Cost Behaviour and Cost-Volume-Profit Analysis PDF

Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Seminar 2 Cost Behaviour and Cost-Volume-Profit Analysis Page 1  Seminar 2 : Topic 2 - Cost...

Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Seminar 2 Cost Behaviour and Cost-Volume-Profit Analysis Page 1  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Topic 2 – Cost Behaviour and Cost-Volume-Profit Analysis - Intended Learning Objective 1. Explain cost behaviours 2. Prepare income statement using the contribution margin approach 3. Calculate operating leverage and demonstrate its effects on profitability 4. Illustrate and apply cost estimation methods 5. Determine the sales volume to breakeven or to achieve a desired profit 6. Discuss the effects of different cost structures on profitability 7. Compute margin of safety and discuss its significance 8. Perform cost-volume-profit analysis and discuss its limitations AD2102 Managerial Accounting Page 2  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost Behaviour Cost behavior refers to how a cost will react to changes in the level of activity (within a Operating Leverage relevant range). Operating leverage is a measure of The most common classifications are: how sensitive net operating income ❖ Variable costs. is to percentage changes in sales. A cost that varies, in total, in direct proportion to changes in the level of activity. The more sensitive the effects on A variable cost per unit is constant. profits to a slight change in sales a Change in variable cost may be caused by changes in any of the activity bases for example, higher operating leverage. labour hours, machine hours, units produced, miles driven, etc. A higher operating leverage reflects ❖ Fixed costs. a higher risk. A cost that remains constant, in total, regardless of changes in the level of the activity. Companies whose cost structures If expressed on a per unit basis, the average fixed cost per unit varies inversely with change in comprises a higher percentage of activity. fixed cost versus variable cost will The relevant range of activity for a fixed cost is the range of activity over which the graph of be more sensitive to effects of the cost is flat. change in sales. ❖ Mixed costs. A mixed cost contains both variable and fixed elements, for example utility cost, or mobile Contribution Format Income Statement phone charges. Sales SP X Q ❖ Classification of variable and fixed costs depends on Context - Variable costs UVC X Q Costs may be fixed or variable relative to the cost object = Contribution margin CM - Fixed costs FC = Net income NI (NL) Percentage change in net operating Degree of Contribution margin (Sales – Variable Costs) = income = Degree of operating leverage GAAP / IFRS Format Income Statement Net operating income operating leverage X Percentage change in sales Sales SP X Q - COGS TUC X Q = Gross margin Higher Fixed Costs, Lower Variable Costs, CM will be higher - Selling, General and Admin expenses Lower Fixed Costs, Higher Variables Costs, CM will be lower AD2102 Managerial Accounting = Net income PageNI (NL) 3 Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost Behaviour – Applied in Real Life How does cost behavior play a part in this marketing decision of Starhub? AD2102 Managerial Accounting Page 4  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost Estimation MethodsThe Least Square Regression The High-Low Method Scatter Diagram The following relationships between units produced and total cost are observed: Statistical based computation with the use of excel to compute the fixed and variable costs, intercept Using these two levels of activity, compute:  the variable cost per unit. being the fixed cost and slope  the total fixed cost. being the variable cost Utilizes ALL data points as Units Cost compared to some data points for High activity level - December 67,500 $ 29,000 the other 2 methods Low activity level - January 17,500 20,500 Change in activity 50,000 $ 8,500 AD2102 Managerial Accounting Page 5  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 2-21A Effects of operating leverage on profitability Franklin Training Services (FTS) provides instruction on the use of computer software for the employees of its corporate clients. It offers courses in the clients' offices on the clients' equipment. The only major expense FTS incurs is instructor salaries; it pays instructors $6,000 per course taught. FTS recently agreed to offer a course of instruction to the employees of Novak Incorporated at a price of $700 per student. Novak estimated that 20 students would attend the course. Base your answers on the preceding information. Part 1: Required