Azienda Vinicola Italiana produced and bottled wines. The company did not buy grapes but rather bought either mosto or bulk wine. They have seen that this policy had the disadvantage that the firm could not assure itself of a consistently high-quality product. Moreover, the administrative manager wished to re-organize the firm in order to exploit its productive capacity to the utmost and, above all, to increase the net profit, which the owners did not consider satisfactory. The administrative manager assumed a maximum capacity of 900,000 bottles a year which would be equivalent to Lit 1,980 million. The administrative manager decided, therefore, to try to discover a way to change costs and revenue so as to obtain a profit of 176 million. I. PROBLEM STATEMENT
How to re-organize the firm to achieve a profit of Lit. 176 million a year, which would be almost 9% of sales of Lit 1,980 million? II. OBJECTIVES
a. to show the changes in income statement when selling price is assumed to increase. b. to show the changes in income statement when fixed costs are assumed to decrease. c. to show the changes in income statement when variable costs are assumed to decrease. d. to purchase grapes instead of mosto or bulk wine to ensure the quality of the product.
A. The presentation below shows the Income Statement using the contribution margin approach to have a better view on the costs which are variable and fixed
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AZIENDA VINICOLA ITALIANA
Income Statement
(Contribution Margin Approach)
For the Year 1993
Production Capacity – 871,850 bottles
Unit CostIn Lire SALES2,203.791,921,370,000.00
Less: Variable Costs
Labor Cost245.78214,282,000.00
Raw Materials690.8602,272,000.00
Axiliary Materials451.36393,514,000.001,210,068,000.00
Contribution Margin815.85711,302,000.00
Less: Fixed Costs
Labor Cost142,854,000.00
Staff Salaries118,196,000.00
General Manufacturing Expenses52,744,000.00
General Administrative Expenses66,000,000.00
Advertising Expense86,900,000.00
Interest82,500,000.00
Depreciation115,940,000.00665,134,000.00
Net Income46,168,000.00
Contribution margin ratio (Contribution Margin/Sales)37.02% BEP in Sales815,261.24
BEP in Lire1,796,660,931.05
B. By accepting the administrative manager’s estimate of cost allocation between fixed and variable, the chart below shows the changes of the total variable cost and the increase of sales revenue. As production increases so as the total variable cost increases. The break-even in sales volume and the profit at full capacity is also shown below.
AZIENDA VINICOLA ITALIANA
Income Statement
(Contribution Margin Approach)
For the Year xxxx
Production Capacity – 900,000
Unit CostIn Lire
SALES2,200.001,980,000,000.00
Less: Variable Costs
Labor Cost245.78221,202,000.00
Raw Materials690.8621,720,000.00
Axiliary Materials451.36406,224,000.001,249,146,000.00
Contribution Margin812.06730,854,000.00
Less: Fixed Costs
Labor Cost142,854,000.00
Staff Salaries118,196,000.00
General Manufacturing Expenses52,744,000.00
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General Administrative Expenses66,000,000.00
Advertising Expense86,900,000.00
Interest82,500,000.00
Depreciation115,940,000.00665,134,000.00
Net Income65,720,000.00
BEP in Sales Volume819,070.02
(Total Fixed Costs/Contribution Margin per unit)
III. ALTERNATIVE COURSES OF ACTION
ACA 1: Assumes that selling price increase
AZIENDA VINICOLA ITALIANA
Income Statement
(Contribution Margin Approach)
For the Year XXXX
Production Capacity- 900,000 bottles
Unit CostIn Lire
Sales 2,322.53 2,090,280,000.00
Less: Variable Cost
Labor Cost245.78 221,202,000.00
Raw Materials690.80 621,720,000.00
Auxiliary Materials451.36 406,224,000.00 1,249,146,000.00
Contribution Margin934.59 841,134,000.00
Less: Fixed Costs
Labor Cost 142,854,000.00
Staff Salaries 118,196,000.00
General Manufacturing Expenses 52,744,000.00 General Administrative Expenses 66,000,000.00 Advertising Expense 86,900,000.00
Interest 82,500,000.00
Depreciation 115,940,000.00 665,134,000.00 Net Income 176,000.00
Contribution Margin Ratio(Contribution Margin/Sales) 40.24% BEP Sales 711,682.80
BEP in Lire1,652,907,024.94
ACA 2: Assumes that fixed cost decrease
AZIENDA VINICOLA ITALIANA
Income Statement
(Contribution Margin Approach)
For the Year xxxx
Production Capacity – 900,000
Unit CostIn Lire
SALES2,200.001,980,000,000.00
Less: Variable Costs
Labor Cost245.78221,202,000.00
Raw Materials690.8621,720,000.00
Axiliary Materials451.36406,224,000.001,249,146,000.00
Contribution Margin812.06730,854,000.00
Less: Fixed Costs
Labor Cost119,168,638.67
Staff Salaries98,598,964.09
General Manufacturing Expenses43,998,982.73
General Administrative Expenses55,057,122.32
Advertising Expense72,491,877.73
Interest68,821,402.91
Depreciation96,717,011.55554,854,000.00
Net Income176,000,000.00
Contribution Margin Ratio 36.91%
BEP in Sales683,267.25
BEP in Lire1,503,187,941.78
ACA 3. Assumes that variable cost decrease.
