INT1009 Lecture 3A: Management Accounting - Cost Volume Profit Analysis

INT1009 Lecture 3A: Management Accounting - Cost Volume Profit Analysis

Overview

  • Chapter 3: Cost–Volume–Profit Analysis
    • Focus on understanding costs as they relate to volume and profit.

Learning Outcomes

  • Prepare a Break-Even Chart: Understand how to plot costs against volume and determine the break-even point for various activities.
  • Introduce Cost Volume Profit Formulas: Learn the essential formulas associated with cost volume profit analysis.
  • Distinguish Various Cost Behaviors: Grasp different types of costs, particularly within the relevant range.

Lecture Aims

  • Theory Components:
    • Cost Behavior
    • The Relevant Range
    • Cost-Volume-Profit Analysis
    • Break-even Analysis
    • Margin of Safety
    • Target Profit
  • Practical Components:
    • The High – Low Method for splitting costs.

Contextual Examples

  • Annual Visitors for The New York Wheel: Requires 3 million visitors to break even.
  • Young Bull Prices: Imperative for farmers to break even on investments.
  • Shell and Brazilian Pre-salt Costs: Discussion on breakeven costs of less than $40.

Cost Behavior

  • Types of Costs:
    • Fixed Costs:
    • Remain constant regardless of the volume of activity (e.g., salaries, rent).
    • Variable Costs:
    • Change in direct proportion to the volume of activity (e.g., raw materials, wages).
    • Semi-Variable Costs:
    • Comprise both fixed and variable elements.
    • Example: Utility costs like electricity.
    • Stepped Fixed Costs:
    • Increase in increments based on capacity needs (e.g., renting an additional storage space).

Graphical Representations

  • Fixed Cost vs. Volume of Activity: Illustrates stability (y-axis)
  • Variable Cost vs. Volume of Activity: Indicates a direct relationship (y-axis).
  • Rent Cost vs. Volume of Activity: Shows steps in costs increases according to policy.

The Relevant Range

  • Definition: The production levels at which fixed and variable costs behave predictably.
  • Short-Term Decision Making: Costs can change outside this range.
    • Examples:
    • A factory that can produce 10,000 units without additional investments.
    • A store needing more staff if customer footfall exceeds planned numbers.
    • A delivery business needing more vans as deliveries increase.

Decision Making Based on Cost Behavior

  • Predictions on Costs and Efficiency:
    • Planning production levels
    • Understanding profitability in case of declining sales
    • Analyzing impacts of pricing changes
    • Making decisions regarding production resources

Breakeven Analysis

  • Understanding Cost-Volume-Profit Relation:
    • Formula and context enabling analysis of costs vs. revenues.
  • Scenario for Breakeven Calculation:
    • Example Trip to London:
    • Fixed costs include coach hire (£200) and insurance (£100).
    • Variable costs per person amounting to (£7 for travel + £15 for refreshments + £25 for entry) = £47.
    • Selling price of the tickets is set at £65, leading to a contribution of £18 (£65 - £47).
  • Calculation of Breakeven Point (BEP):
    • Formula: BEP = rac{ ext{Total Fixed Costs}}{ ext{Contribution per Unit}}
    • Result: Breakeven occurs at 17 tickets sold (as $300/18 = 16.66$ rounded up).

Contribution Statements and Proof of Breakeven

  • Total Contribution Calculation:
    • Total sales ($17*65 = 1105$) less total variable costs ($799$) yields a profit of $6$ after covering fixed costs.
  • Break-even Chart Representation:
    • Illustrates total cost, fixed/variable cost, and sales revenue.

Margin of Safety

  • Definition: The amount by which actual sales exceed breakeven sales, measured in units or percentage.
  • Calculation: For expected ticket sales of 30 and BEP of 17, margin of safety equals 13 tickets.
  • Profit Estimation Using Margin of Safety: Profit is calculated using margin of safety multiplied by contribution.Profit = ext{Margin of Safety} imes ext{Contribution} yields £234.

Target Profit Analysis

  • Determining Sales Requirements for Target Profit:
    • Scenario: For a desired profit of £1,200 on the trip, needing to sell additional tickets beyond BEP based on contribution per ticket.
    • The final required ticket count equals 84 (17 + additional needed for profit).

Numeric Break-even Analysis Problems

  • Examples of diverse scenarios exploring sales revenue, variable costs, and profit calculation based on set parameters.
  • Final Notes: Understanding contributions and implementing breakeven analysis is essential for informed managerial decisions.

Summary of Cost Volume Profit (CVP) Analysis

  • Importance: Critical for understanding interrelationship between cost, volume, and profit.
  • Applications: Impacts decision-making regarding pricing, product mix, and overall business strategy.