Week 4 Flashcards
When looking at marginal costing what did we do?
We worked out total contribution by separating fixed and variable elements, then we took away fixed cost ( both manfuacturing and non manfuacturing)
What will we be looking at today?
Breakeven analysis
What is another name for breakeven analysis?
Cost volume profit analysis
What are the first 2 assumptions we make when doing CVP analysis?
1) Total costs are linear
2) Only one cost driver (e.g. labour hours, no. of units)
What is another assumption we make in CVP analysis?
Costs are defined as variable or fixed with respect to
a) a specific cost object
b) a defined time span
c) a particular ‘relevant range’ in the level of the cost driver
Would semi variable costs work in our assumptions, to do breakeven analysis?
No it would not, as they have fixed and variable elements to them( so we need a relevant image to do breakeven analysis)
What would be the relevant image for a semi variable cost?
What are stepped fixed costs?
This usually means a cost increases when the activity of a business exceeds a certain level, and the fixed cost then suddenly increases, but remains fixed at this new higher level.
When we have mixed costs which comprise of fixed and variable cost elements, we don’t always know how much they consist of so how do we do this?
Using the high low method ( the assumption is the cost has to be linear)
With the high low method, how would we find the variable cost per unit with a linear mixed cost?
It is the slope of the line so
Slope = Rise/run =y2-y1/x2-x1 = variable cost ( per unit of activity)
In otherwords
What is the variable cost per unit and total variable cost for march and december?
total variable cost = 3.18 x 850 for march
3.18 x 300 for december
How would we find our fixed costs?
Fixed cost = total cost - variable cost
FC = 4675 - 2704
=1971
So what does these numbers tells us about our mixed cost?
Our fixed cost element of our mixed cost is = 1971
Our variable cost for march and december are the same but number of units are different so
3.18 X 850 + 3.18 x 300 and add to the fixed cost to get $2704
You select the highests miles travelled and lowest
You select highest maintenance and lowest
find the change and find variable cost per mile
Fixed cost = total cost - variable cost
What is the break even point?
When profit is = 0
What is the difference between contribution and contribution per unit and total contribution
Contribution = total sales - total variable costs
Contribution per unit = selling price per unit - variable cost per unit
Total contribution = contribution per unit X number of units sold
What is the formula for Break even in units?
Contribution being either ( total contribution / no of units sold or selling price per unit - variable cost per unit.
What is breakeven in units for subs and what does this mean?
BE point in units = Fixed costs /contribution per unit ( selling price per unit- variable cost per unit.
What this is saying is that if we dont want to lose money, we have to sell at least 10000 subs at the price of $5 and variable cost of $3.
What is the forumla for breakeven to get a desired profit in units ?
How do we work out break even in sales?
BE IN Sales = FIXED COST / C/S RATIO
What does the contribution margin tell you?
you the aggregate amount of revenue available after variable costs to cover fixed expenses and provide profit to the company,”
Calculate BE in sales
Alternatively you could of done units to break even X selling price per unit to get $50000
so $50000 in sales providing we sell at $5 per unit and variable cost of $3 will allow us to break even and cover the fixed costs of $20000
What is the forumla for breakeven to get a desired profit in sales?
What does Margin of safety mean?
This is the amount sales can drop above break even point before we start incurring loses
What is the formula of margin of safety in units and in sales
Budgeted sales units - breakeven sales units
Margin of safety units X Selling price = MOS IN £s
How do we calculate Margin of safety in terms of a percentage?
Margin of safety % = (MoS units/Budgeted Sales units) x 100%
What is Mos in units and Mos as percentage and what does this mean
Margin of safety in units = budgeted sales units - breakeven sales units = 50000
50000/250000 = 20%
This means our forcasted budgeted sales can fall 20% before we start losing any money
Work out units required to BE FOR A DESIRED PROFIT and sales required to breakeven for a desired profit.
Contribution per unit = selling price per unit - variable cost per unit
35-20 = £15
BE in sales units = Fixed costs+ Desired profit / Contribution/unit
45000+30000 /15 =5000 units to BE
5000 x 35 = 175000 are the sales required to break even keeping the selling price and variable cost the same.