a. Relative to the number of students in a single course, is the cost of instruction a fixed or a variable cost? b. Determine the profit, assuming 20 students attend the course. c. Determine the profit, assuming a 10 percent increase in enrollment (i.e., enrollment increases to 22 students). What is the percentage change in profitability? d. Determine the profit, assuming a 10 percent decrease in enrollment (i.e., enrollment decreases to 18 students). What is the percentage change in profitability? AD2102 Managerial Accounting Page 6  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 2-21A Effects of operating leverage on profitability e. Explain why a 10 percent shift in enrollment produces more than a 10 percent shift in profitability. Use the term that identifies this phenomenon. Part 2: The instructor has offered to teach the course for a percentage of tuition fees. Specifically, the instructor wants $300 per person attending the class. Assume that the tuition fee remains at $700 per student. Required f. Is the cost of instruction a fixed or a variable cost? g. Determine the profit, assuming 20 students take the course. h. Determine the profit, assuming a 10 percent increase in enrollment (i.e., enrollment increases to 22 students). What is the percentage change in profitability? AD2102 Managerial Accounting Page 7  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 2-21A Effects of operating leverage on profitability i. Determine the profit, assuming a 10 percent decrease in enrollment (i.e., enrollment decreases to 18 students). What is the percentage change in profitability? j. Explain why a 10 percent shift in enrollment produces a proportional 10 percent change in profitability. Part 3: Team Discussion Activity FTS sells a custom wood plaque to students who complete the training course. Due to the custom nature of these plaques, FTS has to produce them in advance based on the estimated number of students to be enrolled in the course. Any plaques made for students who do not end up completing the course will be discarded. Prior to the first class, FTS pre-ordered 20 plaques based on the client's estimate of the number of people who would attend the course. FTS will only have 20 plaques to offer students regardless of whether enrollment is below or above expectations due to them having to be made in advance of the course. Each plaque costs $30 and is sold to students who complete the course for $50. AD2102 Managerial Accounting Page 8  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 2-21A Effects of operating leverage on profitability Required k. Calculate the cost of plaques in total and per unit, assuming 18, 20, or 22 students complete the course. Round your computation to two decimal points. l. Classify the total cost of plaques as fixed or variable relative to the number of students attending the course. m. Discuss the risk of holding inventory as it applies to the plaques. n. Explain how a just-in-time inventory system can reduce the cost and risk of holding inventory AD2102 Managerial Accounting Page 9  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Team Presentation on Topic 1 Discussion Questions AD2102 Managerial Accounting Page 10  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Graphical Form Cost-Volume-Profit $350,000 Equation Form $300,000 Unit CM = Selling price per unit – Variable expenses per unit Unit CM = P – V $250,000 Profit = Sales – Variable expenses – Fixed expenses $200,000 Sales Profit = (P × Q – V × Q) – Fixed expenses Total expenses Profit = (P – V) × Q – Fixed expenses $150,000 Fixed expenses Profit = Unit CM × Q – Fixed expenses $100,000 Formula Form $50,000 Target profit + Fixed expenses $0 Dollar sales to attain the target profit = CM ratio 0 100 200 300 400 500 600 Target profit + Fixed expenses Units Unit sales to attain the target profit = CM per unit Margin of safety Expected sales - Break-even sales percentage = Expected sales Formula Form – Sales Mix Target profit + Fixed expenses Margin of safety is the amount by which sales can drop before the Dollar sales to attain the target profit = Weighted Average CM ratio company incurs a loss. Margin of safety may be expressed as a percentage of expected sales. Target profit + Fixed expenses Unit sales to attain the target profit = Weighted Average CM per unit Cost-Plus Pricing Prestige Pricing Target Costing Selling price is a markup on cost: Rationale: People willing to pay a Determining the maximum allowable cost for a new product and Selling price = (1 + Markup percentage) x Cost premium to be first to use a new product. then develop the product. Target cost = Anticipated selling price – Desired profit Reasons for target costing Market determines the price AD2102 Managerial Accounting Product cost determined at design stage Page 11  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost-Volume-Profit – Assumptions and Limitations 1. All costs can be classified into two categories: fixed costs and variable costs. This assumption is not always true because certain costs like depreciation cannot be determined exactly. Different depreciation methods may yield different results. There is a third category of costs known as ‘semi-variable’ costs. These costs are also called mixed costs, because part of the cost is fixed and part is variable (for example, Telephone expenses). 