MANAGEMENT ACCOUNTING

Region Fly – Cutting Costs in the Airline

Project 3

Instructor: Purusottam Sen

Submitted by: Group 1

ABM/18/027 PANDEY RISHABH YOGESH ([email protected]
PGP/37/223 AADITYA JADHAV ([email protected])
PGP/37/224 AISHWARYA VISHWANATH BHAT ([email protected])
PGP/37/231 AYUSHI AGRAWAL ([email protected])
PGP/37/268 CHETAN SONAWANE ([email protected])
PGP/37/269 SOUMAJIT NATH ([email protected])
PGP/37/276 VARUN GUPTA ([email protected])
PGP/37/504 ANKUR SINGH SENGAR ([email protected])
 Q1 Are the route costs reported by the cost system appropriate for use in the current strategic
analysis? Your judgment should be informed by a classification of the costs listed in Exhibit 2
as variable or fixed.
A:
2011 2012 2013 2014
Total Overheads $26,97,292 $28,09,015 $23,31,876 $21,79,686
Total Variable Direct Cost $10,13,732 $10,53,342 $7,71,782 $7,22,206
Overhead Allocation Rate 266% 267% 302% 302%

Every year, we witness an increase in the overhead allocation rate. They cut two routes, which means that
variable direct costs are lower, revenue is lower, and overhead costs are lower, but not by much. The
variable cost decreases more than the overheads. Resource spending IS NOT THE SAME as resources
consuming. If Region fly wants to make more profit, they need to reduce spending on resources for the
savings to take effect. If we reduce only resource consuming it will not be effective.

No, the current Strategic analysis aims at increasing profitability and cutting costs. The current cost system
doesn't consider that even with a drop in route, the decline in fixed costs would not be proportional to
revenues and variable costs. Hence, the costs reported are not appropriate. The management team expects
that dropping a route would lead to high profitability, which would not be the case with the current cost
system. So, in conclusion 1000,3000,7000 costs are variable, which means these costs change proportionally
with volume. 2000,4000,5000 and 6000 are semi-fixed, which means these costs will not decrease
proportionally with the volume. (They decrease but not so much if we drop the route).

Q2: What happened to the costs when Route 2 and Route 4 were dropped? What is likely to
happen if Route 7 is dropped as well?
A: Both revenue and direct costs declined once Routes 2 and 4 were eliminated. Some overhead costs
were also reduced (i.e., 1000, 3000, 7000). Other overhead expenditures, on the other hand, did not
fall considerably (i.e., 2000, 4000, 5000, 6000). However, operating profit falls as well. From 2012 to
2013:

 Revenue decreased by ($5,713,233 - $4,416,922)/$5,713,233 = 22.69%

VCD $ decreased by ($1,053,342 - $771,782)/$1,053,342 = 26.73%
 Overhead decreased by ($2,809,015 - $2,331,876)/$2,809,015 = 16.99%
 Operating profits decreased by ($1,850,877 – 1,313,264)/$1,850,877 = 29.05%

Revenue and direct variable costs both decreased, while overhead costs did not. Dropping route 7 may
have a similar effect because some overhead costs are permanent or largely fixed, therefore dropping
route 7 will not result in a major reduction in costs.

Q3: Assume that revenues and variable direct costs for each route in 2015 will be the same as they
were in 2014. Also assume that if Route 7 is kept, revenues and variable direct costs will not
change either. With this information:
i)Prepare an estimate of the budget for 2015, with respect to the following scenarios:
1)No additional routes are dropped;
2)Route 7 is dropped in 2015;
ii)What assumptions did you make to prepare this estimation?
 A: Budget for Revenue and VDC are assumed to be the same as in 2014:

Revenue
2015 Do not drop Route 7 Drop Route 7
Route
1 1273941 1273941
2 0 0
3 901845 901845
4 0 0
5 608818 608818
6 539726 539726
7 840010 0
Total 4164340 3324330

Direct variable Costs

Route
1 205474 205474
2 0 0
3 154203 154203
4 0 0
5 98196 98196
6 84332 84332
7 180000 0
Total 722205 542205

We need to assess how overhead costs would change if Route 7 was eliminated. We don't have precise
information on how they change, so the most we can do is make educated guesses based on data from 2012
and 2013, when Routes 2 and 4 were eliminated:
 Variable Direct Costs
2011 2012 % drop 2013 2014
1013732 1053342 26.73% 771784 722206
Overhead
1000 755242 787084 26.73% 576696 538631
2000 134865 138900 15.06% 117982 111485
3000 485512 510102 26.73% 373752 349082
4000 755242 783004 2.80% 761080 717969
5000 269729 281473 6.20% 264022 242362
6000 53946 56287 4.80% 53585 47592
7000 242756 252165 26.73% 184761 172566
Total 2697292 2809015 16.99% 2331878 2179687
Based these rates, we can estimate the overhead costs if dropping Route 7:

Overhead Accounts 2012/2013 drop rate With route 7 Without Rate 7

1000 26.73% 538631 394655
2000 15.06% 111485 94695
3000 26.73% 349082 255772
4000 2.80% 717969 697866
5000 6.20% 242362 227336
6000 4.80% 47592 45308
7000 26.73% 172566 126439
Total 2179687 1842071
Profit 1262448 940055
Allocation 3.02 3.4

Assumptions made to prepare these estimations:

 If route 7 is not dropped, market circumstances will not alter in 2015, resulting in identical
revenue and expenditures.
 Other changes, such as changing tactics, selling channels, or equipment, will not be made by
the corporation.
 Cost behaviors remain the same.
– For example, if the company eliminates some administrative positions or relocates
its headquarters to a less expensive structure, the fixed costs will vary.

Q4: Would you drop Route 7 in 2015? Why or why not? What additional information would you
require before making a final decision?

A: Dropping route 7 may not be a good decision for Region Fly, as it is likely to cause a death spiral. If
Route 7 were dropped:
1. Products were dropped. Production volume would decrease.
2. Reported costs of remaining routes increase.
3. More routes would be dropped until no routes were left.
4. Death of the firm.
5. The burden rate for the remaining routes would increase.
6. Allocation base would decrease disproportionately more than overhead costs decrease.

To make decision about whether to drop Route 7 and what the company should do in the next step,
additional information shall be collected, for example:
1. Analysis of the airline market: Price? Customer preference? Competitors?
2. Any change in cost behaviors?
3. Recent Change in technology and current status quo.
4. Future Prospects