Pedaltrain Ltd. is a private UK company formed in 2017 by Johnny Miller. The company manufactures a high-tech stationary exercise cycle that is favoured by high grade athletes and serious cycling enthusiasts when they can’t get out on a real bike.
The company prides itself on producing an innovative product that is of excellent quality that enjoys a world-wide reputation with the cycling community.
The business manufactures one model of bicycle but the product can be modified to make the most of online training apps and sessions that are now available on an on-demand basis. The thing that sets all Pedaltrain cycles apart from the other cycles on the market is that a small automatically generated electric shock can be delivered to the rider if their cycling pace slows. This is a truly innovative feature that does not exist on any other cycle in the market and is highly favoured by serious riders.
Due to the high-end nature of the product, the unmodified cycle currently retails at a price of £1,500 and the modified cycle retails at a price of £2,000. Approximately 45% of customers buy the product with the added connectivity while the remaining customers buy the unmodified model.
The variable costs of production for the unmodified cycle are 55% of its selling price whereas for the modified cycle with added connectivity, the variable cost falls to approximately 50% of its selling price.
The stationary training cycle market has a number of key players including Nordictrack and Pelaton to name two, and although Pedaltrain products are seen as premium in the market there are some competitors who adopt different pricing strategies. The competitors’ cycles contain advanced features and innovations but do not have the electric shock feature that Pedaltrain has copyrighted. In addition, Pedaltrain sell their cycle in customisable colours for a truly unique bike!
The factory works a 38 hour week for 48 weeks per year and employs 21 people who are directly involved in the cycle manufacture process on 7 identical production lines. The company prides itself on its machine utilization efficiency but as the majority of the process Is labour driven (welding, assembly, painting), overheads are absorbed on a labour hour basis. It has been estimated that a cycle can go through the manufacturing process from start to finish in approximately 0.85 hours although there may be some possible delays due to bottlenecks and non value-added activities being incurred in the production process along the way. The business estimates that unproductive time is approximately 8% of the time available.
|Statements of profit or loss for the year ended 31st January 2022
|Cost of sales
|Profit before tax
|Profit after tax
Sales revenue is expected to continue to grow by approximately 5% per year in the future. Approximately 25% of the cost of sales are related to fixed production overheads while the remaining 75% are classed as variable and directly related to output.
The company operates on a small industrial site on the edge of a large town in in the north of England. Due to government incentives the rents and taxation on the profits are favourable but production capacity is limited in terms of the space available. The company feels that it would struggle to increase capacity above its current level of 50,000 units per year.
Mr. Miller knows that for the company to take control of its costs and increase its capacity it must reduce its non-productive and non-value-added time. Johnny Miller has played a significant role in imposing quite difficult budgets on managers. He has done this by simply making a percentage reduction in budgeted costs from the previous years to represent cost savings that he expects to be achieved. This has caused tension with managers and employees in the organisation.
Due to the pressure placed on targets and cost control by the company Mr. Miller has noticed that employees and managers do not seem quite as motivated as they did in the earlier stages of the company’s life. The directors of the company are proud of their growth and wish to maintain it. They recognise that measuring performance is critical and so are considering the ways that they can improve their performance measurement systems to ensure that they stay ahead in a fast moving industry where competition is fierce.
Produce a business report to Mr. Miller, in good style, that reports on the following issues:-
- Calculations on the expected level of sales of each product that you believe need to be made to break even. Back this up with further calculations that show risk in terms of margin of safety. Ensure that you clarify any assumptions that you make and fully discuss the results obtained. (Note, that there are several ways that you can calculate break even and MoS and you can use a number of these in this section.) (20 marks)
- Discuss the appropriateness of changing from an absorption costing system to an activity-based costing (ABC) system in order to manage the overhead costs of the business. (20 marks)
- Discuss how the present incremental budgeting process may be improved in Pedaltrain to enhance employee motivation and to reduce the possible slack that exists within the budget. (20 marks)
- Make suggestions as to whether the price of the cycles should be adjusted in the light of current market conditions and current product cost estimates. (20 marks)
- Discuss some of the potential drawbacks in using financial performance measures and suggest, with examples, some of the alternative, non-financial measures of performance that could be used in Pedaltrain. (20 marks)
Answers to Above Accounting Questions
Answer 1: Break-even point is an important concept in accounting and it implies a point of production level at which the total production revenue is equivalent to the total production cost. In the given case scenario of Pedaltrain Ltd, the figures of sales revenue, cost of sales, and other fixed costs such as administration expenses, and interest charges are given, and it is therefore possible to calculate the break even point as follows:
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