Introduction
Borders Group Inc. produces and sells more than one product. The products considered are books, magazines, and CDs/DVDs. The assumed fixed costs of this firm p.a. are $100 million consisting of managers salaries and rent expenses, and it is included in the selling/ general/ administration expense of the year ended 31/12/09;
Analysis
The sales and contributions of these thee products for a specific year are shown below:-
The axes on the profit chart are drawn in the usual way, and the profit (loss) from these three products is shown under the graph below. The solid line shows the cumulative profit made by three products. The profit of product X after deducting fixed costs is $ 60million. The cumulative product X and Y is 110million. The cumulative profit of the three products is $ 125million.
The dotted line shows the overall profit line. The break-even point of sales is $ 355millions. It can be calculated as under:-
B/E point = Fixed costs
Total contribution
= $100milllion÷ 225,000
800,000
= $ 100,million x 800,000
225,000
= $ 355million
A break-even point can be defined as a point at which output sold produces revenue that is equivalent to the total cost, meaning that at that point, the profit is zero. The company will be interested in the break-even point in order to avoid operating losses.
Contribution is the difference between sales value and the marginal cost of sales. It gives to arise of break-even point which can be described as at the point in which the business makes no loss or profit. It is claimed that contribution is more relevant to management in supply than are costs prepared with loading for the fixed expense. This implies that when trade is bad and output small, an attempt to recover all fixed overhead will result in an uncompetitive price. There are, of course, dangers in this view, and these are dealt with later. Subject to the dangers, there is little doubt that the approach is of value to business people, as it deals with the common business situation of a manufacturer desiring to maximize his profits in the knowledge: (a) that he has an inescapable burden of fixed overheads, and (b) that he can attract or repel an order according to the price he quotes.
The Break-Even Chart
In a multiproduct company like Borders Group Inc., the chart has two break-even points. If the output is less than one or more than one, the total cost will be greater than the total revenue, and the firm will be operating at a loss. The firm will be earning maximum profit at that level of output where the gap between total revenue curves is based on three laws of return. As a result, total cost increased beyond a specific level of output (OM units of output in this chart). If production is less than ON units of output, then due to fixed cost, the total cost is higher than the total revenue. In this case, the firm will earn profit within a specific range of output (On units to output to OM units of output.
Considering books alone, the chart will be a break-even chart that will be easy to plot. The graph below depicts the relationship between the costs, revenues volume of output, and resultant profit. The area between the revenue curve and the variable cost curve represents the contribution to fixed costs and profit at each level of output. The point at which the revenue curve crosses the total costs are gradually recovered until the break-even point, and thereafter each unit of output contributes to profit. The excess of break-even point is known as the margin of safety. The margin of safety ratio is the percentage by which sales revenue may fall before a loss is incurred and is expressed as follows:
The margin of safety ratio = margin of safety revenue
Actual sales.
Conclusion
There are situations that a company can use marginal costing, such as taking a special order which will be profitable in the future. They can also use when entering a new market. When making a decision on whether to shut down a branch or not, marginal costing will be used instead of considering all costs.
It is difficult to identify the fixed costs associated with each product line. It is not easy to have data for each product separately since the company operates outlets.
References
- Atril, P.F. and McLaney, E. J. (2002). Management accounting for non-specialists, 3rd edn (financial times prentice Hall).
- Drury C; (2000); Management and cost Accounting; 5th edition, business press Thomson Learning.
- Horngren, C. T., Bhiman A., foster G., and Datar, S. M. (1999). Management and cost accounting (prentice Hall Europe).