BAFS Elective Part Accounting Module Cost Accounting

Transcription

1 Accounting Module Cost Accounting : Cost-Volume-Profit Analysis Technology Education Section Curriculum Development Institute Education Bureau, HKSARG April 2009

2 Lesson One Cost-Volume-Profit Analysis (i) 2

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4 Terms commonly used in CVP Analysis Variable costs Fixed costs Selling price Contributions Profit Rates of return Break-even point Margins of safety Volume for a target profit 4

5 Basic Assumptions Within a relevant volume range and in a short run 1. The costs can be accurately divided into variable and fixed elements. 2. The unit selling price and unit variable costs remain constant throughout the whole range. 3. Fixed costs are costs, that in total, remain constant for a specified time period. 5

6 Case Study Should Eric buy the cake shop? Activity 1 : Please help Eric to figure out the annual profit and rate of return of the cake shop. 6

7 Activity 1 Profit and Rate of Return of the Cake Shop 1. Calculate the contribution per unit of cake. 2. Identify the fixed costs and calculate the total fixed costs per month. 3. Calculate monthly profit and annual profit. 4. Calculate the investment rate of return. 7

8 Activity I Key Points Learned 1. Profit calculation 2. Rate of return calculation 8

9 Break-even Point At the break-even point, there is no profit nor loss. It is the point where Sales revenue = Total costs Contribution = Fixed costs 9

10 Case Study Should Eric buy the cake shop? Activity 2 : Please advise Eric whether he should buy the cake shop based on the rate of return and the margin of safety. 10

11 Activity 2 Breakeven Point and Margin of Safety 1. Calculate units of cakes to be sold per month to break even. 2. Calculate the margin of safety. 3. Recommendation. 11

12 Activity 2 - Recommendation Margin of safety The investment is not risky. 25% Rate of return High. 20% Recommendation Acquire the business. 12

13 Activity 2 Key Points Learned Break-even point Margin of safety as a measure of the risk of incurring a loss. 13

14 Activity 3 Another Situation There is a 20% chance that the supplier will increase the price of each cake from $6 to $7.5, but in Mary s opinion, the selling price can only be increased by $1 to maintain the existing sales volume. Should I buy the cake shop in view of the new information? 14

15 Steps for Activity 3 1. Calculate revised unit contribution. 2. Calculate revised monthly break-even point. 3. Calculate revised margin of safety in units & in %. 4. Calculate revised annual profit. 5. Calculate revised annual rate of return. 6. Determine the risk of the business and the reasonableness of the return in the new situation. 7. Make your recommendation. 15

16 Activity 3 - Recommendation An 80% chance the rate of return is 20% and the margin of safety is 25%. A 20% chance the rate of return is 10%. Even in the situation, this is still a good investment as the return is reasonable and the risk involved is acceptable with 14% on margin of safety. Recommendation Acquire the business. 16

17 Activity 3 Key Points Learned when there is a change in selling price and variable cost. 17

18 Activity 4 Acceptance of a proposal Eric receives a proposal from Mary and you are required to analyse the proposal to determine whether to accept it or not. Mary 18

19 Activity 4 The Proposal The company spends $10,000 per month in advertising the cake, the monthly sales volume would be increased by 10,000 units. Should the proposal be implemented? 19

20 Activity 4 - Eric s wrong concept Mixes up variable costs with fixed costs and draws a wrong conclusion. A variable cost is a cost that varies with some measure of output or activity. A fixed cost is a cost that, in total, remains constant for a specified time period. 20

21 Activity 4 - Correct approach The fixed cost $30,000 per month will not increase even if the sales volume is increased by 10,000 units. Correct approach compare the additional contribution with the additional expenditure. Incremental profit = Additional contribution Additional expenditure = 10,000 units * $4 - $10,000 = $30,000 Recommendation : Implement the proposal 21

22 Activity 4 Key Points Learned Different behavior of Variable costs and Fixed costs. Comparing additional contributions with additional expenditures in making a decision. 22

23 Conclusion Profit and rate of return calculations Break-even point and margin of safety - calculation and interpretation Cost behavior of variable costs and fixed costs CVP analysis used when there are changes in the selling price and variable costs 23

24 Lesson Two Cost-Volume-Profit Analysis (ii) 24

25 Activity 5 Solving Business Problem Eric receives a letter from the landlord informing him that the monthly rent will increase by 20%. Activity 5 : Advise Eric how it affects the company s annual profit, rate of return and the risk of this investment. 25 Dear Mr. Eric Chan, The monthly shop rent will be increased by 20% if you wish to renew the rental lease which will expire in six months. Yours faithfully, Landlord

26 Steps for Activity 5 1. Calculate revised fixed cost 2. Calculate revised monthly break-even point 3. Calculate revised margin of safety in units & % 4. Calculate revised annual profit 5. Calculate revised annual rate of return 6. Determine the risk of the business and the reasonableness of the return in the new situation 7. Make your recommendation 26

27 Activity 6 Adding chocolate mix topping on the cake Eric has a plan to develop his business by selling a new style cake with chocolate topping. Selling price, unit variable costs, monthly fixed costs and sales volume will be changed. Advise Eric whether he should carry out his plan. 27

28 Steps for Activity 6 1. Calculate the new variable cost and monthly fixed cost for the new product if it is launched. 2. Calculate the break-even point, margin of safety in units and in percent, annual profit and rate of return if the new product is launched. 3. Compare results to results arrived at in Activity Make recommendations to Eric. 28

29 Activity 7 - Boost Sales Eric phones you one day and says that he would like to earn the same amount of profit as last year s ($120,000) and plans to boost sales more by staying in the cake shop on weekends. Advise Eric 29

30 Activity 8 - Qualitative Factors Eric wants you to advise him what other factors he should consider before implementing his 2 plans as stated in Activity 6 and Activity 7. Form groups of four or five and discuss the qualitative factors to be considered before making the decision. 30

31 Group discussion and Presentation Present the qualitative factors drawn by your group to the class. 31

32 Qualitative Factors I 1. Does the change require additional working capital? 2. What is the opportunity cost to Eric in promoting the new product? 3. Is it absolutely certain that fixed operating costs will not change? One more staff is added in the shop and there are more operations and sales. Will the shop keepers ask for a raise of wages in view of the increase in workload? 32

33 Qualitative Factors II 4. How accurate are the forecasts? 5. Are the supplier discounts be sustainable in the foreseeable future? It seems that the supplier is very generous in allowing the discounts in this case. 6. Is it possible to cut the advertising expenditures after the new product has been launched? 33

34 Conclusion CVP analysis when there are changes in the selling price, variable costs and fixed costs. Sales volume required to earn a target profit. Qualitative factors to be considered before making decisions. 34

35 The End 35