Cost volume profit analysis

Transcription

1 Cost volume profit analysis Shown below is a typical cost volume profit chart: Required: (a) Explain to a colleague who is not an accountant the reasons for the change in result on this cost volume profit chart from a loss at point (a) to a profit at point (b). (3 marks) (b) Identify and critically examine the underlying assumptions of this type of cost volume profit analysis and consider whether such analyses are useful to the management of an organization. (14 marks) (Total 17 marks) ACCA Level 1 Costing Total revenue Question IM 8.1 Intermediate Total costs Variable costs (a) Volume The graphs shown below show cost volume profit relationships as they are typically represented in (i) management accounting and (ii) economic theory. In each graph TR=total revenue, TC=total cost, and P=profit. You are required to compare these different representations of cost volume profit relationships, identifying, explaining and commenting on points of similarity and also differences. (15 marks) ICAEW Management Accounting (b) Question IM 8.2 Intermediate + TR + TC P TR TC 0 Volume 0 Volume P COST VOLUME PROFIT ANALYSIS 45

2 Question IM 8.3 Intermediate Question IM 8.4 Advanced Question IM 8.5 Multi-product profit volume graph A break-even chart must be interpreted in the light of the limitations of its underlying assumptions (From Cost Accounting: A Managerial Emphasis, by C.T. Horngren.) Required: (a) Discuss the extent to which the above statement is valid and both describe and briefly appraise the reasons for five of the most important underlying assumptions of break-even analysis. (c. 14 marks) (b) For any three of the underlying assumptions provided in answer to (a) above, give an example of circumstances in which that assumption is violated. Indicate the nature of the violation and the extent to which the break-even chart can be adapted to allow for this violation. (c. 6 marks) (Total 20 marks) ACCA P2 Management Accounting The accountant s approach to cost volume profit analysis has been criticized in that, among other matters, it does not deal with the following: (a) situations where sales volume differs radically from production volume; (b) situations where the sales revenue and the total cost functions are markedly non-linear; (c) changes in product mix; (d) risk and uncertainty. Explain these objections to the accountant s conventional cost volume profit model and suggest how they can be overcome or ameliorated. (17 marks) ACCA Level 2 Management Accounting JK Limited has prepared a budget for the next twelve months when it intends to make and sell four products, details of which are shown below: Sales in units Selling price Variable cost Product (thousands) per unit ( ) per unit ( ) J K L M Budgeted fixed costs are per annum and total assets employed are You are required (a) to calculate the total contribution earned by each product and their combined total contributions; (2 marks) (b) to plot the data of your answer to (a) above in the form of a contribution to sales graph (sometimes referred to as a profit volume graph) on the graph paper provided; (6 marks) (c) to explain your graph to management, to comment on the results shown and to state the break-even point; (4 marks) (d) to describe briefly three ways in which the overall contribution to sales ratio could be improved. (3 marks) (Total 15 marks) CIMA Stage 2 Cost Accounting Question IM 8.6 Break-even chart with increases in fixed costs (a) Identify and discuss briefly five assumptions underlying cost volume profit analysis. (10 marks) (b) A local authority, whose area includes a holiday resort situated on the east coast, operates, for 30 weeks each year, a holiday home which is let to visiting parties of children in care from other authorities. The children are accompanied by their own house mothers who supervise them throughout 46 COST VOLUME PROFIT ANALYSIS

3 their holiday. From six to fifteen guests are accepted on terms of 100 per person per week. No differential charges exist for adults and children. Weekly costs incurred by the host authority are: ( per guest) Food 25 Electricity for heating and cooking 3 Domestic (laundry, cleaning etc.) expenses 5 Use of minibus 10 Seasonal staff supervise and carry out the necessary duties at the home at a cost of for the 30-week period. This provides staffing sufficient for six to ten guests per week but if eleven or more guests are to be accommodated, additional staff at a total cost of 200 per week are engaged for the whole of the 30-week period. Rent, including rates for the property, is 4000 per annum and the garden of the home is maintained by the council s recreation department which charges a nominal fee of 1000 per annum. You are required to: (i) tabulate the appropriate figures in such a way as to show the break-even point(s) and to comment on your figures; (8 marks) (ii) draw, on the graph paper provided, a chart to illustrate your answer to (b)(i) above. (7 marks) (Total 25 marks) CIMA Cost Accounting Stage 2 (a) The analysis of total cost into its behavioural elements is essential for effective cost and management accounting. Required Comment on the statement above, illustrating your answer with examples of cost behaviour patterns. (5 marks) (b) The total costs incurred at various output levels, for a process operation in a factory, have been measured as follows: Question IM 8.7 Analysis of costs into fixed and variable elements and break-even point calculation Output (units) Total cost ( ) Required: Using the high low method, analyse the costs of the process operation into fixed and variable components. (4 marks) (c) Calculate, and comment upon, the break-even output level of the process operation in (b) above, based upon the fixed and variable costs identified and assuming a selling price of per unit. (5 marks) (Total 14 marks) ACCA Foundation Paper 3 COST VOLUME PROFIT ANALYSIS 47

