17 256 800 / 29 600 000) 58,30%

Budgeted contribution margin

[([17 256 800 + ((20 – 7-1,34)*10 000)](1) /
[29 600 000 + (10 000 x 20)] (1) 58,30%

Therefore, budgeted break even-point sales

R17 256 800/58,30% R29 600 000 [1P]
Therefore, break-even point sales 1 480 000 [1P]

Margin of safety – in retrospect

(1 490 000 – 1 480 000)/ 1 490 000
OR (10 000 x 20)/29 800 000 0,67% [1P]

Analysis and recommendations:

• In retrospect, PLK has budgeted margin of safety of only 0,67% which
increases the likelihood of losses (1);
• The company’s cost structure is dominated by fixed costs (1). Of the R29,6 m
incurred costs during 2015, R17,3 m is fixed costs i.e. 58,4%. (1), this is not
ideal as the company is currently operating at 82% (1 480 000 units/
1 800 000 units) (1) of its maximum production capacity, but is not yet
making profits.
• Special attention and efforts could be directed towards reducing fixed sales
and administration costs (1).
 o The sales commission is relatively higher compared sales i.e. 12,30%
(1) of sale revenue. One way, could be to renegotiate sales
remuneration structure with the company’s sales staff to move
towards a more variable formula (1).
• On the administration side, attention could be given to the following:
o The question should be asked, whether the company at the growth
stage such as PLK, really need luxurious administrative offices such
as those it currently occupies (1).
o Secondly, the possibility that sales staff members could share offices
as they do not spend sufficient time in office to warrant occupation of
own office (1);
o Thirdly, only one floor of the currently rented three floor building is fully
occupied, any possibilities to sublease the unused office space or
renegotiate the lease agreement to pay only for the space needed?
(1)
o Salaries for administrative staff members on average equals or
approximate the salary of the equivalent of a CEO i.e. executive
chairman (1) (R1 840 000 (20 – 16) = R460 000) (1). This may
suggest administration staff members are overpaid, reasons thereof
should be investigated and dealt with accordingly (1);
Max [14]
Language skills [1]
Question 1 Total [40]