Explain why it is more difficult to work out the contribution per unit of different meals produced in a restaurant compared to the contribution per unit of the output of a large high-tech factory producing large runs of one product.

Answer:

            Contribution means that every unit sold makes a contribution towards fixed costs first then then towards profit assuming selling price is higher than the variable cost. It can be explained with the following formula:

Selling price per unit – variable cost per unit = contribution per unit

We can say that it is the difference between variable cost per unit and selling price per unit.

In large scale production we have the benefit of economies of scale and constant variable cost on the other hand in a restaurant each meal has its own unique ingredients and thus comes with its own unique cost which makes it difficult to work out contribution per unit of different meals.

a.      Briefly explain four limitations of contribution analysis as a management tool.

Answer:

Contribution analysis is a powerful tool for management of a company. It helps in making critical decisions about production. Although a powerful decision-making tool it has some limitations which are mentioned below:

·         It makes some unrealistic assumption that costs are linear and can be easily be divided into fixed and variable components. Also, it does not consider discounts given for large number of orders. It assumes that variable cost per unit and selling price are constant. In real life sales line may not be straight because discounts are usually given in bulk sales. Also, variable costs are assumed to be constant as well which is not true in real life. Variable cost may fall due to production efficiencies and discounts given on bulk purchasing.

·         It assumes that variable cost and revenue per unit and fixed costs remain constant in small relevant range. If there is any production activity which goes beyond relevant range will affect variable cost per unit, fixed costs and revenue per unit. These limitations make it difficult for management to decide production criteria.

·         Production methods don’t remain the same. They change with the advancement in the technology. Contribution analysis doesn’t take into account changes in production methods, efficiencies, input costs (both variable and fixed), sales price due to market conditions. These conditions are continuously changing with market dynamics. In order for contribution analysis to be meaningful cost and revenue conditions need to be stable and that is usually not the case. This makes it difficult for management to use as a decision-making tool.

·         Contribution analysis assumes that a single product is being sold. In real life businesses sell multiple products at different price points which makes it difficult to calculate contribution per unit. It assumes that where a range of product is sold the variable cost of these products will remain constant which is also not the case.

b.      Briefly describe how variances can be used to improve planning and budgeting in an organisation.

Answer:

            Variances can help in assessment of two different figures. It is a tool which can be used to improve planning and budgeting in the organization. It can help in spotting trends which can be used for decision making. It also helps in finding out what opportunities lies ahead and what kind of threats thee company can face in a short term or long-term period. Variance analysis helps in managing budgets by giving us a criterion to control our budgeted vs actual costs. Understanding variances greatly helps in future planning. Variance can be used to find relationship between pairs of variables. It helps us find positive and negative correlations between pairs of variables which helps in business planning.

            Variance analysis helps us in forecasting by using patterns from past business data to give us a picture of future gains. It helps us in forecasting business trends by factoring in holidays and seasonal changes. Some changes may be outside of management’s control such as recession in the economy. Variance can be analysed and applied to factors which are within management’s control for example if revenue is more than the management expected they can use variance to analyse why revenue was higher than expected. It can be due to improved marketing strategy, higher prices or due to the release of a new product.

c.       Explain six reasons why organizations prepare budgets. For each of these reasons, refer to an organization you are familiar with as an example.

Answer:

            Here are the six reasons for which organizations prepare budgets:

1.      Budgets are prepared to forecast future demand and trends for example Levis prepare its budget to forecast future demand and trends.

2.      Budgets are used for planning and monitoring for example Apple plans its budget for different products after careful planning and monitoring.

3.      Budgets are used for coordination with different departments for example Samsung prepares its budget in coordination with its different divisions.

4.      Budgets are used to inform stakeholders about future plans of the company for example Master Card company prepares its budget to inform its stakeholders about future plans of the company.

5.      Budgets are used to motivate employees of the company for example google prepares its budgets with its employees needs in mind.

6.      Budgets are used for performance evaluation for example Microsoft uses its budget to evaluate the overall performance of the company.