CHAPTER 13 THE ACCOUNTING PROFIT GAME INTRODUCTION ------------ Your very best friend, John Brown, has just Inherited $5000 from his grandmother, He made a very smart investment by buying a company called COMPUTER GAMES INC. for his $5000. He received $5000 of Inventory. The Inventory consists of 1000 computer disks which have computer games of various types recorded on them. These games will run on any IBM compatible microcomputer, He has also taken over various fixed expenses, such as, renting an office, renting a car, paying $2500 per month for office workers, etc. The computer game disks will be sold wholesale to computer stores for resale. As part or the agreement John must pay the authors of these games royalties of $ 1.00 per disk sold. John was a music major and plays in a band every night. He realizes that he does not know how to run this business, so he has asked you to be the business manager. He knows you are a business major and that you know all about running a business. You have agreed to accept the position as business manager for three months. You have agreed that your salary will be 25% of the profits after taxes, which will be paid at the end of the three months. OBJECT OF THE PROFIT GAME ------------------------- The object of the PROFIT GAME Is to select decisions which will realize the largest net profit for your company. You will make SALES DECISIONS ( on a per unit sold basis ) which will effect your sales volume, and your competitors sales volume. You will make COST CONTROL DECISION ( on a per unit produced basis) which will effect your product cost per unit. You will have a cash flow problem, so you will make decisions to borrow money which are called FINANCIAL DECISIONS. You will make decisions for each of the following planned expenditures (BUDGETS) for your company for each of three periods: SALES DECISIONS COST CONTROL DECISIONS FINANCIAL DECISIONS --------------- ---------------------- ------------------- Price Production Control Short Term Borrowing Advertising Employee Incentives Long Term Borrowing Product Research Maintenance Reduction in ST Debt Credit Losses Equipment Replacement Reduction in LT Debt Sales Salaries Equipment Expansion Dividends # of Units Produced Sale of Stock Each of the above decisions will have a direct effect on your company's profit. Also you are in an industry of 5 to 10 other firms, and the decisions of these competitors will directly effect your profits. For example, if a competitor lowers his price per unit, his sales volume will increase and your sales volume will decrease. Each time you change a decision, the computer will display a summary of the results, assuming the competitors do not change their decisions. Take notes on the results of each change that you make, so you can develop a set of decision rules or DECISION STRATEGY. -------- After you have selected your decisions, then select from the MAIN MENU the WHAT-IF REPORTS option and print out the detailed results of your decisions. You can select the QUIT MENU (option EXIT- TO DOS ) at any time. The computer will save your decisions and you can continue at some other time. When you have finalized your decisions for Period 1, then select the QUIT MENU (option SAVE FINAL DECISIONS ). The computer will then print out your INCOME STATEMENT and BALANCE SHEET so you can present the results of your management to John Brown. After you have printed out the reports, select OPTION 5 (PROCEED TO NEXT MONTH'S DECISIONS). IF OPTION 5 Is selected the computer will close out all the accounts and update all files so you can continue to make our decisions for Period 2. COMPETITION ----------- When you start PerIod 2 or 3, the computer will display PERIOD 2 on the SCREEN. The competitor's decisions will be made by the computer and automatically loaded , unless you are using a NETWORK or saving decisions on a hard drive C to be retrieved by student's IDs. To compete with other students use the QUIT MENU and use the LOAD COMPETITORS DECISIONS option, For Period 2 and Period 3, you will repeat this decision process. Your long run objective is to maximize your company's profits over the three periods. SALES DECISIONS --------------- The SALES DECISION BUDGETS are budgeted on a per unit sold basis. For example, your advertising budget might be $.20 per unit sold. The following SALES DECISION BUDGETS all effect sales volume: PRICE- lowering the price of your product will increase your sales volume and decrease the sales volume of your competitors. ADVERTISING,PRODUCT RESEARCH, CREDIT LOSSES, OR SALES SALARIES BUDGETS- budgeting and spending more on advertising , product research, credit losses, or sales salaries will increase your sales volume and decrease your competitor's sales volume. THE CONCEPT OF MARGINAL COST AND MARGINAL REVENUE ------------------------------------------------- YOUR GOAL or OBJECTIVE is to maximize your company's profits in the long run, In this PROFIT GAME you will operate your company for three periods with the objective of maximizing your profits over these three periods, To realize this goal, gather data reflecting the relationships of each of the relevant factors in your company that effect your sales volume. For