FDP Company produces a variety of home security products. Gary Price, the company's president, is concerned with the fourth-quarter market demand for the company's products. Unless something is done in the last two months of the year, the company is likely to miss its earnings expectations of Wall Street analysts. Price still remembers when FDP's earnings were below analysts' expectations by two cents a share three years ago, and the company's share price fell 19% the day earnings were announced. In a recent meeting, Price told his top management that something must be done quickly. One proposal by the marketing vice president was to give a deep discount to the company's major customers to increase sales, it may not help the bottom line; to the contrary, it could lower income. The controller said, "Since we have enough storage capacity, we might simply increase our production in the fourth quarter to increase our reported profit." Discussion points: Gary Price is not sure how the increase in production without a corresponding increase in sales could help boost the company's income. Explain to Price how income carries with respect to production level.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
FDP Company produces a variety of home security products. Gary Price, the company's president, is concerned with the fourth-quarter market demand for the company's products. Unless something is done in the last two months of the year, the company is likely to miss its earnings expectations of Wall Street analysts. Price still remembers when FDP's earnings were below analysts' expectations by two cents a share three years ago, and the company's share price fell 19% the day earnings were announced. In a recent meeting, Price told his top management that something must be done quickly. One proposal by the marketing vice president was to give a deep discount to the company's major customers to increase sales, it may not help the bottom line; to the contrary, it could lower income. The controller said, "Since we have enough storage capacity, we might simply increase our production in the fourth quarter to increase our reported profit."
Discussion points:
- Gary Price is not sure how the increase in production without a corresponding increase in sales could help boost the company's income. Explain to Price how income carries with respect to production level.
- Is there an ethical concern in this situation? If so, which parties are affected? Explain.
(Chapter 19 Ethics Challenge BTN 19-3, Financial &
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