AZIENDA VINICOLA ITALIANA
Income Statement
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(Contribution Margin Approach)
For the Year xxxx
Production Capacity – 900,000
Unit CostIn Lire
SALES2,200.001,980,000,000.00
Less: Variable Costs
Labor Cost224.08201,673,332.77
Raw Materials629.81566,831,875.15
Axiliary Materials411.51370,360,792.081,138,866,000.00
Contribution Margin934.59841,134,000.00
Less: Fixed Costs
Labor Cost142,854,000.00
Staff Salaries118,196,000.00
General Manufacturing Expenses52,744,000.00
General Administrative Expenses66,000,000.00
Advertising Expense86,900,000.00
Interest82,500,000.00
Depreciation115,940,000.00665,134,000.00
Net Income176,000,000.00
Contribution Margin Ratio 42.48%
BEP in Sales711,682.80
BEP in Lire1,565,702,159.23
ACA 4. Purchase grapes instead of mosto or bulk wine as raw material.
AZIENDA VINICOLA ITALIANA
Income Statement
(Contribution Margin Approach)
For the Year xxxx
Production Capacity – 900,000
Unit CostIn Lire
SALES2,200.001,980,000,000.00
Less: Variable Costs
Labor Cost245.78221,202,000.00
Raw Materials580.8522,720,000.00
Axiliary Materials451.36406,224,000.001,150,146,000.00
Contribution Margin922.06829,854,000.00
Less: Fixed Costs
Labor Cost142,854,000.00
Staff Salaries118,196,000.00
General Manufacturing Expenses52,744,000.00
General Administrative Expenses66,000,000.00
Advertising Expense86,900,000.00
Interest82,500,000.00
Depreciation143,440,000.00692,634,000.00
Net Income137,220,000.00
Contribution Margin Ratio 41.91%
BEP in Sales751,181.05
BEP in Lire1,652,598,312.47
IV. RECOMMENDATION
After a thorough discussion and analysis of the given data, we have chosen alternatives number one which is to increase the selling price and number three to decrease the variable costs since it generates higher contribution margin ratio which we considered to be the determinant in achieving the 176m profit. The contribution margin ratio tells a company how much of the contribution margin of its products change in response to an increase or decrease in sales volume. As the sales increases the contribution margin also will increase and will have an equivalent increase in profit. V. CONCLUSION
The Business plan on Benefits of computing gross profit on sales in contrast to contribution margin
The computation of gross profit on sales, which can be derived under the absorption costing approach, is a profitability measure normally conducted under financial analysis. This accounting ratio outlines the gross profit generated from every $100 of sales. Such measure is highly useful in financial analysis, because it provides indications on the profitability potential and cost efficiency of ...
By using the contribution margin approach of presenting the income statement of the company, we observed the behavior of costs which helped us in deciding the best alternatives to be use in solving the case of Azienda Vinicola Italiana. Though alternative number two (decreasing the fixed cost) can still generate the goal profit still it was not an ideal action, because fixed costs should remain fixed, we cannot change it over time and it will generate a low contribution margin. However, in the case when contribution margin is still low after all the decrease in variable costs and a corresponding increase in selling price, then that’s the time when the company should decide to decrease its fixed costs by eliminating some machineries and equipments, decreasing the costs of rentals by maximizing the use of space. On the other hand, a decrease in variable costs and increase in selling price could help increase its contribution margin which would help increase its sales at a certain volume.
