The objective of the simulation exercise is to maximize the profit of Aunt Connie’s Cookies. The simulation is attempted to help Maria Villanueva, the company’s CEO, to execute cost, volume, and price decisions, which might lead to the maximum profits for the company. This simulation demands Maria decide as to whether the company should spend more on advertising and at the same time for which product the advertising budget needs to be increased. She has also to decide regarding the volume of lemon crème versus real mint cookies to produce and the prices at which the cookies need to be sold. Maria must note that all of these decisions have a strong impact on the contribution margin of the company and in turn on the overall operating profits.
To evaluate the different options available fully, Maria must acquire knowledge on the behavior of each type of cost about proposed changes in the volume of a product. She must also understand the relationship between costs, volume, and the impact of this relationship on the profit of the company. The results of the changes in choices are demonstrated through the contribution margin in this simulation. A contribution margin enables a firm to assess the amount; each of its products is contributing to the total profitability of the company. The contribution margin deals with the elements of income in such a way that it emphasizes this relationship and the calculation of contribution margin enables managers to make better managerial decisions daily.
Designing and implementation a cost accounting system, which provides the contribution margin readily and helps the managers to base their decisions can assist them to make the best decisions concerning the products that are most profitable. The managers will also be able to decide on the volume of the products that need to be produced and priced to maximize the profits for the company.
In the case of Aunt Connie’s Cookies, price escalations have led to a reduction in sales volume and consequently reduced profits. The option here is to lower the prices and to increase the volume so that the sales can be increased leading to greater profits. It is also essential that the sales mix of Lemon Crème and Real Mint are fixed in such a way to maximize the production possibilities and the demand for the cookies can be met easily.
In this instance, Maria planned to reduce the price of lemon crèmes and mint cookies to have increased sales volumes. However, based on her experience, she thinks that a reduction in price alone will not be enough to enhance the sales volumes and to result in profits. Therefore, Maria decides to incur additional advertising costs. Another decision is to increase the margin to the distributors so that the sales volumes go up. The key to these decisions is to ascertain the appropriate mix of price, fixed costs, variable costs, and volume that can lead to maximum profits. Maria mustn’t reduce prices to a level, which leads to a tremendous increase in the volumes and at the same time, the profits are lowered. Such decisions become more complex when there are multiple products involved in the decision.
The first action is to decide on increasing the price for one of the products so that sales revenue can be enhanced. Lemon crème is the best-selling product for the company. Therefore, the price of Lemon Crème is changed to $1.93 per box from the original price of $2.00for the lemon crème. The changed price for the product lemon crème leads to enhanced sales of 992 packs from 725,000 packs. This increase in the number of packs results in increased sales revenue from $1,450,000 to $1,915,000. The reduction in the price of the best-selling product has led to an increase in the total sales revenue. The price change also led to the reduction in the price of the other product real mint cookies from $1.80 to $1.72 per pack. The reduction in the price of real mint cookies has resulted in increased sales of 968 packs from the original sale of 822 packs. In terms of sales revenue, the sales have increased from $1,480,000 to $1,665,000 The decrease in price lowers the contribution margin. However, the increased revenue offsets this effect.
The next action is to decide on the share that the company wants to pay to the distributors. When the distributors’ profit in the lemon crème cookies is increased from $.06 to $0.10, it may lead to a reduction in the contribution margin. Nevertheless, the increase in the sales revenue will help nullify this reduction. The decision was taken not to effect any change in the distributors’ share for the real mint cookies. This is because this product does not provide maximum profits. With this decision, the profits of the company raises to the optimum level of $ 993,000 within the advertising budget constraint of $ 275,000.
Aunt Connie can use the cost accounting system to help determine the most profitable price point for cookies by evaluating the cost – volume – profit relationship. “The cost accounting system is the most fundamental component of a cost management system. It supports all other cost management system tools and techniques” (Horngren, Sundem, Stratton, Burgstahler, & Schatzberg, 2008, p. 137). Maria recognizes that price reductions drive volume increases based on experience, so this is a good starting point for her analysis. Adding a fixed cost like advertising and tracking the impact on volume and profits can help Maria to decide on the price point that maximizes the firm’s profitability.
Reference
Horngren, Sundem, Stratton, Burgstahler, & Schatzberg, (2008) Introduction to Management Accounting 14th Edn, UK: Prentice Hall.