2. Fixed costs will not change at all levels of sales within the assumed relevant range of activity. 3. Selling price per unit remains constant. 4. Variable costs vary in direct proportion to changes in activity i.e. as a percentage of sales revenue. They remain constant. 5. Efficiency and productivity are constant. 6. Inventory levels in manufacturing companies are constant. 7. The sales mix is assumed to remain constant if more than one product is sold. 8. The projections are over a short period of time only – all CVP variables within relevant range. AD2102 Managerial Accounting Page 12  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis – Use in the Real World CVP Example - Introducing Amazon Go and file:///Users/lianghiam/Documents/NTU/AD2102 the world’s most advanced shopping Managerial Accounting/Seminars 1 - 10/Slides - technology.mov AY2324 S2/Tesla Pauses Model 3 Production To Focus On Automation | CNBC.mp4 What was Amazon able to achieve in terms of costs What are the pitfalls with introduction of automation with the introduction of Amazon Go? for Tesla? (Hint: Cost behavior) AD2102 Managerial Accounting Page 13  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost-Volume- Profit Analysis – Use in the Real World Page  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost-Volume- Profit Analysis – Use in the Real World Page  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Cost-Volume- Profit Analysis – Use in the Real World Page  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-23A Comprehensive CVP analysis Trevino Company makes and sells products with variable costs of $24 each. Trevino incurs annual fixed costs of $315,000. The current sales price is $87. Required The following requirements are interdependent. For example, the $252,000 desired profit introduced in Requirement c also applies to subsequent requirements. Likewise, the $80 sales price introduced in Requirement d applies to the subsequent requirements. a. Determine the contribution margin per unit. b. Determine the break-even point in units and in dollars. Confirm your answer by preparing an income statement using the contribution margin format. AD2102 Managerial Accounting Page 17  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-23A Comprehensive CVP analysis c. Suppose that Trevino desires to earn a $252,000 profit. Determine the sales volume in units and dollars required to earn the desired profit. Confirm your answer by preparing an income statement using the contribution margin format. d. If the sales price drops to $80 per unit, what level of sales is required to earn the desired profit? Express your answer in units and dollars. Confirm your answer by preparing an income statement using the contribution margin format. AD2102 Managerial Accounting Page 18  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-23A Comprehensive CVP analysis e. If fixed costs drop to $280,000, what level of sales is required to earn the desired profit? Express your answer in units and dollars. Confirm your answer by preparing an income statement using the contribution margin format. f. If variable cost rises to $30 per unit, what level of sales is required to earn the desired profit? Express your answer in units and dollars. Confirm your answer by preparing an income statement using the contribution margin format. AD2102 Managerial Accounting Page 19  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-23A Comprehensive CVP analysis g. Assume that Trevino concludes that it can sell 10,000 units of product for $80 each. Recall that variable costs are $30 each and fixed costs are $280,000. Compute the margin of safety in units and dollars and as a percentage. h. Draw a break-even graph using the cost and price assumptions described in Requirement g. AD2102 Managerial Accounting Page 20  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Team Activity Conceptual Review Questions EEO, Problem 3-25B Determining the break-even point and margin of safety for a company with multiple products