4 Question IM 8.8 Non-graphical CVP analysis and the acceptance of a special order Video Technology Plc was established in 1987 to assemble video cassette recorders (VCRs). There is now increased competition in its markets and the company expects to find it difficult to make an acceptable profit next year. You have been appointed as an accounting technician at the company, and have been given a copy of the draft budget for the next financial year. Draft budget for 12 months to 30 November 2001 ( m) ( m) Sales income Cost of sales: Variable assembly materials Variable labour Factory overheads variable Factory overheads fixed (782.2) Gross profit Selling overheads commission 38.4 Selling overheads fixed Administration overheads fixed (166.4) Net profit The following information is also supplied to you by the company s financial controller, Edward Davies: 1 planned sales for the draft budget in the year to 30 November 2001 are expected to be 25% less than the total of 3.2 million VCR units sold in the year to 30 November 2000; 2 the company operates a Just-In-Time stock control system, which means it holds no stocks of any kind; 3 if more than 3 million VCR units are made and sold, the unit cost of material falls by 4 per unit; 4 sales commission is based on the number of units sold and not on turnover; 5 the draft budget assumes that the factory will only be working at two-thirds of maximum capacity; 6 sales above maximum capacity are not possible. Edward Davies explains that the Board is not happy with the profit projected in the draft budget, and that the sales director, Anne Williams, has produced three proposals to try and improve matters. 1 Proposal A involves launching an aggressive marketing campaign: (i) this would involve a single additional fixed cost of 14 million for advertising; (ii) there would be a revised commission payment of 18 per unit sold; (iii) sales volume would be expected to increase by 10% above the level projected in the draft budget, with no change in the unit selling price. 2 Proposal B involves a 5% reduction in the unit selling price: (i) this is estimated to bring the sales volume back to the level in the year to 30 November Proposal C involves a 10% reduction in the unit selling price: (i) fixed selling overheads would also be reduced by 45 million; (ii) if proposal C is accepted, the sales director believes sales volume will be 3.8 million units. Task 1 (a) For each of the three proposals, calculate the: (i) change in profits compared with the draft budget; (ii) break-even point in units and turnover. (b) Recommend which proposal, if any, should be accepted on financial grounds. 48 COST VOLUME PROFIT ANALYSIS

5 (c) Identify three non-financial issues to be considered before a final decision is made. Edward Davies now tells you that the company is considering a new export order with a proposed selling price of 3 million. He provides you with the following information: 1 The order will require two types of material: (i) material A is in regular use by the company.the amount in stock originally cost 0.85 million, but its standard cost is 0.9 million. The amount in stock is sufficient for the order. The current market price of material A to be used in the order is 0.8 million; (ii) material B is no longer used by the company and cannot be used elsewhere if not used on the order. The amount in stock originally cost 0.2 million although its current purchase price is 0.3 million. The amount of material B in stock is only half the amount required on the order. If not used on the order, the amount in stock could be sold for 0.1 million; 2 direct labour of 1.0 million will be charged to the order. This includes 0.2 million for idle time, as a result of insufficient orders to keep the workforce fully employed. The company has a policy of no redundancies, and spreads the resulting cost of idle time across all orders; 3 variable factory overheads are expected to be 0.9 million; 4 fixed factory overheads are apportioned against the order at the rate of 50% of variable factory overheads; 5 no sales commission will be paid. Task 2 Prepare a memo for Edward Davies: (a) showing whether or not the order should be accepted at the proposed selling price; (b) identifying the technique(s) you have used in reaching this conclusion. AAT Technicians Stage PE Limited produces and sells two products, P and E. Budgets prepared for the next six months give the following information: Product P per unit Product E per unit Selling price Variable costs: production and selling Common fixed costs: production and selling for six months Question IM 8.9 Calculation of break-even points based on different product mix assumptions (a) You are required, in respect of the forthcoming six months, (i) to state what the break-even point in s will be and the number of each product this figure represents if the two products are sold in the ratio 4P to 3E; (3 marks) (ii) to state the break-even point in s and the number of products this figure represents if the sales mix changes to 4P to 4E (ignore fractions of products); (3 marks) (iii) to advise the sales manager which product mix should be better, that in (a) (i) above or that in (a) (ii) above, and why; (2 marks) (iv) to advise the sales manager which of the two products should be concentrated on and the reason(s) for your recommendation assume that whatever can be made can be sold, that both products go through a machining process and that there are only machine hours available, with product P requiring 0.40 hour per unit and product E requiring 0.10 hour per unit. (2 marks) COST VOLUME PROFIT ANALYSIS 49

