Contingency Management Accounting Control -Myassignmenthelp.Com

Question: Discuss About The Contingency Management Accounting Control? Answer: Introduction Prada Group is a leading luxury fashion house in Italy founded in 1913 and it operates in the global market as well by taking into account all the social and cultural factors (Pradagroup.com, 2018). The three products of the operations that have been considered here include leather handbags, travel accessories and perfumes. The first two products constitute of a significant portion of the business earnings of Prada Group. The contribution of perfumes is not enough; however, this product has been selected to find out the way the unessential product aids the profitability of the organisation. Estimation of selling prices, variable costs and contribution margins for the identified products: After conducting adequate research, it has been identified that the average price for each handbag in the Italian leather market is 50. In addition, as Prada Group is involved in selling quality products, the average price charged for travel accessories is 500. Finally, the average cost of each perfume for Prada Group is obtained as 45. As obtained from the annual report of 2017 of Prada Group, the variable cost identified is selling, general and administrative expense. The total selling, general and administrative expense is provided as 661,437,000, out of which it is assumed that 60% of the expenses are spent on these products only. Hence, the total selling, general and administrative expense on these products is 396,862,200 (661,437,000 x 60%). Out of this cost, 60% of the cost is variable and the remaining 40% is fixed. Hence, the total variable cost for the three identified products is 238,117,200. A certain percentage of the total selling price of each item is allocated to the variable cost of that particular unit, which is depicted as follows: Leather handbags - 40% Travel accessories - 50% Perfumes - 10% Based on the above information, the following table is prepared for arriving at the total contribution margin ratio: In addition, another table is prepared to determine the contribution margin and contribution margin ratio for each of the three products, which is represented as follows: Difference in contribution margins for the three identified products and importance of such difference: In accordance with the above two tables, it could be stated that with the help of contribution margin, the managers could ascertain the contribution of a product for covering fixed costs (Chenhall Moers, 2015). The main difference between the contribution margins of the three products is due to the variation in the selling price and sales volume of each of the three products along with the variation in variable cost. In case of leather handbags and travel accessories, the sales volume is higher; however, the selling price for each travel accessories is higher in contrast to the leather handbags. This has lead to the difference in profit generated from each item. On the other hand, the contribution margin for perfumes is much lower, since the volume of sales is lower in the market and the selling price is the lowest in contrast to the other two products. In auditing, it does not need extensive services that need to be undertaken. Thus, it is inherent to identify the difference in the contribution margins of the three products. In addition, such difference would help the managers of the Prada Group to identify the most profitable segment and accordingly, investment could be made to enhance those areas of business activities and operations (Kamal, 2015). Reasons for not producing the product only with the highest contribution margin: There are certain reasons that Prada Group would not produce only travel accessories, since it has the highest contribution margin and such reasons are described as follows: If the competitors come up with identical products at cheaper prices, the customers might switch over to them. As a result, the contribution margin for Prada Group would be minimised. Secondly, if the cost of raw materials for producing travel accessories rise, there would be increase in variable cost of the product as well. As a result, the contribution margin of that product would decline. Finally, diversification of product base would help in generating additional customers for Prada Group, since they could obtain various products from a single place. Not all the customers are prone to purchase travel accessories only; thus, the other products are included in order to maintain the profitability level of the organisation. Resource constraints for Prada Group and relevancy of these constraints on the identified products for decision-making: The possible constraints that could affect the decision-making process of Prada Group comprise of the following: Skilled staffs are the most significant resource constraint that Prada Group might face in order to carry out its business operations effectively. This is because there are various departments within the organisation, which include customer-handling department, storage department and many others (Otley, 2016). Hence, it needs to recruit skilled and competent staffs for carrying out