Chapter 2 - Decision-making Techniques Flashcards
What is a relevant cost?
A future incremental cash flow
What are the tests that a cost must pass to be relevant?
It must be:
- Future
- Incremental
- Cash flow
What is the relevant cost of materials?
- Is there material in inventory? - No = current purchase price, Yes = go to step 2.
- Is it currently used elsewhere in the business? No = scrap/resale value, Yes = go to step 3.
- Can it be replaced? No = contribution/opportunity cost, Yes = current purchase price.
What is the relevant cost of labour?
- Is labour at full capacity? No = zero (no extra cost), Yes = go to step 2.
- Could we hire more staff? No = lost sales proceeds less saving in material costs, Yes = cost of hiring more staff OR overtime cost
What is the relevant cost of machines and other non-current assets?
The lower of: - Replacement cost (new machine) OR - the higher of: a) net realisable value (sold) b) economic value in business (kept)
What is the opportunity cost?
The benefit foregone by choosing one course or action instead of the next best alternative
How do you work out contribution per unit?
Selling price per unit - Variable cost per unit
What is the contribution sales ratio?
Contribution / sales
How do you work out total contribution?
Number of units sold X contribution per unit
What does total contribution equal?
Fixed costs
How do you calculate fixed costs?
= Total contribution thus:
Number of units sold X contribution per unit
How do you calculate the breakeven point in units?
Fixed costs / contribution sales ratio
How do you calculate the breakeven revenue?
Fixed costs / contribution sales ratio
What is the margin of safety?
A measure of how much sales would need to drop by before a loss is made
How do you calculate the margin of safety in units?
Budgeted sales units - breakeven sales units
How do you calculate the margin of safety in percent?
(Budgeted sales units - breakeven sales units) / budgeted sales units
What is the calculation for units sold to achieve target profit?
(Fixed costs + Target profit) / Contribution per unit
What does the profit/volume charge show?
The relationship between sales volume and profit.
What are the assumptions of breakeven analysis?
- Constant fixed costs at any output level
- Constant variable cost per unit and constant selling price per unit
- No change in inventory levels
What does a multi-product breakeven analysis assume?
- A constant product mix, OR
- All products have identical c/s ratios
What is the calculation for units (bags) sold to breakeven?
Fixed costs / Contribution part standard mix
How do you calculate breakeven revenue for multi-products?
Fixed costs / contribution sales ratio per standard mix(bag)
What are the steps for the calculation of margin of safety for multi-products?
- Calculate the average contribution per mix
- Calculate the breakeven revenue
- Calculate the margin of safety
What are the steps for determining the optimal production plan with one limiting factor?
- Identify what the limiting factor is
- Calculate the contribution per unit of limiting factor
- Rank the products according to the contribution per unit of limiting factor
- State the optimum production plan