Logi Service Limited started operations on January 1, 2020, providing a range of logistical services to clients. The company was set up with a total of £400,000 share capital funding, with £300,000 being provided by ordinary shareholders (common stockholders) and £100,000 being provided by preference shareholders (preferred stock holders). Ordinary shareholders require twelve per cent (12%) return and the preference shares provide a return of eight per cent (8%).

The company is considering providing a new type of service and intends to set it up in November and December 2023 and January 2024 and then operate it for one year from 1 February, 2024 on a trial basis to assess if it is financially beneficial to the company. Thereafter the new service may be continued or not.

For this new one-year service the company has negotiated a special tax arrangement with the tax authorities and will not be required to pay any tax on any profits generated in the one-year period relating to this service.

To assess the financial viability of the new one-year service, in the first two (2) weeks of November 2023 the company employed a financial consultant for a fee of £5,000. The consultant’s work has been completed but the fee has not yet been paid. The company’s intention is to charge the fee for the financial viability report to the

company’s annual income statement of the financial year ending 31 January 2024. Unfortunately, the consultant

had an argument with Logi Service’s Chief Financial Officer and has refused to release the financial viability report.

The following information is available:

1. Sales during the one-year period are anticipated as being 1,000 units of service at a selling price of £1,000 each, all paid for by customers at the time of purchase.

2. Variable operating costs associated with the new service during the one-year period are estimated as being £750 for each unit of service, all paid in cash.

3. The company purchased a ten-year (10 years) lease on buildings on 1 February, 2020 at a cost of £300,000, paid in cash at that time. The lease is amortised over ten years. For profit calculation purposes, the company’s total annual lease amortisation expense is charged to each of the company’s individual different types of services based on ten percent (10%) of the annual sales of each type of service.

4. This new service will require the fixed payment in January 2024 of £40,000 in cash for the rental for one year of a computing service from a supplier, the rental period being operational from 1 February 2024. This expense is not included in the company’s total fixed overheads and should not be included.

5. This new one-year service will also require the use of an existing computer which will now be used only for the new service. This computer was purchased on 1 February, 2020 for £50,000 and at the time of purchase had an anticipated operational life of five (5) years, depreciated on a straight-line basis. It will be disposed of on 31 January, 2025 but will not generate any sales receipt as it will be donated to a local charity. This expense is not included in the company’s total fixed overheads and should not be included.

6. The introduction of the new service would require the discontinuance of an existing service. This service’s contract would normally expire on December 31, 2024. The service to be discontinued regularly provides the company with annual sales of £100,000 but with variable expenses of £40,000.

7. To support its range of existing operations, the company currently pays total annual fixed overheads of £180,000, excluding the lease on buildings.

8. If the new service is introduced, the discontinuance of the existing service will save £30,000 of the company’s current total existing fixed overheads. However, If the new service is introduced, the company’s current total existing fixed overheads will increase by £20,000 for the financial year.

9. For profit calculation purposes, total annual fixed overheads are charged into the operational costs of any one service for annual profit measurement purposes based on ten per cent (10%) of sales revenues of a service.

10. This discontinuance of the other service activity will release staff. The staff currently employed on the existing activity can all be fully employed on the new service during the one-year period at a total salary bill of £100,000 which will be fixed for the year. This amount of £100,000 is £20,000 more than the staff transferred to the new service activity normally earn as permanent employees. New staff will also be employed to work on the new service and will be paid £60,000 which will be fixed for the year.

Required

a) Prepare an Income Statement for the one-year project. Show the Operating Profit (EBIT).

b) Calculate each of the break-even point in units and margin of safety in units for the one-year projec

Answer rating: 100% (QA)

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