PQ
43
PQ Magazine June 2020
the troubleshooter
• rank the products per the contribution per
limiting factor, to consider the alternatives.
• revise the production and sales mix.
• revise the budget.
Firstly, let us consider the original plan.
Products H1 H2 H3 Total
£ £ £
Selling Price 90.00 80.00 72.00
Variable
Costs
Direct Labour 36.00 31.50 27.00
Direct
Material 15.00 14.00 13.00
Variable
Overhead 11.08 9.70 8.31
62.08 55.20 48.31
Contribution
per Unit 27.92 24.80 23.69
Volume 1200 1100 1200
Contribution 33504 27280 28428 £89212
Contribution £89212
Fixed Costs £36000
Budgeted
Profits £53212
Limiting Factor Analysis:
Products H1 H2 H3
Contribution per Unit £27.92 £24.80 £23.69
Standard hours per Unit 4 3.5 3
Contribution per labour
hour
£6.98 £7.09 £7.90
Ranking Contribution /
Labour Hour
3 2 1
NB: The ranking per limiting factor differs from
that of ranking per contribution per unit of
output.
Revised Production and Sales Mix
Revised hours available 11025
Ranking
(1) H3
1200 units @ 3 std hrs
3600
7425
Ranking
(2) H2
1100 @ 3.5 std hrs
3850
Available for production of H1 3575
3575 hrs
4 std hrs per unit/ = 893 units
A shortfall of 1200-893 = 307 units
Revised Operating Statement March 2019
Products H1 H2 H3 Total
Contribution per
Unit
£27.92 £24.80 £23.69
Volume 893 1100 1200
Contribution 24933 27280 28428 80641
Fixed Costs 36000
Revised Profit £44641
Profit shortfall £53212 – £44641 = £8571
Shortfall of 307 units of H1 x £27.92 = £8571
Conclusion
The revised production and sales mix is
viewed only from a financial perspective.
The business may decide to consider
alternative strategies to avoid loss of
customer satisfaction in not being able to
meet the demand for H2. They may in the
short run be able to buy in a substitute or
contract out the work. However, they may
decide to spread the shortfall across all
products to minimise the adverse effect on
the customer perspective.
• Dr Philip E Dunn is a freelance author and
technical editor for Kaplan and Osborne Books
PQ
42 PQ Magazine June 2020
the troubleshooter
Know your limits
Philip Dunn explains all you need to know about decision making
and the limiting factor
In the structure and outline of CIMA P1
Management Accounting there is reference
to costing to support budgets and decision
making, and this includes the concept of limiting
factors. It is generally accepted that businesses
have one or more limiting factors or, as the late
Professor John Sizer states: “a factor in the
activities of an undertaking which at a particular
point in time or over a period will limit the
volume of output”.
Within the planning stage of the budgetary
cycle it will be apparent that there will
be a factor or factors which will limit the
organisational activities. This is often referred to
as the key factor or principal budget factor, and
its effects on the organisational plans must be
fully assessed.
Such factors are often referred to as scarce
resources that limit volume and may include:
•supply of skilled labour.
•supply of materials.
•factory space.
•finance – working capital availability.
•plant capacity.
•market demand.
It is often the case that a business may
face a single constraint situation; however,
others may experience a multi-constraint
scenario. Budgetary plans are usually set
some months prior to the period to which they
relate. Circumstances alter and situations often
arise where limits are placed on a resource or
series of resources after the plans have been
formulated. Where resources can limit capacity,
in the short run, a business must decide on
the product mix which will secure maximum
contribution (and therefore maximum profit).
This is the decision making process faced
by the finance team in which the marginal cost
model often features.
The use of the marginal cost model
in decision making
The function of the decision making process is
the selection of a future course of action from a
number of alternatives. It is recognised that some
costs are common to every alternative and in the
evaluation process they will have no direct bearing
on the ranking of the alternatives. It is often the
case in the decision making process that the fixed
costs are disregarded as they are by definition
insensitive to changes in volume of activity.
It is because of the nature of fixed costs and
their behaviour that marginal costing techniques
are applied.
The strategic objective of management is to
select that course of action which will obtain
from the resource base, the maximum amount
of contribution, profit and thus return on
investment.
Case Study
Hockeyskill have planned the following activity
for March 2019:
Products HI H2 H3
Budgeted Selling Price £90 £80 £72
Volume 1200 1100 1200
Direct Labour per Unit £36.00 £31.50 £27.00
Labour hours per Unit 4 3.5 3
Direct Material per Unit £15.00 £14.00 £13.00
Variable overhead recovery rate per standard hour £2.77
Fixed Costs for the month £36000
Early in the first week of the budget period
March 2019, a machine in the primary
preparation area, suffers a major breakdown and
a replacement part from an overseas supplier
and will not be available until the month end.
This will effect operating hours adversely by
10% in the budget period.
It will however not effect the employees’ basic
working week as the original plan for the month
included some overtime working.
The capacity in direct labour hours required to
produce the original plan was:
Products H1 H2 H3
Standard hours/unit 4 3.5 3
Production and sales 1200 1100 1200
Standard direct labour
hours
4800 3850 3600
= 12250 direct labour hours
The limiting factor is direct labour hours
and there will be a shortfall of 1225 hours and
capacity will be reduced to 11025 hours.
The business must therefore make a short-
term decision, which will result in the most
favourable course of action to minimise the
effect of this shortfall in capacity.
The business needs to revise its budget and
product mix, so that in the short run, it can
secure maximum profit.
The decision making process involves the
following steps:
•determine the contribution per unit of output/
product.
•determine the contribution per limiting factor
– the labour hour.
