case #1 - Baska Ltd.
Baska Ltd. produces a lens used for webcams. Summary data from its year 2013 income statement are as follows:
|
Revenues
|
$8,000,000
|
|
Variable costs
|
4,320,000
|
|
Fixed costs
|
3,900,000
|
|
Operating Income
|
$(220,000)
|
The president of Baska, Rob Keen, is very concerned about the company's operations. He has discussed the situation with Operations Manager, Don Bell and controller, Clair Watson.
After two weeks, Don returns with a proposal. After researching various component parts, he advises that he can reduce variable costs to 48% of revenues by changing both the direct materials and the production process. The downside of this proposal is that the new direct material (although cheaper) results in more waste and is more toxic to the environment. Currently, waste produced in the production process does not require any special treatment and is disposed of normally. Don points out that there are no current specific laws governing the disposal of this waste created by the use of the new material, and therefore production costs can be cut by using this material. Clair is concerned that this would expose the company to potential environmental liabilities. She believes that these potential future costs need to be estimated and included in the analysis. Don disagrees and reiterates that there are no laws being violated and replies, "There is some possibility that we may have to incur costs in the future, but if we bring it up now, this proposal will not go through because our senior management always assumes these costs to be larger than they are. The market is very tough and we are in danger of shutting down the company. We don't want all our colleagues to lose their jobs. The only reason our competitors are making money is because they are doing exactly what I am proposing."
Required: IN REPORT FORMAT, ANSWER EACH OF THE FOLLOWING QUESTIONS
1. Calculate Baska's breakeven revenues for 2013.
2. Calculate Baska's breakeven revenues if variable costs are 48% of revenues.
3. Calculate Baska's operating income in 2013 if variable costs had been 48% of sales.
4. What should Rob Keen do? Provide the analysis and recommendations.
Body Products Division of World Wide Drugs
Ahmed Diba is the controller of the Body Products Division of World Wide Drugs (WWD). It is located in Winnipeg, which is the headquarters of WWD. Diba is helping develop a proposal for a new product to be called Vital Hair. This product is a cream to be rubbed on the scalp to restore hair growth. Cheryl Kelly, president of the division and Diba are scheduled to make a presentation to the WWD executive committee on the expected profitability of Vital Hair. The fixed costs associated with the development, production and marketing of Vital Hair are $24,000,000. Each customer will pay a doctor $96 per monthly treatment, of which $66.00 is paid to WWD. Diba estimates WWD's variable costs per treatment to be $26.40. Included in this $26.40 is $9.60 for potential product litigation costs.
Kelly is livid at Diba for including the $9.60 estimate.
She argues that it is imperative to get the R and D funds approved (and quickly) and that any number that increases the breakeven point reduces the likelihood of the Vital Hair project being approved. She notes that WWD has had few successful lawsuits against it, in contrast to some recent "horrendous" experiences of competitors with breast implant products. Moreover, she is furious that Diba put the $9.60 amount in writing. "How do we know there will be any litigation problem?" She suggests Diba redo the report excluding the $9.60 litigation risk cost estimate. "Put it on the chalkboard in the executive committee room, if you insist, but don't put it in the report sent to the committee before the meeting. You can personally raise the issue at the executive committee meeting and have a full and frank discussion."
Diba takes Kelly's "advice". He reports a variable cost of $16.80 per treatment in the proposal. Although he feels uneasy about this, he is comforted by the fact that he will flag the $9.60 amount to the executive committee meeting in his forthcoming oral presentation.
One month later, Kelly walks into Diba's office. She is in a buoyant mood and announces she has just come back from an executive committee meeting that approved the Vital Hair product proposal. Diba asks why he was not invited to the meeting. Kelly says the meeting was held in Toronto, and she decided to save the division money by going alone. She then says to Diba that it "was now time to get behind the new venture and help make it the success the committee and her team members believe it will be."
Required
1 - What is the breakeven point (in units of monthly treatments) when WWD's variable costs
(a) include the $9.60 estimate?
(b) exclude the $9.60 estimate for potential product litigation costs?
2 - Should Diba have excluded the $9.60 estimate in his report to the executive committee of WWD? Explain your answer.
3 - If you were Diba, what would you do in response to Kelly's decision to make the Vital Hair presentation on her own?