complex tasks, which could have impact on future services. Another significant resource constraint is the availability of raw materials required to produce the final products. The suppliers might raise the prices of materials, which would increase its product cost in the operating market. Ratio analysis and economic profit: The following ratios are conducted with the help of the restated financial statements for evaluating the financial condition of Prada Group: According to the above table, it could be found out that the profit margin of Prada Group has fallen over the years due to the increase in operating cost and raw material price, while there is fall of product demand in the market. This is further supported by the inventory turnover ratio (in days), since the organisation is taking 215 days in 2016 to complete one inventory cycle. This is quite a longer time span and hence, it needs to minimise its inventory level in order to avoid inventory loss or theft. However, the current ratio of the organisation is well above the ideal standard of 2 in 2016, which denotes that Prada Group has adequate amount of idle working capital. On the other hand, despite the fall in earnings ratio and price earnings ratio below 1, the organisation is paying increased dividend per share to its shareholders, which denotes that it intends to maximise the wealth of the shareholders. The similar trend is observed in case of ratios based on restated financial statements, which implies that Prada Group is not enjoying healthy and competitive position in the apparel industry of Italy. Economic profit: Economic profit or loss is the difference between the revenue obtained from selling an output and opportunity cost of the inputs used. Thus, the opportunity costs are subtracted from revenues earned at the time of calculating economic profit. The economic profit for Prada Group for the years 2016, 2015, 2014 and 2013 is depicted as follows: In case of Prada Group, the economic profit for Prada Group has fallen over the years, which denotes that the organisation is struggling to maintain competitive advantage in the operating market. Options available to Prada Group: It is assumed that Prada Group is planning to install machinery for increasing its production level. Two machines are available to the organisation in the form of alternatives, in which various assumptions are made. The first machine would help in raising the overall sales volume of the organisation, while the second machine would focus on increasing the overall product quality. These assumptions are depicted as follows: Assumptions: Particulars Units Initial investment for machine 1 (2,000,000) Initial investment for machine 2 (2,700,000) Discount rate 10% Application of investment appraisal techniques on the available options: The following investment appraisal techniques are used for both the projects, which are depicted briefly as follows: Recommendations: Based on the above tables, it could be stated that the NPV for machine 1 is obtained as 1,039,862.33, while the same for machine 2 is 1,861,949. This measure is used in capital budgeting to analyse the profit level of a projected investment (Taleb, Gibson Hovey, 2015). The higher the NPV, the better is the profitability of the specified investment. In this case, the NPV is greater for the second machine, which signifies that Prada Group should choose the second machine for maximising its profitability and productivity. IRR is used in capital budgeting for similar purpose like NPV and if it is higher than the discount rate, it is considered as a feasible investment (Uyar Kuzey, 2016). In case of machine 1, the IRR is obtained as 17.9%, while in case of machine 2, the IRR is 21.8%. Thus, in terms of IRR, machine 2 needs to be selected. On the other hand, payback period denotes the duration within which the capital investment could be recovered. In this case, the payback period for the first machine is 5.93 years, while the same for the second machine is 4.48 years. Hence, by evaluating the techniques of investment appraisal, it could be inferred that Prada Group needs to select the second machine for increasing its overall sales and profit margin. References: Chenhall, R. H., Moers, F. (2015). The role of innovation in the evolution of management accounting and its integration into management control.Accounting, Organizations and Society,47, 1-13. Kamal, S. (2015). Historical Evolution of Management Accounting.The Cost and Management,43(4), 12-19. Otley, D. (2016). The contingency theory of management accounting and control: 19802014.Management accounting research,31, 45-62. Pradagroup.com. (2018). Retrieved 6 February 2018, from https://www.pradagroup.com/content/dam/pradagroup/documents/Financial-Report---presentation/2_FULL-YEAR-2016-results----12-Apr-2017/e-Annual%20Report%202016.pdf Taleb, M. A., Gibson, B., Hovey, M. (2015). Fifty years of Sustainability Accounting: does accounting for income in business sustainability really exist?.International Journal of Accounting and Financial Reporting,5(1), 36-47. Uyar, A., Kuzey, C. (2016). Does management accounting mediate the relationship between cost system design and performance?.Advances in Accounting,35, 170-176.