At IPS you spend the first few years analyzing the industry, comparing your firm’s financial health to other firms in the industry and making sure…

Roadmap for Project 3

Project 3 tests managerial accounting competencies.

What are these competencies and why are they important?

Managers of firms need to know if their firms are being run efficiently. While the engineers may develop new technologies, the managers still have to figure out the best technology/process among the alternatives.

Firms have revenues and costs. The optimum that managers aim for is the maximum profit, that the is maximum of revenues minus costs.

If a firm produces multiple products that share production facilities (like most large firms do), then managers have to judge the profitability of individual products. To judge the profitability of individual products, managers have to allocate the total costs of shared resources among the different products.

Estimating costs is only part of the process of maximizing profits, managers also have to decide the price of the products and the level of output that maximizes profits.

Project 3 takes you through the various calculations described above. I will now give you a guide for the individual steps.

Step 1: This step asks you to allocate costs using factory space and labor as the allocation bases.

Background material for analysis of costs is in the video “Using Financial Information and Production Cost Allocation – Part 1” and “Using Financial Information and Production Cost Allocation – Part 2”.

The relevant material to answer the questions are:

1) Text material that can be found by following the link “review materials on production cost allocation”.

Hint: You have to look for fraction used. Make sure to pay attention to component cost of $25000.

2) Examples 1 and 2 from the “Activity Based Costing” video found by following the link “alternate method of assigning costs is activity-based costing” -> Resources Activity-Based Costing.

Note that this video is a bit out of sequence as it appears for Step 2, whereas you are still in Step 1. Examples 1 and 2 are most closely related to the questions asked in Step 1 but you should also study the other materials related to costs.

Step 2: In this step you are asked to calculate the cost of a certain product using activity based costing. The most relevant material for answering this step is Example 3 of the Activity Costing video, but you should also study the other material for a through understanding of the subject.

Step 3: One way in which products are priced are a markup. This is a simple but not necessarily the profit-maximizing method of pricing. In this step you are to calculate the price of the product using a markup. This requires you to first calculate the cost and then apply the markup.

The video to watch for completing this step is “Mark-Up Pricing”. The URL from your class is likely incorrect, the correct URL is:

Markup Percentage Example

Boyles, Inc. has recently expanded their services to include purchasing and installing office computers for small businesses. The first large order has come in from an accounting firm nearby. The firm will need 50 computers at a cost of $500 a piece (variable cost). Boyles will also be installing software on all of these computers, which will cost approximately $10,000 (fixed cost). If Boyles wants to earn a 10% markup percentage for the job what will he need to charge the company?

Step 1

First, Boyles must calculate the total cost of the project. The total cost is the cost of software plus the cost of the computers.

FC + VC*Q = TC = $10,000 +($500* 50) = $35,000

Step 2

Next, Boyles must multiply his desired markup (10%) by the total cost calculated in the first step. Then, he must add this number to the total cost, which will give him the sales price. The formula to find the sales price is:

Sales Price = (Cost * Markup Percentage) + Cost 

Or 

Sales Price = ($35,000 * 10%) + $35,000 = $38,500 

Boyles must charge the accounting firm $38,500. This is the equivalent of a profit margin of 9.1% (38,500-35,000)/38,500.

As you can see, two advantages of markup pricing are that the concept is easy to apply and if enough units are sold, the company should earn a reasonable profit.

The two main disadvantages of markup pricing are (1) it is difficult to determine the proper markup and (2) is inherently circular (the circularity problem occurs because demand must be estimated to determine costs but, price affects demand.)

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