- •Lecture Notes b.Devlin
- •Introduction
- •Management accounting
- •1 Financial accounting.
- •2 Management accounting
- •To provide information about product costing to be used in financial
- •To provide information for planning, controlling and organising.
- •To ascertain the cost of a product. This information is used to value stock which is required for external reporting .
- •To assist management in the decision-making process.
- •Marginal costing
- •Decision making
- •In the short-run all fixed costs remain unchanged and therefore treated as irrelevant.
- •Variable overhead
- •2 Shut-down decisions
- •3 Make or Buy
- •Variable overheads £2
- •Variable cost of production £7
- •Variable overhead £2
- •4 Limiting factor decisions
- •5 Profit Planning or cost profit volume analysis
- •Cost volume profit analysis
- •It is possible to ascertain these by using a break-even chart or by using formulae.
- •Budgeting
- •1. Sales Budget 19x0
- •Production budget 19x0
- •3. Materials Usage Budget 19x0 (Component usage)
- •4. The Material Purchase Budget 19x0
- •Cash summary December 19x0
- •Depreciation never appears in a cash budget as it is a non-cash expense.
- •In respect to credit transactions time lags have to be built into the cash budget
- •It is useful to have a memo column to record items which will appear in the balance sheet if required. Budgeted Profit and Loss Account for six months ending 30 June 19x1
- •Budgeted Balance Sheet as at 30 June 19x1
- •Investment appraisal methods
- •1 Payback
- •2 Accounting rate of return
- •Investment appraisal compares the cash outflows with the cash returns from the project and these cash flows take place over a lengthy period of time.
- •3 Net Present Value
- •6 Profitability Index
- •The costing
- •Overheads
- •Indirect materials used in Dept. B £35,000
- •Insurance of machinery £5,000
- •In the absorption stage an overhead recovery (absorption) rate (oar) is calculated. The formula used is:
- •30,000 Machine hrs.
- •35,000 Labour hrs.
- •In recent years there has been criticism of the traditional system of costing for overheads ( Kaplan & Cooper ). Traditional cost systems were designed when:
- •Information processing costs were high;
- •Inspection cost:
- •Standard costing
- •Variances represent the differences between standard costs and actual costs. The standard cost is what the cost is estimated to be and this is compared to what the cost is actually.
- •Variable Overhead Variance
- •Variable overhead efficiency variance
- •Responsibility accounting
- •It is a ‘ system of accounting that segregates revenues and costs into areas of personal responsibility in order to assess the performance attained by persons to whom authority has been assigned’.
- •Net Residual Income
5 Profit Planning or cost profit volume analysis
Management feels it helpful to ascertain the level of profits earned at certain levels of output and sales.
Example:
A company makes product X which has a selling price of £10 per unit and variable costs of £5 per unit with fixed costs of £20,000.
Sales (units) |
2,000 |
4,000 |
6,000 |
8,000 |
10,000 |
|
------- |
------ |
------- |
------- |
-------- |
|
£ |
£ |
3 |
£ |
£ |
Sales revenue |
20,000 |
40,000 |
60,000 |
80,000 |
100,000 |
Variable costs |
10,000 |
20,000 |
30,000 |
40,000 |
50,000 |
|
-------- |
-------- |
-------- |
-------- |
-------- |
Contribution |
10,000 |
20,000 |
30,000 |
40,000 |
50,000 |
Fixed costs |
20,000 |
20,000 |
20,000 |
20,000 |
20,000 |
|
-------- |
-------- |
-------- |
-------- |
-------- |
Net profit (loss) |
(10,000) |
--- |
10,000 |
20,000 |
30,000 |
|
-------- |
-------- |
------- |
------- |
-------- |
At sales of 4000 units the company is at break-even point ie. contribution is equal to the fixed costs.
Cost volume profit analysis
Lesson 3
Cost Volume Profit Analysis
The CVP model makes the assumptions that costs can be simply divided into fixed and variable costs. It assumes that over a range of output levels - the relevant range - fixed costs remain constant and variable costs increase directly with output. The variable costs behave in a linear fashion. The fixed costs are periodic costs so that cost items such as rent, rates, insurance, depreciation etc. are constant at all levels of output. There is also an assumption that the sales revenue behave in a linear fashion ie. the selling price is constant per unit of output.
Economists take a more realistic view of cost behaviour. They contend that variable costs do not behave in a linear fashion but are effected by economies of scale. Companies can benefit from discounts for bulk purchases of materials and
the economies from the division of labour. The economists’ model represented in a curvilinear graph shows the total cost line rises steeply at low output levels, levels off within a range of output and finally rises steeply again as the benefits of economies of scale decline. The total revenue line rises steeply, levels off and then declines. This curvilinear total revenue line reflects the fact that to achieve more sales the company may have to reduce the selling price and does not increase proportionally with output.
As a compromise it is possible to accept the assumptions that the CVP model is based on within a certain range of output - the relevant range. Therefore, the CVP model can be used as a planning technique to:
(a) find the break-even point
(b) determine the margin of safety
(c) determine a target volume
(d) establish the profit volume ratio or contribution volume ratio
(e) determine the operating gearing