Or SALES IN £ = FC + Desired profit / C/S ratio ( contirbution/unit / selling price/ unit)
75000/(3/7)
=175000
Show profit on an income statement
Sales less Variable Costs = Contribution
Contribution Less Fixed Costs = Profit
Continuing from previous example (S.P £35): • Peacock Ltd. is considering automating part of its production process, which it is envisaged will result in variable costs falling to £15 per unit, but fixed costs will increase to £67,500 per annum due to increased hire charges and machine servicing costs. 1. How many units must be sold to maintain the profit level of £30,000? What does this show?
Contribution margin = selling price per unit - variable cost per unit = 35-15 = £20
Fixed costs are £67500
Desired profit level is £30000
Be in Units = Fixed costs+ Desired profit level/ contribution per unit
£67500 + £30000 /20 = 4875 units
This shows that the decision to automate is the correct one, because profit of £30,000 requires 125 less units to sell
Continuing from previous example (S.P £35): • Peacock Ltd. is considering automating part of its production process, which it is envisaged will result in variable costs falling to £15 per unit, but fixed costs will increase to £67,500 per annum due to increased hire charges and machine servicing costs
What will the profit be now at the original production target of 5,000 units (that we worked out earlier) units per annum
Continuing from previous example (S.P £35): • Peacock Ltd. is considering automating part of its production process, which it is envisaged will result in variable costs falling to £15 per unit, but fixed costs will increase to £67,500 per annum due to increased hire charges and machine servicing costs
What will the profit be now at the original production target of 5,000 units (that we worked out earlier) units per annum
Can you show the desired profit level on an Income statement
Contribution margin = Contirbution margin per unit X number of units sold
• Peacock Ltd. is considering automating part of its production process, which it is envisaged will result in variable costs falling to £15 per unit, but fixed costs will increase to £67,500 per annum due to increased hire charges and machine servicing costs.
What is the new B/E point?
What is the Margin of safety in units and in sales for this Peakcock example?
Budgeted Sales – Breakeven Sales
5,000 units – 3,375 units = 1,625 units
1,625 x £35/unit = £56,875
Do you want Margin of safety to be high as possible?
Higher the Margin of Safety, lower the risk of making loss whereas lower the Margin of Safety, greater the risk of doing business.
Graphically thow can we show a break even point?
Can we determine BE with this relevant image and what does MR AND MC mean in this scenario?
They are 2 breakeven points, we cant have that
MR = THE PRICE PER UNIT
MC = VARIABLE COST PER UNIT
WHICH CHANGES WITH EACH LEVEL OF ACTIVITY.
How do we solve algebraically the units to break even
Equate total revenue and total cost functions and solve for Q
TR = P x Q
TC = FC + (VC x Q)
TR = TC
P x Q = FC + VC x Q
(P x Q) – (VC x Q) = FC
Q (P – VC) = FC ; (Q (P – VC) would be total contribution)
Q = FC/(P – VC), or in terms of units of sales at BE point
BE IN Sales would be FC/(P-VC) X P which is the same as QXP = F.C/(P-VC)/P
What is the total contribution, contrubtion per unit and Contribution margin ratio?
Total contribution = sales less variable cost of sales = 570000 - 387600 = 182400
Contribution per unit = selling price per unit - variable cost per unit = 28.5 - 19.38 = 9.12
Contiubtion margin ratio = contribution per unit / selling price per unit =9.12/28.5
=0.32
Workout break even in units and sales using the formula?
Work out Break even in units using algebra
Sales revenue = Total cost ( solve for Q)
£28.50 x = £19.38 x + £ 140,000
£9.12 x = £140,000
x = 15,351 units (rounded upwards)
Break-even volume for product XYZ = 15,351 units
If selling price per unit is less than Variable cost per unit than what does it mean for the contribution per unit?
Contribution per unit is negative.
CVP in times of austerity A government’s health department, has a £1,200,000 lump-sum annual budget appropriation for an agency to help rehabilitate mentally ill patients. On top of this, the agency charges for each patient £600 a month for their board and care. All of the appropriation and revenue must be spent (BEV).
The variable costs for rehabilitation activity average £700 per patient per month. The agency’s annual fixed costs are £800,000. The agency manager wishes to know how many patients can be served per year? can we use BE formula
We need to find Break even in terms of Units we can use algebra so BE is when TR= TC
We cannot use formula as revenue for the healthcare is semi variable in nature
CVP in times of austerity A government’s health department, has a £1,200,000 lump-sum annual budget appropriation for an agency to help rehabilitate mentally ill patients. On top of this, the agency charges for each patient £600 a month for their board and care. All of the appropriation and revenue must be spent (BEV).