a change a in budget to be desirable, it must increase your company's net profit. That is, the cost of the change must be less than the change in revenue. Or in other words, the MARGINAL COST must be less than the MARGINAL REVENUE for your profits to increase. Finally, you should try to match your production (number of units you produce ) with your sales demand. If you overproduce you will require more cash and investment in INVENTORY. This will also increase your company's cost and decrease your profits. FIXED AND VARIABLE COSTS ------------------------ FIXED COSTS- are costs that do not vary, at least in the short run. You usually will not be able to change the fixed cost in the near future. For example, 1. You have a contract to pay $ 1,200 rent for each of the next 6 periods 2. You are committed to pay office wages,of $2500 each period. 3. Your Utilities run $300 per period. 4. Your insurance runs $325 per period. 5. You have signed a contract to lease an automobile for $ 1000 per period. These are all examples of fixed expenses which will occur no matter how many units you sell. So your company has over $5000 of expenses that must be paid even if you do not sell a single unit. VARIABLE COSTS- are costs that vary with the number of units you produce (manufacture), or the number of units you sell, or vary with something else. For example: 1. We have to pay the authors of the computer games $1 for every unit we sell. 2. In the past, the cost of producing each unit was $5.00. 3. Advertising is a variable cost that varies with the number of units sold. 4. Sales salaries is a variable cost that varies with the number of units sold because the salespersons are paid on a commission bases. COST CONTROL DECISIONS ---------------------- The PRODUCTION CONTROL BUDGET is a variable cost that various with the number of units produced. An increase in the budget on production control will decrease the DIRECT MANUFACTURING COST per unit (the COST OF GOODS SOLD ). The EMPLOYEE INCENTIVES BUDGET is a variable cost that varies with the number of units produced. An increase in the budget on employee incentives will decrease the DIRECT MANUFACTURING COST per unit. The MAINTENANCE BUDGET is a variable cost that varies with the number of units produced. An increase in the budget on maintenance will decrease the DIRECT MANUFACTURING COST per unit. Conversely, a decrease in the budgets of any of the COST CONTROL DECISIONS will increase the DIRECT MANUFACTURING COST per unit (the COST OF GOODS SOLD ). THESE ARE ALL COSTS THAT YOU HAVE CONTROL OVER. You can budget more or less on each of these budgets, and thereby change your costs and your profits. Again, the MARGINAL COST AND MARGINAL BENEFITS concept is the method to ANALYZE your alternative budget decisions. FINANCIAL DECISIONS ------------------- CASH FLOW is one of the major problems of managing a business. You can not operate with a negative cash balance. You must plan for necessary cash requirements. Cash may be available from short term borrowing, long term borrowing, sale of stock, as well as, from operations. If you borrow money you will be charged interest at the rate of 18% per year, or 1.5% per period, Therefore your profits will be decreased by borrowing. If you obtain additional cash from the sale of stock, your stock will command cash at 6 times your profit per share. You will dilute your profits per share by selling stock. If you are not making a good profit per share, your stock will not sell. You must have a positive cash balance in the second period or you will be declared bankrupt and loose the game. ACCOUNTING MEASUREMENT METHODS ----------------------------- Inventory Methods ----------------- To determine the COST OF GOODS SOLD or the cost of the ending INVENTORY we must choose between various methods of estimating these values. In this case we have the choice of two inventory methods: 1. THE FIRST-IN-FIRST-OUT METHOD 2. THE LAST-IN-FIRST-OUT METHOD The FIFO method assumes that we will sell FIRST the first units that we acquired first. Therefore , the FIFO inventory method will assume that we will sell the units in the beginning inventory first. Our beginning inventory in period I is the 1000 units purchased at $5 each. The LIFO method assumes that the last units purchased ( or manufactured) are the first units sold. As you will see, each method presents a different COST OF GOODS SOLD and ENDING INVENTORY valuation, and therefore a different net profit. DEPRECIATION METHODS -------------------- DEPRECIATION may be defined as a measure of the consumption of an asset. As we use a car, truck, or computer we gradually consume it. It wears out. It does not last forever. The consumption of an asset is an expense that we must estimate. In this case we have the choice of three methods to estimate depreciation. They are as follows: 1, THE STRAIGHT LINE METHOD 2. THE DOUBLE DECLINING BALANCE METHOD 3. THE SUM OF THE DIGITS METHOD Each of these methods will give a different depreciation expense, and therefore a different net profit for your company. You may select any of the inventory methods and depreciation methods OR LEASE METHOD , but you must use the same methods in all three periods