Cost volume profit analysis
Question 2 Cost Volume Profit Analysis 1. 0 Introduction According to Jon Scheumann “a successful organizations need a culture that is attuned to cost management and pay attention to cost structure” From that statement manager must pay attention and carefully thinking when do decision making to the cost. For example when manager want to target the profit. They must take every cost that related in production such as variable cost and fix costs. Cost Volume profit analysis is used in decisions making in a company.
The reasons why used cost volume profit analysis as a method to make decisions making because It elps manager to estimate future cost, revenue, expenses and profit that helps them to monitor the level of activity in production and monitor the plan. Besides that when used CVP analysis we can identify monitor the activity level and make analysis to avoid loss, find a target profit and maximize the production of unit.
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Moreover CVP analysis can help manager to Identify the risk and effect for their decision making and a technique to analyse the profit change bases on sales volumes, costs, and process.
When do CVP analysis the manager can get the information like the product that want to analyse he volume Is required to achieve a certain level of profit total of revenue is needed before the company will incurred loss(break event point) Those flx cost can effects the organization to an unacceptable level of risk. a) A break – even analysis must be interpreted in the light of the limitations of its underlying assumption (From Cost Accounting: A managerial Emphasis, by C. T. Horngren) 2. 0 Introduction to Assumption What is assumption?
Assumption is something like a rule is must be made or a certain item be ignore when do assumption in CVP analysis. Why need to do assumption In CVP analysis? There Is a limitation of CVP analysis. The effectiveness of CVP analysis must be done with assumption in order to make CVP analysis is useful when the manager do decision making for the future plan. How to make the assumption? It to simplify the cost that hard to calculate and that cost behaviour is always changes. So when do the assumption we can solve It faster at any of period of times and situations.
In order to make assumption we must to understand that every assumption Is made that no has too much cost, long period, break a law and company policies. Normally when did the new assumption people hard to accept and eed time to convince them. After we done with assumption for CVP analysis, we should listing all assumption to make other analysis. If assumption Is made is violating, the CVP analysis is can easily modified and make it realistic. What use of 1 org assumption? 10 slmpllTy a complex analysls more easlly ana to set up some conoltlon and control it when do an analysis.
Sometime when we do assume there a risk we must to be taken and face it like hidden cost, increasing in petrol cost and tax. 3. 0 Assumption To used assumption in CVP analysis the manager must recognize the cost first. For xample when do CVP analysis, we must identify sales volume, cost, and profit. So when identify the cost there are condition must be made to make the assumption 1 . All cost included variable and fixed cost Why we assume that variable cost and fixed cost included all cost? Because in the firm, we are cannot identify each type element of cost.
Besides that firm cannot identify which element of cost should be fixed or variable cost. If the firm cannot identify Fixed and variable cost, it impossible to used cost volume profit analysis. For example if the firm cannot identify fix and variable cost there will be a problem when o CVP analysis. There are a way how to identify which costs are fixed and variable cost. Every cost that related in production and always changes base on the volume of the unit produce is variable cost. Example cost of material and labour to produce item in production.
For fix cost is the cost that not affected when level of activity in production is changing. Example is rent and manager salary. So when the firm done correctly to identify fixed and variable cost, it can do CVP analysis correctly and manager can used the correct CVP analysis to make decision making. 2. In graph Cost are in straight line Assume that fixed cost no change in any of range. Variable Cost is proportional and parallel to the line revenue. So in the reality cost of behaviour not remain constant.
It mean when we do CVP analysis we must assume a straight line (constants) so when do a calculation it easy to calculate the cost and make analysis. For example if we see in graph the cost is curve line it hard to calculate the cost if the cost is out of range from the graph. So that why we must assume in straight line so it easy to calculate and identify the cost even it out of range in graph. 3. Price is fixed for every volume as purchase/selling ( selling price/direct material) When buy a lot of item, item we buy was offering/make a discount.
These make a problem to determine contribution margin ratio. Example normally when we buy/sell a lot of item we can receive/give discount. Event we know that it hard to calculate when price always changes base on the quantity item of we buy/sell. So in order to make easy calculation we must make assumption fixed price every volume was purchase and selling and ignore the cost that give effect the change in price and volume. 4. Variable cost is fix per unit not alculated based on volume produce So when it calculated per unit it hard to identify what actual cost and hidden cost of total volume produce.