6 (b) You are required to compare and contrast the usefulness of a conventional break-even chart with a contribution break-even chart. Your explanation should include illustrative diagrams drawn within your answer book and not on graph paper. (5 marks) (Total 15 marks) CIMA Stage 2 Cost Accounting Question IM 8.10 Decision-making and non-graphical CVP analysis York plc was formed three years ago by a group of research scientists to market a new medicine that they had invented. The technology involved in the medicine s manufacture is both complex and expensive. Because of this, the company is faced with a high level of fixed costs. This is of particular concern to Dr Harper, the company s chief executive. She recently arranged a conference of all management staff to discuss company profitability. Dr Harper showed the managers how average unit cost fell as production volume increased and explained that this was due to the company s heavy fixed cost base. It is clear, she said, that as we produce closer to the plant s maximum capacity of packs the average cost per pack falls. Producing and selling as close to that limit as possible must be good for company profitability. The data she used are reproduced below: Production volume (packs) Average cost per unit a Current sales and production volume: packs Selling price per pack: 420 a Defined as the total of fixed and variable costs, divided by the production volume You are a member of York plc s management accounting team and shortly after the conference you are called to a meeting with Ben Cooper, the company s marketing director. He is interested in knowing how profitability changes with production. Task 1 Ben Cooper asks you to calculate: (a) the amount of York plc s fixed costs; (b) the profit of the company at its current sales volume of packs; (c) the break-even point in units; (d) the margin of safety expressed as a percentage. Ben Cooper now tells you of a discussion he has recently had with Dr Harper. Dr Harper had once more emphasized the need to produce as close as possible to the maximum capacity of packs. Ben Cooper has the possibility of obtaining an export order for an extra 5000 packs but, because the competition is strong, the selling price would only be 330. Dr Harper has suggested that this order should be rejected as it is below cost and so will reduce company profitability. However, she would be prepared, on this occasion, to sell the packs on a cost basis for 340 each, provided the order was increased to packs. Task 2 Write a memo to Ben Cooper. Your memo should: (a) calculate the change in profits from accepting the order for 5000 packs at 330; (b) calculate the change in profits from accepting an order for packs at 340; (c) briefly explain and justify which proposal, if either, should be accepted; (d) identify two non-financial factors which should be taken into account before making a final decision. AAT Technicians Stage 50 COST VOLUME PROFIT ANALYSIS

7 A company has two products with the following unit costs for a period: Product A ( /unit) Product B ( /unit) Direct materials Direct labour Variable production overheads Fixed production overheads Variable other overheads Fixed other overheads Question IM 8.11 Marginal costing and absorption costing profit computations and calculation of break-even point for a given sales mix Production and sales of the two products for the period were: Product A Product B (000 units) (000 units) Production Sales Production was at normal levels. Unit costs in opening stock were the same as those for the period listed above. Required: (a) State whether, and why, absorption or marginal costing would show a higher company profit for the period, and calculate the difference in profit depending upon which method is used. (4 marks) (b) Calculate the break-even sales revenue for the period (to the nearest 000) based on the above mix of sales. The selling prices of products A and B were 5.70 and 6.90 per unit, respectively. (7 marks) (Total 11 marks) ACCA Foundation Stage Paper 3 A local government authority owns and operates a leisure centre with numerous sporting facilities, residential accommodation, a cafeteria and a sports shop. The summer season lasts for 20 weeks including a peak period of 6 weeks corresponding to the school holidays. The following budgets have been prepared for the next summer season: Accommodation 60 single rooms let on a daily basis. 35 double rooms let on a daily basis at 160% of the single room rate. Fixed costs Variable costs 4 per single room per day and 6.40 per double room per day. Sports Centre Residential guests each pay 2 per day and casual visitors 3 per day for the use of facilities. Fixed costs Sports Shop Estimated contribution 1 per person per day. Fixed costs 8250 Cafeteria Estimated contribution 1.50 per person per day. Fixed costs During the summer season the centre is open 7 days a week and the following activity levels are anticipated: Double rooms fully booked for the whole season. Question IM 8.12 Advanced: CVP analysis based on capacity usage in a leisure centre COST VOLUME PROFIT ANALYSIS 51

8 Single rooms fully booked for the peak period but at only 80% of capacity during the rest of the season. 30 casual visitors per day on average. You are required to (a) calculate the charges for single and double rooms assuming that the authority wishes to make a profit on accommodation; (6 marks) (b) calculate the anticipated total profit for the leisure centre as a whole for the season; (10 marks) (c) advise the authority whether an offer of from a private leisure company to operate the centre for five years is worthwhile, assuming that the authority uses a 10% cost of capital and operations continue as outlined above. (4 marks) (Total 20 marks) CIMA Stage 3 Management Accounting Techniques 52 COST VOLUME PROFIT ANALYSIS