FOR YOUR FINAL DECISIONS. WHAT IF ? --------- We all have to make decisions every day. Some of these decisions are very important. Think how nice it might be if for the important decisions we could ask WHAT IF I decided this way and see the results. For example, assume you were trying to decide whether to price your game disks at $ 10 or $11. What if you could ask the computer to show you the effect on your sales volume and net profit of the $ 10 price and then show you the effect on your sales volume and net profit of the $11 price? You could then compare the two alternatives and select the best decision for your company. The Accounting Profit Game allows you to ask WHAT IF? So you can compare alternatives and then make your final decision. RUNNING THE ACCOUNTING PROFIT GAME ---------------------------------- TO RUN THE PROFIT GAME PROCEED AS FOLLOWS: 1. Turn on your computer using DOS 3.0 or greater. 2. Insert the Profit Game disk in drive A 3. Type A: and press return 4, Then type PG and press return The computer will display the following: (the underlined items are the user's response.) =============================================================== Your last period was 1 File name is TR1.DAT Company is: Games Inc, Month is 1 Do you want a General Description of the Profit Game (y/n)? N -- Enter game difficulty level (1,2,3,4 or 5)? 1 -- Select Inventory Option 1. First-In-First-Out Inventory Method 2. Last-In-First-Out Inventory Method Enter a 1 or 2 ? 1 -- Select Purchase or Lease Method 1. Lease automobile 2. Purchase automobile Enter a I or 2 ? 2 -- Select Depreciation Method 1. Straight Line Depreciation Method 2. Double Declining Balance Method 3, Sum of the Digits Method Enter a I or 2 or 3 ? 1 - =============================================================== After we have selected the above alternatives the computer will display the Menus. There are five basic Menus as follows: VOLUME, COST, FINANCIAL, WHAT IF-REPORTS, HELP AND QUIT. Each of these MENUS provide a list of alternatives. We can select a different Menu by pressing the right and left arrows. We can select a specific item from a Menu by using the UP and DOWN ARROWS and then the Fl Key. The following is the SALES DECISIONS MENU: Press Fl to Change PRICE BUDGET SALES DECISIONS MENU ---------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ---------------------------------------------------------- PERIOD 1 CHANGE PRICE Advertising Budget Product Research Budget Credit Losses Budget Sales Salaries Budget Number of Units Produced PRESS ARROWS THEN F1 FOR SELECTION ================================================================= The above SALES DECISIONS MENU may be used to select any of the decision budgets that effect your company's sale volume. You select the items in the menu by using the up and down arrows. If you press the RIGHT ARROW, the next menu to the right will be displayed as follows: ============================================================== Press F] to Change PRODUCTION CONTROL BUDGET COST DECISIONS MENU -------------------------------------------------------------- Volume COST Financial What If -Reports Help Quit ----------------------------------------------------------------- CHANGE PRODUCTION CONTROL BUDGET Employee Incentives Budget Maintenance Budget Equipment Replacement Budget Equipment Expansion Budget Inventory Method Depreciation Method ================================================================= If we press the RIGHT ARROW again we will move to the FINANCIAL DECISIONS MENU as follows: =============================================================== Press FI to Change SHORT TERM BORROWING FINANCIAL DECISIONS MENU ----------------------------------------------------------------- Volume Cost FINANCIAL What If -Reports Help Quit ----------------------------------------------------------------- SHORT TERM BORROWING Long Term Borrowing Budget Sale of Stock Reduction In Short Term Debt Reduction in Long Term Debt Dividends Paid If we press the RIGHT ARROW again we will move to the WHAT IF-REPORTS MENU as follows: ================================================================ Press FI to Change PRINT MONTHLY STATEMENT WHAT IF-REPORTS MENU ----------------------------------------------------------------- Volume Cost Financial WHAT IF-REPORTS Help Quit ----------------------------------------------------------------- PRINT MONTHLY STATEMENT Print Account Balances Print Income Statements Print Balance Sheet Print Statement Analysis Print Cash Flow Statement ================================================================ Lets now go back to the first MENU, THE SALES DECISION MENU. To do so we press the left arrow until the following MENU appears: ================================================================= Press Fl to Change PRICE BUDGET SALES DECISIONS MENU ----------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ----------------------------------------------------------- PERIOD 1 CHANGE PRICE Advertising Budget Product Research Budget Credit Losses Budget Sales Salaries Budget Number of Units Produced ============================================================= By pressing the UP and DOWN ARROW we can select the menu item