1. Please complete the questions stated in the file that says Question Numbers. I have attached screenshots of the questions from the textbook to be completed.
2. I have also attached the theory for your use.
Microsoft PowerPoint - Week 10.pptx 8/10/2018 1 T O P I C 1 0 C O S T V O L U M E P R O F I T A N A L Y S I S OUTLINE • Cost volume profit (CVP) analysis and the break-even point • Target net profit • CVP analysis for management decisions • CVP analysis with multiple products • Including income taxes in CVP analysis • Assumptions underlying CVP analysis • An activity-based approach to CVP analysis • Financial planning models 1 (cont.) WHAT IS COST VOLUME PROFIT (CVP) ANALYSIS? • Calculates how changes in an organisation’s sales volume affect its costs, revenue and profit • Provides information for management decision making; can determine the impact on revenue and costs quickly • Useful for both profit-seeking and not-for-profit organisations 2 8/10/2018 2 THE BREAK-EVEN POINT • The volume of sales where the total revenues and costs are equal, and the operation breaks even (no profit or loss) • The break-even point can be calculated for an entire organisation or for individual projects or activities 3 BREAK-EVEN FORMULAS • Break-even point (in units): Fixed costs Unit contribution margin • Break-even point (in $): Fixed costs Unit contribution margin ratio (cont.) 4 BREAK-EVEN FORMUL AS • Unit contribution margin: Unit sales price – Unit variable cost • Contribution margin ratio (percentage): Unit contribution margin Unit sales price 5 8/10/2018 3 TARGET NET PROFIT • Target net profit (in units): Fixed costs + Target net profit Unit contribution margin • Target net profit (in $): Fixed costs + Target net profit Contribution margin ratio 6 USING CVP ANALYSIS FOR MANAGEMENT DECISION MAKING • Safety margin – Difference between the budgeted sales revenue and break-even sales revenue • Changes in fixed costs – Percentage changes in fixed costs will lead to a similar increase in the break-even point (in units or dollars) • Changes in SP and VC will affect the contribution margin per unit 7 (cont.) CVP ANALYSIS WITH MULTIPLE PRODUCTS • Sales mix − The relative sales proportions of each type of product sold by the organisation • Weighted average unit contribution margin − The average of the products’ unit contribution margins, weighted by the sales mix • Break-even point (in units): Fixed costs Weighted average unit contribution margin 8 8/10/2018 4 EXAMPLE, • Sales mix = – Product A 24,000, CM = $5 – Product B 96,000, CM = $4 – Product C 48,000, CM = $3 • Sales Mix = 1A, 4B. 2C • Fixed cost = $405,000 • CM per sales mix package = (1*5)+(4*4)+(2*3)= $27 • BEP – 405,000/27 = 15,000 packages • BEP Sales mix = 15,000A + 60,000B + 30,000C • BEP Package CM = (15000*5)+(60,000*4)+(30,000*3) = $405,000 INCLUDING INCOME TAXES IN CVP ANALYSIS • Sales volume required to earn net profit after tax: Fixed costs + Target net profit after tax (1 – t ] Unit contribution margin 10 ASSUMPTIONS UNDERLYING CVP ANALYSIS • The behaviour of total revenue is linear • The behaviour of total costs is linear over a relevant range • Sales volume is the only cost driver for both variable and fixed costs • The sales mix remains constant over the relevant range • In manufacturing firms, the levels of inventory at the beginning and end of the period are the same 11 (cont.) 8/10/2018 5 CVP ANALYSIS AND LONGER-TERM DECISIONS • CVP analysis is usually regarded as a short-term or tactical decision tool • Classification of costs as variable or fixed is usually based on cost behaviour over the short term • The financial impact of long-term decisions is best analysed using capital budgeting techniques 12 TREATING CVP ANALYSIS WITH CAUTION • CVP analysis is a simplified model • The usefulness of CVP analysis may be greater in less complex, smaller firms, or for stand-alone projects • For larger, more complex firms, CVP analysis can be valuable as a decision tool for the planning stages of new projects and ventures 13 AN ACTIVITY-BASED APPROACH TO CVP ANALYSIS • ABC categorises activities at unit, batch, product or facility level – Batch, product and facility activities are non-volume related activity costs • Break-even point (in units): Total batch, product and facility level costs Selling price – unit level costs 14 (cont.) 8/10/2018 6 AN ACTIVIT Y-BASED APPROACH TO CVP ANALYSIS 15 LIMITING ASSUMPTIONS OF CVP ANALYSIS USING ACTIVITY-BASED COSTS • Total batch level costs are dependent on the batch size and the break- even/target production level • Management may change the batch size at certain production volume levels • More complex models are needed where there are multiple products 16 INCLUDING CUSTOMER-RELATED COSTS IN CVP ANALYSIS • Profit = sales revenue – (unit level costs + batch level costs • + product level costs • + order level costs • + customer level costs • + marketing level costs • + facility level costs) 17 8/10/2018 7 FINANCIAL PLANNING MODELS • Sensitivity analysis – CVP can be run using different combinations of variables • Goal seek approaches – The analyst specifies the outcome, and the software specifies the necessary inputs • What-if analysis – The analyst specifies changes in assumptions and data to examine the effect of these changes on the outputs 18 SUMMARY • CVP analysis is a decision tool • The break-even point is the sales level at which sales revenue covers costs: there is zero profit • The break-even formula can be modified to calculate target profit • CVP analysis has several assumptions which limit its usefulness for decision making • Activity-based approaches and financial planning modelling can provide more sophisticated models 19 PART 2 INFORMATION