Wairarapa Water Solutions Ltd - Accounting Management

Executive summary

Wairarapa Water Solutions Ltd produces three types of water tanks: Watercatcher, Watersaver and Waterpure. ‘Material X’ and labour are required to produce each tank. Demand for the water tanks is high, Material X is in short supply and it is not possible to expand the staff.

This report presents a cost-volume-profit analysis that indicates whether supply of Material X or current staffing levels will constrain the business from meeting its expected demand; the optimal quantity of each water tank the business should produce each week; the maximum amount the business should be prepared to pay as an overtime rate and for quantities of Material X; the steps the business might take to improve profitability; and other financial and non-financial factors which are deemed important.

Results of the above analysis is summarised as follows:

• To meet the expected weekly demand for water tanks, 27,500 units of Material X is required for production. 30,000 units are available; therefore supply of Material X is sufficient to meet demand and thus will not constrain the business.
• To meet the expected weekly demand for water tanks, 592 manufacturing labour hours are required. The company’s manufacturing hours are limited to 480 hours/week, therefore staffing levels is the factor that constrains the business.
• We have made assumed that fixed costs will be unaffected by the product mix, and thus irrelevant to the business decision. The decision is therefore based on contribution.
• The calculated contribution per unit of Watercatcher and Watersaver is $9.00; and Waterpure is $12.00.
• We have assumed there is no shortage of market demand for the tanks.
• By ranking products according to the contribution per unit of labour, it was determined that the optimal quantity of tanks to produce is:

• 500 units of Watersaver using 292 hours

• 200 units of Waterpure using 167 hours
• 32 units of Watercatcher using 22 hours

• The most profitable product is Watersaver as it generates a contribution of $15.43/labour hour. Waterpure and Watercatcher generate $14.40 and $13.59 respectively.
• A manufacturing plan that prioritises contribution per unit of the limiting factor, results in demand for Watersaver and Waterpure being fully satisfied and a shortfall of 168 units of Watercatcher.
• To meet demand for Watercatcher, an extra 112 labour hours are required, resulting in $896 of overtime wages; an additional $924 of Material X is also required.

Based on the above we can conclude:

• To maximise profit, the production structure should be changed to prioritise products by contribution per unit of the limiting factor (labour). I.e. Production of Watersaver followed by Waterpure and Watercatcher.  
• If the business optimises production structure to maximise profit, demand for Watercatcher cannot be met due to labour constraints (without staff doing overtime).

Other financial and non-financial factors to meet demand and/or increase profitability include:

• Redesigning products so less labour time is required to manufacture each product.
• Increasing product margins by raising price.
• If machine time was a constraint, capital investment in more machines, hiring machines or extending existing machine hours is possible.
• To mitigate risks associated with capital investment, products can be bought from other manufacturers.

1. Introduction

Wairarapa Water Solutions Ltd produces three types of water tanks: Watercatcher,     Watersaver and Waterpure. ‘Material X’ and labour are required to produce each tank. Demand for the water tanks is high, Material X is in short supply and it is not possible to expand the staff.

This report presents a cost volume profit analysis that indicates whether supply of Material X or current staffing levels will constrain the business from meeting its expected demand; the optimal quantity of each water tank the business should produce each week; the maximum amount the business should be prepared to pay as an overtime rate and for quantities of Material X; the steps the business might take to improve profitability; and other financial and non-financial factors which are deemed important.

1. Financial Analysis

2.1 Identify the limiting factor

To determine which factor will constrain the business from meeting the expected demand for water tanks, we first need to calculate the material demand and labour hours needed separately.

[pic 1]

To meet the expected weekly demand for water tanks, 27,500 units of Material X is required for production. This requirement for material X is able to be met within the current supply levels, thus it will not constrain the business from meeting the expected demand for water tanks.

 [pic 2] 

To meet the expected weekly demand for water tanks, 592 manufacturing labour hours are required. As the company manufacturing hours are limited to a maximum of 480 hours per week, the level of staffing will be the factor that constrains the business from meeting the expected demand for water tanks.

2.2 Calculate the contribution per unit of each product

We have made the assumption that fixed costs will be unaffected by the product mix and thus irrelevant to the business decision. So our decision is based on contribution.

To determine the optimal quantity of each water tank that the business should produce each week, we need first to allocate the manufacturing overheads to products, as follows:

[pic 3]

Then we calculate the contribution (sales revenue less variable costs) per unit of each product:

[pic 4]

2.3 Calculate the contribution of each product per unit of the limiting resource consumed

[pic 5]

2.4 Establish production priority by ranking products according to the contribution per unit of the limiting resource so that the business can produce the optimal quantity of each water tank per week