Management Accounting Home Exam – Student Paper

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Choice Two – Management Accounting

Part A

1. Breakeven point to Music Maker for Idle Talent

Equation Method

Profit = Sales – Variables expenses – Fixed expenses (Tracy 2008)

Sm = Revenues received by Music Maker

0 = Sm – 0.2Sm – 5

5 = 0.8 S

Sm = \$ 6.25 million

Hence the breakeven point to Music Maker for Idle Talent expressed in terms of (a) revenues received by Music Maker is \$ 6.25 million.

And because the Music Maker receives 62.5% of the total in-store/on-line receipts, therefore, breakeven point to Music Maker for Idle Talent expressed in terms of total in-store/on-line receipts:

S * 62.5% = \$ 6.25 million

S = 10 million

2. Assume the first year’s total in-store/on-line receipts for Idle Talent is \$300 million, the calculation of the operating profit to Music Maker from the album in its first year is shown in the following:

 \$ (million) Sale revenue (total in-store/on-line receipts) 300 Less: Cost of goods sold (300*(1-0.625)) (112.5) Less: Various cost (20% Payment to Media Productions) Less: Fix cost Operating profit 187.5(37.5) (5) \$ 145 million

Table 1 The calculation of operating profit to Music Maker from the album in its first year assuming the sale in-store/on-line receipts for Idle Talent is \$ 300 million

Part B

1.0 Breakeven point for Music Maker expressed in terms of

For contracts A

a. revenues received by that company

Equation Method

Profit = Sales – Variables expenses – Fixed expenses

Assume Sm = Revenues received by Music Maker

0 = Sm – 0.25 * Sm – (15 + 21)

\$ 36 = 0.75 * Sm

Sm =\$ 48 million

b. total in-store/on-line receipts for Idle Talent

S*0.625 = Sm =\$ 48 million

S = 48/0.625

S= \$ 76.8 million

For contracts B

a. revenues received by that company

Equation Method

Profit = Sales – Variables expenses – Fixed expenses

Assume Sm = Revenues received by Music Maker

0 = Sm – (Sm*0.25 + Sm*0.15) – (21 + 3)

24 = Sm – 0.4*Sm

24 = 0.6*Sm

Sm = 24/0.6

Sm = \$ 40 million

b. total in-store/on-line receipts for Idle Talent

S*0.625 = Sm =\$ 40 million

S = \$ 64 million

The reason why the breakeven points in term of both Revenues received by Music Maker and the total in-store/on-line receipts for Idle Talent are more for contract A than those in the case of contract B is because that because in case of contract A there is a fixed-salary component of \$15 million for Urban, Seal and Josh (combined), and in contrast in case of contract B there is a reduced fixed-salary component of \$3 million for Urban, Seal and Josh (combined) while there is an addition of a residual of 15% of the revenues Music Maker receives from Idle Talent 2. Based on the equation that “Profit = Sales – Variables expenses – Fixed expenses”, when the fix cost reduced largely from 36 to 24 and the profit is zero, then the breakeven point in term of sale will reduce accordingly. In another perspective, in case of contract B, Urban, Seal and Josh (combined) share the risk of being unable to achieve the breakeven with the company, they are actually act as the investors of the new album by linking their payment with the sale of the album.

 \$ (million) Sale revenue (total in-store/on-line receipts) 300 Less: Cost of goods sold (300*(1-0.625)) (112.5) Less: Various cost (25% Payment to Media Productions) Less: Various cost (15% Payment to for Urban, Seal and Josh (combined)) Less: Fix cost (production cost) Less: Fix cost (payment to for Urban, Seal and Josh (combined)) Operating profit 187.5(46.875) (28.125)   (21) (3)   \$ 88.5 million

Table 2 The calculation of operating profit to Music Maker from the album in its first year assuming the sale in-store/on-line receipts for Idle Talent II is \$ 300 million under contract B

If the company accept contract B to pay a fixed-salary component of \$3 million for Urban, Seal and Josh (combined) plus a residual of 15% of the revenues Music Maker receives from Idle Talent 2, then based on our calculation, the operating profit will drop significantly from the previous \$ 145 million to \$ 88.5 million. There are several key reasons why the operating profit will drop to this extent. First of all, the budget production cost has risen obviously from the original \$ 5 million in the first album to \$ 21 million in the current album partially because of the great success that the first album has achieved (for example, the studio may thus become famous and request more for the second album); secondly, compared to the fact that all the production personnel and musicians for Idle Talent received a fixed salary (included in the \$5 million), in the Idle Talent 2, the agent for Urban, Seal and Josh has request for a fix salary of \$ 3 million while at the same time taking away 15% of the revenues Music Maker receives from Idle Talent 2 as the major part of their salary linking to the performance of the second album, this is also partially due to the high expectation that the second album will also achieve great success and the stars want to obtain higher payment through making another success; thirdly, the marketing company, Media Productions, also request for a higher ratio of sharing of the profit. Because of these higher fix and various cost, the new album has to achieve a higher sale or else if the sale remains \$ 300 million the operating profit will be much less than that achieved in the first album.

List of reference

Jabbour, G. & Budwick, P. H. The Option Trader Handbook: Strategies and Trade Adjustments. New Jersey: Wiley Publishing, Inc.

Nelson, S. L. QuickBooks 2008 All-in-One Desk Reference For Dummies. New Jersey: Wiley Publishing, Inc

Tracy, J. A. 2008. Accounting For Dummies. Indianapolis: Wiley Publishing, Inc.