FOR DECISIONS: RELEVANT COSTS AND BENEFITS 20 8/10/2018 8 OUTLINE • Decision making • Characteristics of relevant information • Identifying relevant costs and benefits • Accept or reject a special order • Make or buy a product • Add or delete a product or department • Joint products • Implications of activity-based costing (ABC) analysis • Incentives and pitfalls (cont.) 21 THE MANAGEMENT ACCOUNTANT’S ROLE IN DECISION MAKING • Provide relevant information to managers to assist in decision-making • Management accountants are often members of cross-functional teams 22 A MODEL OF THE DECISION- MAKING PROCESS 23 8/10/2018 9 TACTICAL VERSUS LONG-TERM DECISION • Tactical decisions are often short term and do not require significant changes in capacity-related resources • Long-term decisions are more strategic in nature and involve changes in capacity-related resources 24 CHARACTERISTICS OF RELEVANT INFORMATION • Relevant information relates to costs and benefits that differ under competing courses of action • Relates to the future – Past costs cannot be affected by the current action (e.g. sunk costs) • Timeliness versus accuracy – More accurate information may take longer to produce 25 (cont.) CHARACTERISTICS OF RELEVANT INFORMATION • Quantitative or qualitative – Quantitative information can be expressed in numeric terms – Qualitative information cannot be expressed effectively in numerical terms 26 8/10/2018 10 THE IMPORTANCE OF PROVIDING ONLY RELEVANT INFORMATION • Generating information is a costly process • Supplying irrelevant data to managers can lead to a waste of managerial resources • Information overload decreases the effectiveness of decision making 27 INFORMATION FOR UNIQUE VERSUS REPETITIVE DECISIONS • Unique decisions – Arise infrequently or only once – Relevant information will often be found inside and outside the organisation • Repetitive decisions – Made at regular or irregular intervals – May draw on a lot of historical data – Relevant information should be readily available 28 RELEVANT INFORMATION • Relevant information meets the following criteria: – The costs or benefits relate to the future – The costs or benefits differ between the alternatives 29 8/10/2018 11 SUNK COSTS ARE IRRELEVANT IN DECISION MAKING • Costs that have already occurred and cannot be changed are classified as sunk costs. • Sunk costs are excluded because they cannot be changed by future actions. – Irrelevant to the decision IDENTIFYING RELEVANT COSTS AND BENEFITS: TERMINOLOGY • Opportunity costs – The potential benefit given up when the choice of one action precludes a different action – Relevant to the decision • Out-of-pocket costs – The incremental costs incurred if a particular course of action is selected – Relevant to the decision • Avoidable costs – Costs that will not be incurred in the future if a particular decision is made – Relevant to the decision • Unavoidable costs – Costs that will continue to be incurred no matter which decision alternative is chosen – Irrelevant to the decision 31 ACCEPT OR REJECT A SPECIAL ORDER • Whether or not to supply a customer with a single, one-off order • Consider whether spare (idle) capacity can be used to meet the special order • If spare capacity is not available, meeting the order will require using capacity that is usually used for regular products 32 Variable cost of the flight Price of Charter $90 000 $150,000 Fixed costs allocated to the flight $100 000 8/10/2018 12 INCREMENTAL REVENUES AND COSTS … WITH SPARE CAPACIT Y, WALL ABY AIRLINES 33 INCREMENTAL REVENUES AND COSTS … WITH NO SPARE CAPACIT Y, WALL ABY AIRLINES 34 ACCEPT OR REJECT A SPECIAL ORDER: CONSIDERATIONS • Is the order a one-off decision or does it have long-term potential? • Strategic issues – Are there any adverse effects on regular business? – Qualitative factors? 35 8/10/2018 13 MAKE OR BUY A PRODUCT • An organisation chooses to produce or purchase the product from a supplier • Consider avoidable versus unavoidable costs • Opportunity costs are often relevant 36 TOTAL COSTS OF THE MAKE-OR-BUY DECISION, WALL ABY AIRLINES 37 MAKE OR BUY A PRODUCT: CONSIDERATIONS • Treat fixed costs carefully • Strategic issues may include: – Quality of the purchased product – Delivery responsiveness, technical capabilities, labour relations and financial stability of the supplier – Ability of the supplier to respect confidential information 38 8/10/2018 14 OUTSOURCING DECISIONS • When part of a manufacturing process, or another function normally undertaken within an organisation, is contracted to an outside business • Tends to be a long-term decision rather than a tactical ‘make-or-buy’ decision • Difficult and costly to reverse 39 ADD OR DELETE A PRODUCT, SERVICE OR DEPARTMENT • Consider which costs and benefits will change if the decision is taken • Has long-term implications • Traditional accounting data that contains cost allocations should be treated with care • Strategic issues – Consider any potential impact on other areas of the organisation – Will there be an impact on customers or staff morale? 40 JOINT PRODUCTS: SELL OR PROCESS FURTHER • Joint products: two or more products that are produced simultaneously from one production process • Split-off point: the stage in the production process where the two products are separately identifiable • Joint cost: the manufacturing cost incurred in the joint production process 41 (cont.) 8/10/2018 15 ALLOCATING JOINT COSTS Before a manager is able to allocate joint costs, he or she must first look at the context for doing so. Joint costs must be allocated to individual products or services for several purposes, including: • Computation of inventoriable costs and cost of goods sold for financial accounting and