The variable costs for rehabilitation activity average £700 per patient per month. The agency’s annual fixed costs are £800,000. The agency manager wishes to know how many patients can be served per year?
Suppose the manager of the agency is concerned that the total appropriation budget for the coming year will be cut by 10%. All other things remain unchanged. The manager wants to know how this budget cut affects the next year’s service level….Can you help?
A government’s health department, has a £1,200,000 lump-sum annual budget appropriation for an agency to help rehabilitate mentally ill patients. On top of this, the agency charges for each patient £600 a month for their board and care. All of the appropriation and revenue must be spent (BEV). The variable costs for rehabilitation activity average £700 per patient per month. The agency’s annual fixed costs are £800,000.
Suppose the manager of the agency is concerned that the total appropriation budget for the coming year will be cut by 10%
The manager does not reduce the number of patients served despite the budget cut. All other things remain unchanged. How much more does the manager have to charge patients for board and care? In this case, x = care charge per year.
What does this mean?
What does a high and low break even point mean?
A low breakeven point means that the business will start making a profit sooner, whereas a high breakeven point means more products or services need to be sold to reach that point. So, if your breakeven analysis reveals a high breakeven point, then you might want to consider: If any costs can be reduced.
Why do you want to have a lower Break even point?
You want to have a low breakeven point because anything below that you are making a loss, so you don’t have to sell a lot of units and spend lots to break even and even make a profit, (think abaout the diagram)
What does fianancial leverage mean ?
Measures financial risk, it means a business will use debt and equity financing to grow their business
What does Operating leverage mean in accounting?
it is how responsive a companys operating income is to changes in sales volume
What is the formula for Operating leverage?
Will companies with high fixed cost have high operating leverage or low? and explain?
they have high fixed costs compared to variable costs, meaning they take more risks, meaning that the denominator will get smaller pushing ratio up.
When else can a firm have a high operating leverage?
A business that generates sales with a high gross margin and low variable costs has high operating leverage.
What does a low operating leverage mean?
Low-operating-leverage companies may have high costs that vary directly with their sales (high variable costs)but have lower fixed costs to cover each month.
How could be determine if there was an increase in 10% of sales what happens to operating profit/income?
We can calculate this by working out degree of operating leverage, for ABC industries its 135000/5000 = 27
For XYZ company the degree of operating leverage is 120000/40000 = 3
If there was a 10% increase in sales ( we take the 2 multipliers 27 and 3) and times by 10% which tells us for ABC there would be an increase in 270% in net operating income and for XYZ company, net income will go up by 3 X 10 = 30%
Why does ABC operating income increase massively compared to XYZ if there is a small increase in sales when the 2 firms sell the same units and increase both by 10%?
This is because when a firm is close to there breakeven point and there is an increase in sales that has a bigger effect on operating profit. (ABC is very close to break even compared to XYZ)
The further you are away from breakeven point the more the Degree of operating leverage falls, each increase in sales , has less and less impact on operating income.
What is the degree of operating leverage and what does this mean?
If we increased our sales by 10% ( >760000) that would lead to a 760% increase in operating leverage.
What are an advantages and a disadvantage of CVP analysis?
CVP analysis shows best how we can use scarce resources ( the one with highest contribution margin with our scarce resources)
Restrictive assumptions about cost behaviour.
What is CVP mainly used for?
Short term decision making, managers use it to ask what if questions and make decsions e,g about short term prices ( offer discount) etc.
f the same task can be undertaken utilising two different methods; one with high fixed costs and other with high variable costs; e.g. one task being labour intensive and the other machine intensive, what can we work out?
then we can work out which of the two is more feasible if the projected level of activity is known.
What is the method to work out which of the two methods is more feasible if the projected level of activity is known.
Q(break-even) = (£305 - £5)/(£4 - £1) = 300/3 = 100 trees
Will cost £405 to cut 100 trees. Anything above that would make the using of chainsaw more viable.
What is scarce resource (or limiting factor)?
is one where we do not have enough supply to undertake every opportunity to make additional contribution
Labour hours is the limiting factor
Which of the following is not an example of a sunk cost?
Select one:
A) materials needed for production
B) purchase cost of machinery
C) depreciation
D) All are sunk costs.
