The board of directors of Performance Ltd appointed a new manager to the Southern division of the company at the start of year 6. The expectation was that the manager would improve the gross profit as a percentage of sales, as compared with the results for year 4 and year 5. Relevant information in respect of the Southern division for each year is as follows:
1. Sales and costs of the division were as follows:
|
|
Year 4 |
Year 5 |
Year 6 |
|
Sales |
10,000 units |
11,000 units |
12,000 units |
|
Production |
9,000 units |
10,000 units |
15,000 units |
|
Variable cost of production |
£5.00 per unit |
£6.00 per unit |
£7.00 per unit |
|
Variable cost of selling |
£2.00 per unit |
£2.20 per unit |
£2.40 per unit |
|
Total fixed costs of production per annum |
£210,000 |
£230,000 |
£390,000 |
2. Selling prices each year were based on full unit cost plus a percentage mark up on cost:
Year 4: Full unit cost plus 25 per cent of cost
Year 5: Full unit cost plus 24 per cent of cost
Year 6: Full unit cost plus 20 per cent of cost
3. There were 4,000 units of finished goods in stock at the start of Year 4. These were valued using costs identical to those incurred during Year 4.
4. The company policy is to value inventories (stocks) on a FIFO basis.
In year 4 and year 5 the company followed its previous practice of valuing inventories (stocks) at variable cost of production for management accounting purposes. The new manager of Southern division has insisted quite strongly that the inventories (stocks) should be valued on a full absorption costing basis, for consistency with external reporting standards.
Required
Prepare a report to the board of directors of Performance Ltd showing how the profit performance of the Southern division in Year 6 compares with that of Year 5 and Year 4 respectively.