Executive officers of Roth Company have prepared the annual budgets for its two products, Washer and Dryer, as follows. Washer Dryer Total Budgeted Per Unit Budgeted Budgeted Per Unit Budgeted Budgeted Budgeted Quantity Amount Quantity Amount Quantity Amount Sales 500 @ $540 = $270,000 2,000 @ $300 = $600,000 2,500 $870,000 Variable cost 500 @ $300 = ($150,000) 2,000 @ $180 = ($360,000) 2,500 ($510,000 Contribution margin 500 @ $240 = $120,000 2,000 @ $120 = $240,000 2,500 $360,000 Fixed cost ($50,000) ($94,000) ($144,000) Net income $70,000 $146,000 $216,000 Required a. Based on budgeted sales, determine the relative sales mix between the two products. b. Determine the weighted-average contribution margin per unit. AD2102 Managerial Accounting Page 21  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-25B Determining the break-even point and margin of safety for a company with multiple products c. Calculate the break-even point in total number of units. d. Determine the number of units of each product Roth must sell to break even. e. Verify the break-even point by preparing an income statement for each product as well as an income statement for the combined products. AD2102 Managerial Accounting Page 22  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Conceptual Review Questions EEO, Problem 3-25B Determining the break-even point and margin of safety for a company with multiple products f. Determine the margin of safety based on the combined sales of the two products. AD2102 Managerial Accounting Page 23 Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Next Week Group Presentation Questions AD2102 Managerial Accounting Page 24  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Topic 2 Group Discussion Question EEO, Problem 2-27A Estimating fixed and variable cost Myrick Woodcraft Company (MWC) manufactures "antique" wooden cabinets to house modern televisions. MWC began operations in January of last year. Sidney Myrick, the owner, asks for your assistance. He believes that he needs to better understand the cost of the cabinets for pricing purposes, You have collected the following data concerning actual production over the past year. Month Number of Cabinets Produced Total Cost Required a. To understand the department's cost behavior, you decide to plot the points on January 800 $21,000 graph paper and sketch a total cost line. February 3,600 32,500 1) Enter the number of units and their costs in increasing order. March 1,960 29,500 2) Plot the points on the graph. 3) Sketch a graph so the line "splits" all of the points (half of the points April 600 18,600 appear above and half below the line). May 1,600 29,000 4) Using the line you just sketched, visually estimate the total cost to June 1,300 27,000 produce 2,000 units. b. Using the high-low method, compute the total cost equation for the preceding July 1,100 25,600 data. August 1,800 31,000 1) Compute the variable cost per unit. September 2,280 32,000 2) Compute total fixed costs. 3) Sketch a line between the high and low points on your graph. October 2,940 31,500 4) Calculate the total cost assuming 2,000 cabinets are made. November 3,280 32,000 c. Comment on which method you believe is better. December 400 16,500 AD2102 Managerial Accounting Page 25  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Topic 2 Group Discussion Question EEO, Problem 3-25A Determining the break-even point and margin of safety for a company with multiple products Kidd Company produces two products. Budgeted annual income statements for the two products are provided as follows. Power Lite Total Budgeted Per Budgeted Budgeted Per Budgeted Budgeted Budgeted Number Unit Amount Number Unit Amount Number Amount Sales 160 @$500 = $80,000 640 @$450 = $288,000 800 $368,000 Variable cost 160 @$320 = (51,200) 640 @$330 = (211,200) 800 (262,400) Contribution margin 160 @$180 = 28,800 640 @$120 = 76,800 800 105,600 Fixed cost (12,000) (54,000) (66,000) Net income $16,800 $22,800 $39,600 Required a. Based on budgeted sales, determine the relative sales mix between the two products. b. Determine the weighted-average contribution margin per unit. c. Calculate the break-even point in total number of units. d. Determine the number of units of each product Kidd must sell to break even. e. Verify the break-even point by preparing an income statement for each product as well as an income statement for the combined products. f. Determine the margin of safety based on the combined sales of the two products. AD2102 Managerial Accounting Page 26  Seminar 2 : Topic 2 - Cost Behaviour and Cost-Volume-Profit Analysis Breakout for Team Discussion on Discussion Questions AD2102 Managerial Accounting Page 27