A is the answer
Tech Plc customises machinery to clients’ specifications. However, just as the company completed half the customised machines for a client, the client went bankrupt with no possibility of payment. There is another potential customer identified for this machine, but they will require alterations using Material A and Material B.
30 units of Material B will be required. An order of 45 units is required for another job within the company. It is priced at £100 per unit, but the supplier allows a bulk discount of £5 per unit, if the order exceeds 60 units. The business uses Material B constantly.
What is the relevant cost?
Select one:
1) £2,625
2) £3,000
3) £2,850
4) £7,125
The order for 45 units at £100 per unit will be placed irrespective of the decision made. The relevant cost is the difference between the cost of that order and the cost of the new order including 30 additional units at discounted price. The price for the existing order is £100 x 45 units = £4,500. The price for the new order is £95 x 75 units = £7,125 and the difference is £7,125 - £4,500 = £2,625
Tech Plc customises machinery to clients’ specifications. However, just as the company completed half the customised machines for a client, the client went bankrupt with no possibility of payment. There is another potential customer identified for this machine, but they will require alterations using Material A and Material B.
The required quantity for Material A is in the company’s inventory. The required amount for the alteration cost £2,400 when bought and would cost £5,000 to replace it. It will cost £500 for the company to scrap it and the company uses Material A constantly.
What is the relevant cost?
Select one:
1) £2,400
2) £5,000
3) £7,400
4) £7,900
Replacement cost of £5,000 is relevant here. The historic cost and scrap cost of Material A are both irrelevant. As the business uses it constantly, Material A will be used regardless of the decision for accepting alterations. However, if the material is used to alter the machine, it will need to be replaced, therefore it is a relevant cost.
Wicked Corporation has projected its Steel Division will have a contribution margin of $1.6m and fixed costs of $1.8m next year. If Steel Division is to be closed, $1.2m of the fixed costs would be eliminated. What will be the effect on Wicked’s net profit next year if Steel Division is to be closed?
Select one:
A) Increase by $200,000
b) Decrease by $400,000
C)Increase by $600,000
D) Decrease by $1,200,000
Excellent! Relevant contribution margin that would be forgone from the discontinuation of is $1.6m. When this is compared with the relevant fixed costs of $1.2m that could be saved/eliminated, there will be a decrease of $400,000 if Steel Division is to be closed
Contibution / unit = selling price per unit - variable cost per unit = 30-10 = 20
C/S RATIO = contribution/ unit / selling price per unit = 20/30 X 100 = 66.7
The contribution margin ratio always increases when
Select one :
A) the variable expenses as a percentage of sales increase
B) The break even point decreases
C) the variable expenses as a percentage of sales decrease
D) The break even point increases
C because
Contribution margin ratio = contribution per unit / selling price/ unit
selling price per unit lets say its constant
Contribution per unit = selling price per unit - variable price per unit
so if variable expenses go down by a bit lets say
5-2/2 = 1.5 but 5-1/2 = 2 lower variable cost per unit for the second hence C is right.
Break even =
400 = 2000/sp -10
400sp - 4000 = 2000
sp = 15
VC = 4000 / 400 = 10
15 - 10 = 5
D is the answer
D ) 200
Contribution per unit = selling price per unit - variable cost per unit
£450 - 250 = £200
D is correct
D is the correct answer
Positive contribution margin means selling price > variable cost
If both selling price and variable expenses go down by same rate e.g. 5% contribution per unit will decrease as ( selling price per unit - variable cost per unit as a whole is smaller)
Contribution margin ratio stays the same as TBA
A) 32.50
B) 25.70
C) 27.30
D) 17.50
Contribution per unit = selling price per unit - varable cost per unit
Selling price per unit = £780000/13000 = £60
Variable cost per unit = DL + DM + VOH = £467500/ 17000 = 27.50 + Variable selling and adminstrative expenses ( 88400/13000) = 6.8
6.8+27.50 = £34.3
£60 - 34.3 = 25.70
DL + DM + VOH + FOH = 722500
Production = 17000
Product cost per unit = £42.5
Value of closing inventory = 4000
4000 x 42.5 = 170000
Total overheads = 540000
Basis machine hours = 60000
£9/machine hour
Total cost
DL + DM + MOH
6500 +2500 + (9x800) = 16200
