Colin Drury, Cost & Management Accounting: An Introduction Hardhat Ltd

Hardhat Ltd
Stan Brignall, Aston Business School, Aston University

Hardhat Limiteds Budget Committee, which has members drawn from all the major functions in
the business, is meeting to consider the projected income statement for 2000/2001, which is
composed of the ten months actuals to the end of January 2001 and estimates for the last two
months of the financial year:

Hardhat Ltd: Projected Income Statement 2000/2001

(000s) (000s)
Sales (100 000 units) 10 000
Cost of goods sold 6 000
Gross profit 4 000
Selling expenses 1 500
Administrative expenses 1 000
2 500
Net profit before tax 1 500

After some discussion of information principally supplied by the Finance Director, John Perks,
the Committee agrees the following changes for the 2001/2002 budget:

30% increase in number of units sold

20% increase in unit cost of materials
5% increase in direct labour cost per unit
10% increase in variable indirect cost per unit
5% increase in indirect fixed costs
8% increase in selling expenses, arising solely from increased volume
6% increase in administrative expenses, reflecting anticipated higher salary and other costs
rather than any effects of the expected increased sales volume.

The increase in sales volume is meant to be a significant step towards an ambitious target
market share which was included in the latest review of Hardhats strategic plan at the
insistence of the marketing manager, Keith Boskin. Despite the change in volume, inventory
quantities are expected to change little next year because of planned efficiency gains in the
supply and handling of materials and despatch of finished goods.

The composition of the production cost of a unit of finished product in 2000/2001 for materials,
direct labour and production overhead was in the ratio of 3:2:1 respectively. In 2000/2001
40 000 of the production overhead was fixed. No changes in production methods or credit
policies are anticipated for 2001/2002.

The managing director, Steve Hartley, has set a target profit before tax for 2001/2002 of
2 000 000, and the Budget Committee are now debating what this might imply for the unit
selling price, on the basis of the information they have assembled so far. The consensus
appears to be that the profit target is very tough, but that presumably this is what Steve and the
Chairman, Lord Haretop, believe the City expects.
 Colin Drury, Cost & Management Accounting: An Introduction Hardhat Ltd

Keith Boskin is worried that the imposition of the short-term target profit will jeopardize the
staged attainment of his long-run market share. Im concerned that, in order to meet the profit
(target imposed by Steve Hartley) well have to drastically put up our price. If that happens we
might hit the profit, but itll ruin my plans for damaging the prospects of Farfetched Co., who
have been trying to take market share from us for some while now via heavy marketing
expenditure I think theyre getting desperate because our cost structure and product quality
are better than theirs! If we can just keep squeezing them for another year or two we might force
them out of the market, or get them to agree to a takeover on reasonable terms. Then wed
effectively have the market to ourselves. Dick Whittington, Keiths deputy, asked rather than
putting up the price, could we work out how many units wed have to sell at the old price to meet
the profit target? Then we could check to see whether it would be within the plants capacity.

Mark Catchall, the production manager, intervened at this point, saying we can make up to
150 000 units a year with the present plant, but could we sustain that capacity output for long? I
doubt it. We might have to invest in extra capacity, which is a whole new ball game. Besides, I
dont really believe we can sell an extra 30 000 units next year, never mind 50 000 units,
especially at an enhanced price. I suspect we will only manage to sell an extra 20 000 units at
best, and perhaps only 10 000: what would that do for our profits, John? John replied that he
didnt know, but would investigate the various suggestions and come back to the next meeting in
a weeks time with some figures.

As he walked back to his office, John privately mused that perhaps the MD and Chairman
wanted to boost short-term profits to make it easier to raise the finance to take over Farfetched
Co., in which case it wouldnt hurt to give some thought as to the best source of finance for such
a deal.

Required

Write a report to the Board of Hardhat Ltd setting-out the financial effects of the various
proposals and make recommendations as to what price Hardhat should charge next year and in
the longer run.

Your report and presentation should cover:

(a) the sales price needed to earn the target profit, using the information compiled by the
budget committee;
(b) the number of units that would have to be sold at the old price to meet the target profit, and
whether this seems feasible;
(c) what the profit would be if the sales price calculated in (a) were adopted, but sales volume
only rose by 10%, or at best 20%;
(d) any other factors you think should be taken into account when making decisions about the
price to be charged next year, such as any change in risk involved in the costvolumeprofit
structure you propose; the link between short- and long-run prices; and the interactions
between acquisitions policy, financing decisions and pricing decisions.