for which we wish to make a decision. As we press the UP and DOWN ARROWS the emphasized item will change. For example, if we press the DOWN ARROW the menu will change as follows: ================================================================= Press Fl to Change ADVERTISING BUDGET SALES DECISIONS MENU ---------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ----------------------------------------------------------------- PERIOD I Price Budget CHANGE ADVERTISING Product Research Budget Credit Losses Budget Sales Salaries Budget Number of Units Produced =============================================================== If we press F1 now, we will be able to use the WHAT IF? approach to make various changes in the price budget and see the results. Finally, selecting the best alternative which maximizes our profit, =============================================================== Press F1 to Change PRICE BUDGET SALES DECISIONS MENU ---------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ---------------------------------------------------------- PERIOD I -Accounting Information- CHANGE PRICE % change in volume 0.29 Advertising Budget % change in DMC -.07 Product Research Budget YOU MUST BORROW FUNDS OR CUT COSTS Credit Losses Budget Sales Salaries Budget CASH BALANCE -2,878 Number of Units Produced Units available for sale 2,500 Sales Demand - in units 1,288 DMC/PER UNIT = $4,66 6,341 WHAT IF ?? -Income Statement- Income $12,880 100% Enter YOUR decision Cost Gds Sold -7,899 .56 as to THIS BUDGET or PRESS ENTER for no change Gross Margin 4,980 .44 Expenses -4,195 .36 SALES BUDGET WAS $11.00 Profit 786 .07 ENTER YOUR BUDGET FOR SALES PRICE? 10 -- Using FIFO Inventory Method and SL method Prior Profit was $ 825 ========================================================== Press Fl to Change PRICE BUDGET SALES DECISIONS MENU ---------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ---------------------------------------------------------- PERIOD I -Accounting Information- CHANGE PRICE % change in volume .00 Advertising Budget % change in DMC -.07 Product Research Budget YOU MUST BORROW FUNDS OR CUT COSTS Credit Losses Budget Sales Salaries Budget CASH BALANCE -3,251 Number of Units Produced units available for sale 2500 sales Demand - in units 1,000 DMC/PER UNIT = $4,66 5,000 WHAT IF ?? -Income Statement- Income $11,000 100% Enter YOUR decision Cost Goods Sold -6,210 .56 as to THIS BUDGET or PRESS ENTER for no change Gross Margin 4,790 .44 Expenses -3,965 .36 PRICE BUDGET WAS $10.00 Profit 825 .08 ENTER YOUR BUDGET FOR SALES PRlCE? 11.00 ----- Using FIFO Inventory Method and-SL Method Prior Profit was $786 Note that a price of $ 11 provides, a profit of $825 and a sales volume of 1000 units, whereas, a price of $ 10 provides a profit of $786 and a sales volume of 1288. The DMC (Direct Manu- facturing Cost) has not changed. WHAT IF we change the advertising budget from $.10 to $1.00 per unit? Will this change increase the sales volume? Will this change increase the Profit? ================================================================= Press Fl to Change ADVERTISING BUDGET SALES DECISIONS MENU ---------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT ---------------------------------------------------------- PERIOD I -Accounting Information- Price Budget % change in volume 0.27 CHANGE ADVERTISING BUDGET % change in DMC -.07 Product Research Budget YOU MUST BORROW FUNDS OR CUT COSTS Credit Losses Budget Sales Salaries Budget CASH BALANCE -3,466 Number of Units Produced Units available for sale 2,500 Sales Demand - in units 1,266 DMC/PER UNIT = $4,66 6,240 WHAT IF ?? -income Statement- Income s 13,930 100% Enter YOUR decision Cost Gds Sold -7,772 .56 or PRESS ENTER for no change Gross Margin 6,158 .44 Expenses -5,318 -.38 ADVERTISING BUDGET WAS 0,10 Profit $840 .06 BUDGET FOR ADVERTISING 1.00 ---- Using FIFO Inventory Method and SL method Prior Profit was $ 825 ================================================================= A change in the advertising budget from $. 10 to $ 1,00 has increased the sales volume from 1000 to 1266 units. This change has also increased the profit from $ 825 to $840, If we want detailed information on our company we can move over to the WHAT IF-REPORTS MENU and print out the Income Statement and Balance Sheet. SAVING FINAL DECISIONS ---------------------- When we get to a point when we wish to EXIT or SAVE THIS SET OF DECISIONS, we can press the right arrow until we see the QUIT MENU. Press F1 to Change SAVE FINAL DECISIONS QUIT MENU --------------------------------------------------------- VOLUME COST FINANCIAL WHAT IF-REPORTS HELP QUIT --------------------------------------------------------- PERIOD 1 Exit to DOS SAVE FINAL DECISIONS Load competitors decisions Erase files-start over ================================================================= If you press the down arrow you CAN select the SAVE FINAL DECISIONS. The computer will ask the following: ================================================================= Do you want your output on the PRINTER, SCREEN or in a WORD PERFECT FILE or EXIT, Enter a P or S or F or X? P -- ================================================================= END