Flashcards
Chapter 9: Cost-volume-profit analysis
Cards in this deck (22)
- 1Cost-volume-profit (CVP) analysis- Investigation of change in profits in response to changes in sales volume, costs and prices
- Allows businesses to research business ventures before embarking on them - 2Fixed costs- Costs that remain the same in total (within a given range of activity and timeframe) irrespective of the level of activity
- Includes facility-sustaining costs e.g. lease costs, depreciation charges - 3Variable costs- Costs that change in total as the level of activity changes
- E.g. cost of ingredients for a food manufacturer, fuel costs for a courier - 4Relevant range- Activity range over which a company expects to operate during a year and fixed costs remain constant
- If activity level goes outside relevant range, then expected cost behaviour may change
- Fixed costs are no longer assumed as fixed if the entity can renegotiate contracts or change the level of resources required to support operating activities - 5Mixed costs- Costs that possess fixed and variable characteristics
- Aka semi-fixed or semi-variable costs
- E.g. telephone and internet costs consist of a fixed access charge and variable usage charge - 6Break-even analysis- Calculation of the levels of activity required to break-even in a given period
- Break-even occurs when total revenue = total costs (i.e. no profit or loss) - 7Contribution margin- Total revenue - total variable costs
- Revenue that each unit contributes towards covering fixed costs and then contributing to profit
- If contribution margin < fixed costs, the entity is making a loss
- If contribution margin = fixed costs, the entity is breaking even - 8Contribution margin per unitSelling price per unit - variable cost per unit
- 9Calculating break-even units
- 10Calculating units for desired profitNB: need to use pre-tax profit i.e. after-tax profit / (1 - tax rate)
- 11Using income statement for CVP analysis
- 12Margin of safetyIndicates how much revenue / sales in units can decrease before reaching break-even point
- 13Contribution margin ratio- Use to find total sales dollars required to break-even or earn a desired profit, rather than number of units
- Sometimes individual unit price and cost data are unavailable
- 14Calculating sales ($) for break-even / required profitFixed costs / contribution margin ratio = break-even in sales ($)
- 15CVP assumptions1. Behaviour of costs can be neatly classified as fixed or variable
2. Cost behaviour is linear
3. Fixed costs remain ‘fixed’ over the time period / given range of activity (i.e. relevant range)
4. Unit price and cost data remain constant over the time period and relevant range
5. For multi-product entities, the sales mix between the products is constant - 16Break-even data can be useful for...1. Identifying number of products or services required to be sold to meet break-even or profit targets
2. Resource allocation, by focusing on those products that contribute more to profits
3. Determining the impact on profit of changes in the mix of fixed and variable
4. Pricing products - 17Operating leverage- Mix between fixed and variable costs in the cost structure of an entity
- High proportion of fixed costs to variable costs => high operating leverage
- If demand is low, a business with high operating leverage is risky as it must achieve more sales to cover fixed costs and make a profit
- If demand is high, a business with high operating leverage has the potential to make larger profits, as it has a higher contribution margin per unit - 18Outsourcing decision- Decision on whether to make or buy a product / service, or to outsource production (i.e. purchase it from an external provider)
- Can be motivated by need to reduce costs, free up capacity to pursue other ventures, or to focus on core activities
- E.g. accounting needs, building maintenance, office cleaning and security are commonly outsourced - 19Avoidable and unavoidable costs- Avoidable costs - costs avoided if outsourcing decision is accepted (relevant)
- Unavoidable costs - costs incurred regardless of the outsourcing decision taken (irrelevant)
- Relevant costs (income) are costs (income) that will be different under alternative courses of action - 20When making an outsourcing decision, need to consider...1. How existing customers will react to an entity selling one-off orders at a lower price
2. Quality of service delivery by the outsourced provider
3. Ability for outsourced provider to deliver when required
4. Financial stability of outsourced provider - 21Special order decision- Special order - one-off customer order that is different from orders usually received by the entity
- Must consider whether it is willing to supply goods or services at a reduced price or with special features, or a combination of both - 22When making a special order decision, need to consider...1. Available / idle capacity (difference between maximum and current operating capacity) - accepting special order may require maximum capacity and cause shift in normal production to the special order
2. Opportunity to have a long-term relationship with special order customer
3. Effect on normal customers - may react negatively to late deliveries or knowledge of other customers getting a better deal
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- Business/Economics (ACC1200: Accounting for Managers) Flashcards on Chapter 9: Cost-volume-profit analysis, created by Melina Mackey on 24/05/2018.
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