1 Accounting (Managerial) 530 Portfolio Case Study To begin with we would like to provide some background information about

the case under consideration. Long & Associates (L&A) is looking for innovative employees who engage with their work. This is an organization with rapidly growing sales and expanding customer acceptance in the surf wear clothing target market 18-30 years. The clothing is sold under an increasingly recognized brand name worldwide. Sales are made online -both internationally and locally, as well as through franchised outlets. The accounting system has not kept pace with the growth and complexity of the company. It is even more critical for the company to take control of its finances in the current slow recovery of the U.S. and European markets. Issue 1. The management wants to be able to predict the effect on profits resulting from changes in volume, costs and prices. In our opinion, the best method to see correspondence between costs of production and profits is the so-called cost-volume-profit analysis. To begin with we would like to provide a definition of the term cost-volume-profit analysis. In our opinion, one of the best definitions of this term is the following. Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses (Cost-Volume-Profit Analysis). In other words, the cost-volume-profit analysis shows how the changes in volume of production affect the costs and profits. More specifically, it shows how the following factors affect the profits: variable costs, fixed costs, selling prices, volume of production and mix of the sold products. This type of analysis is based on the following principles and assumptions:

2 1. The costs of production are classified as fixed or variable; 2. All the produced units are sold; 3. The costs of production can be affected only by the changes in production activity; 4. The sales mix remains constant even when a company sells more than a one type of product. This type of analysis is a little bit broader, than a breakeven analysis. As you probably know, breakeven analysis shows the volume of production and the selling price, when a companys profits are equal 0. Thus, it shows when all the costs are compensated. Cost-volume-profit analysis provides a companys managers with more detailed information. For example, it lets answer the following questions: what sales volume is required to reach a desired level of profits? How would changes in the selling prices affect the profits of a company? How would the changes in the mix of products sold affect the target profits? A formal definition of the term breakeven analysis can be the following. Breakeven analysis is an analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even analysis calculates what is known as a margin of safety, the amount that revenues exceed the break-even point. This is the amount that revenues can fall while still staying above the break-even point (Breakeven Analysis Definition). Thus, probably the main element of the breakeven analysis is the so-called breakeven point. This point is, in fact, a certain combination of the volume of production and the selling price. At this point the revenues are equal to the costs and it means that a companys profit is equal 0. The main advantage of this analysis is that it shows a companys managers the levels of production and selling prices, where all the costs are compensated. .

3 However, we should understand that we are talking about the fixed costs. Fixed costs are the costs of production that do not change with the changes in the volumes of production. For example, the fixed costs are the following: salary of the managers of a company; expenses on the rent of office; expenses on the research and development processes. In turn, variable costs change with the changes in the volumes of production. Beyond the breakeven point a company is able to earn some profits. The breakeven point can be calculated, using two approaches equation method and contribution margin method. The contribution margin is a shorter version of the mentioned equation method. First of all, we have to define the term contribution margin. Contribution margin is the difference between the total sales revenue and total variable costs. Respectively, contribution margin per unit is defined as the difference between the sales revenue per unit and the variable costs per unit. Contribution margin approach is based on the principle that every product sold provides a certain amount of contribution margin to cover fixed costs (covering all the fixed costs is a necessary requirement of reaching the breakeven point). As a result, in order to define how many products should be sold to reach the breakeven point we have simply to divide the fixed expenses by the unit contribution margin. Issue 2. Previously the company did not use budgets because the owners were the managers of the business and close to activities being managed and did not feel the need for budgets. As the company has grown, and the operations have become more diverse, professional managers have been recruited. Budgeting is an estimation of the revenue and expenses over a specified future period of time. A budget can be made for a person, family, group of people, business, government, country, multinational organization or just about anything else that makes and spends money.

4 A budget is a microeconomic concept that shows the tradeoff made when one good is exchanged for another (Budgeting Definition). As with any phenomenon, budgeting has its positive and negative sides. Advantages of budgeting: impact on motivation and mood in the team; provides an opportunity to coordinate the work of the whole enterprise; analysis of budgets provides time to make corrective changes; provides an opportunity to learn from the experience of budgeting of the past periods; provides an opportunity to improve the process of distribution of resources; facilitates the process of communication; gives an opportunity for beginners to understand the "direction" of the enterprise, thus helping them to navigate; Disadvantages of budgeting: different perceptions of budgets of different people (eg, budgets are not always able to help in solving day-to-day, current problems do not always reflect the reasons for events and deviations do not always take into account changing conditions, in addition, not all managers have sufficient preparation for analysis of financial information); complexity and high cost budgeting system; if the budget is not brought to the attention of every employee, it has little impact on motivaions and results, as seen exceptions-in as a means to evaluate the activities of employees and tracking their mistakes; budgets require from employees high labor productivity, in turn, members of the proopposing this, trying to minimize their burden, etc., which leads to conflicts of depression, anxiety;

5 contradictions between goals and stimulating effect - the budget has no stimulating effect to increase performance, if allurement achieve something difficult, the stimulatory effect is lost because no one believes in the possibility of achieving the goal. Issue 3. The company has a need to make choices sometimes whether to make or buy certain of the products carrying their brand. On other occasions they are also required to make decisions on special prices when a potential retailer makes an offer to buy goods from them at a price lower than their normal price. The management currently base their decisions in these matters on the average cost of goods sold in the previous accounting period. Since the company produces a lot of different types of products, Activity Based Costing looks like the best option for them, since it allows directing particular costs to particular business processes and departments. To begin with we would like to provide a definition of the term activity based costing. In our opinion, one of the best definitions is the following. Activity Based Costing (ABC) is an alternative to the traditional way of accounting. Traditionally it is believed that high volume customers are profitable customers, a loyal customer is also a profitable one, and profits will follow a happy customer. Studies on customer profitability have unveiled that the above is not necessary true. ABC is costing model that that identifies the cost pools, or activity centers, in an organization and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a good or service (Activity Based Costing (ABC)).

6 References Activity Based Costing (ABC). Available from: <http://www.valuebasedmanagement.net/methods_abc.html>. [20 August 2012] Breakeven Analysis Definition. Available from: <http://www.investopedia.com/terms/b/breakevenanalysis.asp>. [08 September 2012] Budgeting Definition. Available from: < http://www.investopedia.com/terms/b/budget.asp#axzz25r58gI2f>. [08 September 2012] Cost-Volume-Profit Analysis. Available from: <http://www.referenceforbusiness.com/management/Comp-De/Cost-Volume-Profit Analysis.html>. [08 September 2012]