Even cannot identify actual and hidden cost help when do CVP analysis. If we calculate variable cost base on volume produce we can get difference cost because of hidden cost. That why we must use variable cost fix as per unit so we can used to calculate in CVP analysis. For example if we cannot used this assumption it hard to identify unit control margin ( ucm ) so IT cannot laentlTy unlt control margin I t nara to Tina Break Even Po 5. Sales Mix constant In level of activity, if product y have different level of activity compare to product z. So in graph it can show two product y and product z.
From the graph we can see which products give higher profitability or not. If company produce a excess from the target in will incurred loss. For example company manufacture umbrella and rain coat for raining seasons. So it produced more products during that season. 4. 0 Limitation of CVP analysis Cost volume profit analysis is limit to acquire a lot of information. Event cost volume profit can help decision making in future for the short run but in Long run it cannot e used because of the information that get is not up to date and always change from time to time.
So manager need to do again analysis in order to get up to date information. Besides that, Cost volume profit is only suitable for a single product when manager used CVP analysis to make decision making. For multi products such as Mc Donald or KFC that run more than one product. It is cannot be used because every type of product did not have same level of activity. So that why when there have two or more product it assumes has same activity. Beside that hard to make variable ratio cost for every product. Moreover, It is hard to identify what element or type of cost that relate.
If the manager cannot identify what type of product it make impossible to used Cost Volume Profit Analysis. For example part time worker should assume as variable cost or fix cost. Beside that Cost Volume Profit cannot identify the performance of worker. So that why performance worker were assume as fixed when we know in reality the performance of worker always change. In addition, cost volume profit cannot identify the hidden cost when produce more product in future or the changes of currency money and company or government policy.
For example hidden cost like increasing petrol cost, tax, or maintenance machine. CVP analysis maybe present by using equation or chart Break – even point (BEP) (in sales revenue) BEP in unit x selling price OR Total Fixed Costs Contribution margin ratio (CMR) Break – even point (BEP) (in unit) Total Fixed Cost Contribution per unit Selling price per unit minus variable cost per unit larget pront (In sales revenue) Target profit in units x selling price per unit Total fixed costs + Target profit Target profit (in unit) Contribution (total or per unit) Sales (total or per unit) Margin of safety (MOS) (in units)
Current/expected sales in units minus BEP in units Margin of safety (MOS) (in sales revenue) Current/expected sales in RM minus BEP in RM Margin of safety (MOS) in % MOS in units (or sales revenue) x 100 Current/expected sales in units (or sales revenue) b) Bartley Company’s primary line of business is making and selling of syrup to bottler. These bottler then sell the finished bottle and cans of syrup to the consumer. In management report say gross margin is decline to 61% to this year(2013) and 62% to the prior year(2012) due to increasing the cost of sweeter and packaging.
Does the ncreasing the cost of sweetener and packaging give effect to gross margin? Cost of sweetener and packaging are Cost of good sold or variable cost because of cost this increase when level of activity increase. Below are the formulae of gross margin. Assume that revenue is same from this year and prior year 2013 2012 Revenue RMIOOO Cost of goods sold(sweetener and packaging) RM390 Formulae Gross Margin=(Revenue-C06S/Revenue)x100 Gross margtn(thts % Gross margtn(pnor So from the formulae above is what we can see that the increasing of variable cost/ Cost of good sold(C06S) effected the percentages of gross margin.
So from the calculation above we can see that a proved that gross margin percentages decline base on increasing cost of goods sold. B i) Are sweetening and packaging a variable or a fixed cost? Sweetener and packaging are variable cost. This is because cost of Sweetener and packaging increase when cost of production increase. Variable cost is like a cost that relate to the production. Both of them are manufacturing material. Manufacturing are come together with direct material, direct labour, and manufacturing overhead. What the impact on the contribution margin of increasing cost per unit for sweetener or packaging?
Contribution margin is defining as total revenue minus total variable cost to obtain contribution margin. For example if cost of sweetener and packaging increase it can give effect to the contribution margin. Below is the situation and calculation if sweetener and packaging cost are increase. Selling Price 10 Variable cost per unit (sweetener and packaging) 6 5 This is a detail of information for selling price and variable cost for the year 2013 and year 2012. Calculation CM = RM4 CM = RM5 CM = Selling Price CM = RMIO- RM6 CM = RMIO- RM5 – Variable Cost From the table above this is the contribution margin for year 2013 and year 2012.
I nls Is snow tnat cnanglng In varlaDle cost can glve erect 0T tne contrlDutlon margln and also can affect the gross margin. Increasing in variable cost can give impact to contribution margin. If the company want to increase contribution margin they must decrease the variable cost in order to increase contribution margin. Contribution margin is a like gross profit. The difference between gross profit and contribution margin is contribution margin is used for to make analysis while gross profit used historical calculation for specific sales volume.
