Week 4

Question 1

CVP Relationships

Answer 1

CVP analysis examines the relationship between changes in activity (output) and changes in total sales revenue, costs and net profit

CVP analysis is dependent on the ability to estimate costs at different levels and hence costs must be analysed into fixed and variable.

Question 2

CVP Analysis (Formula)

Answer 2

Profit = Revenue - Costs

=

Revenue = Profit + Total Fixed Costs + Total Variable Costs

=

(Units Sold x Price) = Profit + Total Fixed Costs + (Units Sold x Variable Costs)

=

(Q x P) = N + F + (Q x V)

Question 3

Unit Contribution Margin

Answer 3

P - V

Question 4

Contribution Margin Ratio

Answer 4

(P - V) / P

Question 5

Break-Even Point Formula

Answer 5

(Q x P) = N + F + (Q x V)

rearranging - (Q x P) - (Q x V) = N + F

simplifying - Q x (P - V) = N + F

Final - Q = (N + F) / (P - V)

If profit is 0 - Q = F / (P - V)
This is the Break-Even Point

Question 6

Acceptance/Rejection of Special Order

Answer 6

These are typically only one-time orders that fall below the prevailing market price.

Hi Co. is currently selling its product at £40 per unit. It has received a special order for 100 units at £30 each. Its variable cost is £25 per unit. Should this order be accepted?
Solution:
Sales 100 x £30 = £3,000
Less: VC 100 x £25 = £2,500
Contribution £5 (P-V) £500
Yes, the special order should be accepted on financial grounds as it generates a positive contribution.

Other Factors:
Do we have spare capacity to produce the special order?
Reactions of other customers
Intentions of the customer
A ‘one off’ order?
Sell in same market and compete with us?
Any hidden costs

Question 6

Marginal Costing for Short Term Decisions

Answer 6

Types of Decisions:
* Trade-offs between fixed and variable costs
* Accept or reject a special order
* Dropping a product or closing down a loss-making department
* Limiting factor analysis/theory of constraints
* Make or buy decisions/outsourcing decisions

Financial and non-financial decisions need to be considered:
* Financial:
-relevant costs and revenues
* Non-financial
- quality, capacity, government policies, technology, environment, reliability, labor force, motivation, etc.

Question 7

Closing Down a Loss-Making Department

Answer 7

Should only close down a department is you begin to make a loss AFTER redistributing fixed costs into more profitable departments.