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?
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.
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
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 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 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.
Labour hours is the limiting factor
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
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
