Question
Part A - Decision making and relevant information
Ishtar Ltd makes an energy drink sold mainly at gyms. Currently the energy drink is available in 500 ml bottles in three different flavours (Coffee, Chocolate, and Vanilla). The energy drink is sold to gyms in cartons containing 12 bottles of the same flavour. Due to the downturn in the economy and competitors entering the market, sales have dropped significantly. The CEO of Ishtar Ltd is concerned about the decline in the profit of the company. The CEO believes that cutting the cost of manufacturing the energy drink will enable Ishtar Ltd to reduce the selling price and regain some of its market. She asked the management accountant (Julius) to investigate the cost structure of making the energy drink. Julius provides the following information about the current monthly activity level:
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Description
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$
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Selling price per carton: Coffee flavour
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36
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Selling price per carton: Chocolate flavour
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60
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Selling price per carton: Vanilla flavour
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50
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Variable manufacturing costs per carton that vary with number of units produced
Coffee flavour (for producing 60 000 litres)
Chocolate flavour (for producing 90 000 litres)
Vanilla flavour (for producing 45 000 litres)
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24
40
34
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Variable costs per set up for making different flavour energy drinks (see additional information below)
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1 000
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Fixed manufacturing costs per month
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50 000
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Fixed marketing costs per month
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25 000
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Variable marketing costs per carton sold per flavour:
Coffee flavour (for producing and selling 60 000 litres)
Chocolate flavour (for producing and selling 90 000 litres)
Vanilla flavour (for producing and selling 45 000 litres)
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1.20
1.40
1.30
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Ishtar Ltd only has one manufacturing plant and can only make one flavour of energy drink at a time. It sets the plant up to make 5 000 litres of one flavour at a time, starting with Coffee flavour, followed by Chocolate flavour and then the Vanilla flavour and then repeat that sequence until the 45 000 litres of Vanilla flavour has been produced. It then starts again with making 5 000 litres of the Coffee flavour, followed by the Chocolate flavour. Once the 60 000 litres of the Coffee flavour energy drink is manufactured, it sets up the plant once to manufacture the remainder of the Chocolate flavour. The company has the capacity to manufacture 195 000 litres of energy drink per month. Currently, it operates at full capacity and makes and sells the following levels per flavour per month:
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Coffee flavour
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Chocolate flavour
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Vanilla flavour
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60 000 litres
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90 000 litres
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45 000 litres
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While investigating the cost structure of the energy drink, Julius (who was born in Kenya) contacted a very close friend in Kenya who has a coffee plantation. Julius discovered that coffee beans could be imported from Kenya at a cost much lower than what Ishtar Ltd currently pays. Currently Ishtar Ltd buys the coffee beans from an Australian coffee farmer in the Atherton Tableland in Queensland. Should Ishtar Ltd import the coffee beans from Kenya, the variable manufacturing costs per carton of the coffee flavour energy drink will decrease to $15, the variable marketing costs will be $1.00 per carton and each carton can then be sold for $30. Assume only one set-up will be required to make the 195 000 litres of Coffee flavour energy drink. Furthermore, Julius believes that importing the coffee beans from Kenya will also be the right thing to do ethically, as it is a fair trade transaction, helping a third world country. Julius decided not to tell the CEO about his relationship with the source of the coffee beans from Kenya. Julies is a member of CIMA, and bound to CIMA's Code of Ethics for Professional Management Accountants.
Julius proposes that Ishtar Ltd imports the coffee beans from Kenya, and use the full capacity to make and sell only Coffee flavoured energy drinks.
Required:
1. Calculate the operating profit / (loss) for one month for Ishtar Ltd using variable costing method for the two scenarios: (a) business as usual and (b) import the coffee beans from Kenya. Use the format of figure 8.4 on page 304 of the prescribed textbook to show your calculations. Show the Income Statements for the two scenarios (a) and (b) next to each other in one table.
To receive maximum marks, please show all your workings and calculations. You will receive zero marks if your figures are incorrect and you do not show any calculations as the marker will not be able to give you partial marks.
Tip: calculate the number of cartons that need to be made and sold per month.
2. Discuss the following issues that Ishtar Ltd will have to consider in making the decision whether to accept or reject Julius' proposal to import the coffee beans from Kenya and to use the full capacity to make and sell Coffee flavour energy drinks only:
(a) Relevant and irrelevant costs and revenue (identify which are relevant and which are irrelevant and justify your decision).
(b) Other non-financial issues.
(c) Any ethical issues that Julius, as a member of CIMA and being bound to CIMA's Code of Ethics for Professional Management Accountants, should consider in making this proposal. Tip: Not all fundamental principles may be relevant, only discuss the relevant principles and justify why it is relevant.