Besides that contribution margin is a like pricing strategy in order to aximum profit from the difference between selling price and variable cost in production. Sometimes by using contribution it can help manager to make analyse the variable cost and a target profit. For example if the manager target to gain profit what show they do if variable cost increase? Should they increase selling price or increase the unit of production. So the impact of variable cost in contribution margin can help manager to make decision. What is implementation of profitability? Implementation profitability is mean a way how the company gain profit.
How to gain profit? By doing CVP analysis the company must identify their level of profit or loss. By identify break event point the company know what level it gain profit or loss. Break event point is a point when the situation the company no gain any profit or loss. If the company sales more than break event point it can gain profit and if company sales less that break event point it will incurred loss. B it) My opinion marketing expenditure a fix cost because what we see from statement in question b) say that increasing [selling expenses] due to higher marketing expenditure.
So from that statement what I can conclude that selling xpenses increase when the expense marketing expenditure is increase. The reason I did not say that marketing expenditure as a variable cost because marketing expenditure not related to level of activity to produce item. For example when production unit increase it not affects the marketing expenditure. Besides that it expense that not relate to the cost of goods sold and marketing expenditure is amount of money that spend for marketing. -CVP analysis is useful especially to plan future production and sales activity that help firm to maximize profit. Enable the firm to determine break event point(BEP) BEP point is where the minimum unit that company sell is no gain any profit or loss Break Event Point(BEP analysis) Use Break event point from cost volume profit or CVP analysis to make decision making. Break event point(unit) where is the total fix cost divided ucm . From CVP analysis we can used formulae Break Event Point BEP(unit)=total fixed cost OR Fixed cost UCM CS Ratio -used BEP formulae to determine the BEP point or sketch the graph from below.
Break event Chart cost(RM) Sales Total Cost BEP(unit) Activity level BEP(RM) These graphs show clearly the BEP of product as well as value in RM value. At BEP oint where the company no gain profit or loss. the term breakeven point is often heard in the context of CVP analysis. Break even means a situation where there is neither profit nor loss. At the breakeven point, the contribution exactly equals the fixed costs. The breakeven quantity is that volume of output at which the fixed costs are equal to the contribution margin; the breakeven revenue is that sales revenue where the contribution margin equals the fixed costs.
Normally it used of single product of company. In managerial, In the equations below, if profit is set to zero, the contribution margin will be equal to fixed costs. Contribution Margin The concept of a contribution margin is central to managerial decision making based on Cost-volume-profit Analysis (CVP Analysis). The starting point in CVP Analysis is the following equation: Profit = Total Revenue – Total Costs This equation can be rewritten as: Profit = Total Revenue – Total Variable Costs – Total Fixed Costs The Contribution Margin is Total Revenue minus Total Variable Costs.
Contribution margin=Total Revenue – Total variable cost Equation for unit contribution margin Unit contribution margin(UCM)=Selling Price – Unit Variable Cost or in ratio can be used this equation CS Ratio = sales Revenue otal contribution Selling price -Reason to usea contrlDutlon margin equation Decause to Tina pront 0T per unlt 0T product -So when used this equation management can make decision how they want gain profit per unit of product. -to find sales revenue required by using CS Ratio. This method is particularly useful in service type organizations where it may be difficult or impracticable to identify variable cost per unit of service Traditional Method -to find or target net profit -from equation below management can make decision how many profit they target base on volume of unit and selling price in unit. NP=Px-(a+bx) Where p=selling price Vv’olume(unit) ”fix cost IF,’ariable cost Margin of safety -show the maximum unit can be reduce before the company incurred loss -the higher the margin, the more company can withstand amount of drop sales which is company can stand fluctuation sales. the lower the margin the more company will suffer of loss -it helps management to measure risk before to sales product Here equation for margin of safety Margin of safety(unit)=expected sales- BEP Conclusion Cost Volume Profit (CVP) Analysis is an important part of short term decision making in a business. Although CVP analysis is cannot get all information need but it help anager to make fast decision making. Event we know that there are many limitation and assumption must be make when do the decision making.
The contribution margin is central to CVP Analysis. It is also the basis for determination of the break even point in a business. ReTerence http://smccd. edu/accounts/nurre/online/chtr6. htm http:// ManagedStudy. com/Assumptions of Cost Volume Profit Analysis. htm