unit 8 cost accounting & decision making 1 -...

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Professional Development Programme on Enriching Knowledge of the Business, Accounting and Financial Studies (BAFS) Curriculum

Technology Education Section, Curriculum Development InstituteEducation Bureau, HKSARG

August 2008

Unit 8 : Cost Accounting for Decision Making 1

Course 1 : Contemporary Perspectives on Accounting

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Learning objectivesLearning objectives

On completion of this unit, you should be able to:On completion of this unit, you should be able to:

•• Explain the objective and assumptions of costExplain the objective and assumptions of cost--volumevolume--profit (CVP) analysis. profit (CVP) analysis.

•• Calculate and explain the breakCalculate and explain the break--even point (BEP) and even point (BEP) and revenue, contribution/sales (CS) ratio, margin of safety revenue, contribution/sales (CS) ratio, margin of safety (MOS) and target profit. (MOS) and target profit.

•• Construct breakConstruct break--even chart, contribution chart and profiteven chart, contribution chart and profit--volume chart.volume chart.

•• Assess the effects of changes in costs, selling price and Assess the effects of changes in costs, selling price and units sold on the breakunits sold on the break--even point and target profit.even point and target profit.

•• Explain the limitations of CVP analysis.Explain the limitations of CVP analysis.

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Organisation of Unit 8

Cost-volume-profit (CVP) analysis

AssumptionsIntroduction and objective

Example 1

Limitations of CVP analysis

Mathematical approach:- break-even point- contribution to

sales ratio- margin of safety- target profit

Graphical approach:- break-even chartcontribution chartprofit-volume chart

Effects of changes in cost, selling price and units sold on the break-even point and target profit

Example 2Example 3 Example 4

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Introduction and objective Introduction and objective (1)(1)

• CVP analysis uses basically the principles of marginal costing and is an important short-term planning tool.

• It explores the relationship, which exists between costs, revenue, output levels and resulting profit.

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Introduction and objective Introduction and objective (2)(2)

• CVP analysis is useful for short-term decision making in that it can assist managers to predict the profits by incorporating changes in total fixed costs, selling price per unit, unit variable cost and units sold.

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Assumptions of CVP analysis Assumptions of CVP analysis (1)(1)

•• Total costs can be separated into variable Total costs can be separated into variable costs and fixed costs.costs and fixed costs.

•• Total revenues and total costs are linear Total revenues and total costs are linear within the relevant range.within the relevant range.

•• Unit selling price, unit variable costs and Unit selling price, unit variable costs and fixed costs are known and constant.fixed costs are known and constant.

•• Volume is the only determinant of cost and Volume is the only determinant of cost and revenue changes.revenue changes.

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Assumptions of CVP analysis Assumptions of CVP analysis (2)(2)

•• The technology and efficiency remain The technology and efficiency remain unchanged.unchanged.

•• The company sells only single product or The company sells only single product or there is a constant sales mix.there is a constant sales mix.

•• The time value of money is ignored.The time value of money is ignored.

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BEP, C/S ratio, MOS and BEP, C/S ratio, MOS and target profit target profit (1)(1)

•• CVP analysis is also known as breakCVP analysis is also known as break--even even analysis. analysis.

•• BreakBreak--even point (BEP) means the level of sales even point (BEP) means the level of sales in units or in dollars that produces neither profit in units or in dollars that produces neither profit nor loss.nor loss.

•• Margin of safety (MOS) is the extent to which the Margin of safety (MOS) is the extent to which the planned volume of sales lies above the breakeven planned volume of sales lies above the breakeven point. MOS can be expressed in %, units or sales point. MOS can be expressed in %, units or sales in dollars.in dollars.

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•• CVP analysis can be undertaken by simple CVP analysis can be undertaken by simple formulas, which are listed below:formulas, which are listed below:

BreakBreak--even point (in units)even point (in units)= Fixed costs = Fixed costs ÷÷ Contribution per unitContribution per unit

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BreakBreak--even revenueeven revenue= Fixed costs = Fixed costs ÷÷ Contribution per unit x Sales Contribution per unit x Sales

price per unit, price per unit, OROR= Fixed costs = Fixed costs ÷÷ Contribution/sales (C/S) ratioContribution/sales (C/S) ratio

= Contribution per unit = Contribution per unit ÷÷ Sales price per unit x Sales price per unit x 100%100%

1111


Margin of safety (in units or in %)Margin of safety (in units or in %)= Planned sales (in units) = Planned sales (in units) –– BreakBreak--even even

point (in units), point (in units), OROR= [Planned sales (in units) = [Planned sales (in units) –– BreakBreak--even even

point (in units)] point (in units)] ÷÷ Planned sales (in Planned sales (in units)units) x 100% x 100%

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Margin of safety (in $ or in %)Margin of safety (in $ or in %)= Planned sales (in $) = Planned sales (in $) –– BreakBreak--even even

point (in $), point (in $), OROR= [Planned sales (in $) = [Planned sales (in $) –– BreakBreak-- even even

point (in $)] point (in $)] ÷÷ Planned Planned sales ($)sales ($) x x 100% 100%

1313


Level of sales to result in target profit (in units)Level of sales to result in target profit (in units)= (Fixed costs + Target profit) = (Fixed costs + Target profit) ÷÷ Contribution perContribution per

unitunit

Level of sales to result in target profit (in $)Level of sales to result in target profit (in $)= (Fixed costs + Target profit) x Sales price per = (Fixed costs + Target profit) x Sales price per

unit unit ÷÷ Contribution per unitContribution per unit

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Example 1 Example 1 (1)(1)

Chai Wan Limited makes and sells wooden chairs with sales price of $30 and variable cost of $18 per unit. The fixed costs for a month are $360,000.

Required:Calculate:a. Break-even point (in units),b. Break-even point (in $ sales), and c. Contribution/sales (C/S) ratio.

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Solution:Solution:Contribution per unit = Selling price Contribution per unit = Selling price –– variable costvariable cost

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Solution:Solution:Contribution per unit = Selling price Contribution per unit = Selling price –– variable costvariable cost

= $30 = $30 -- $18$18= $12= $12

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Solution:Solution:a.a. BreakBreak--even point (in units)even point (in units)

= Fixed costs = Fixed costs ÷÷ Contribution per unitContribution per unit

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Solution:Solution:a.a. BreakBreak--even point (in units)even point (in units)

= Fixed costs = Fixed costs ÷÷ Contribution per unitContribution per unit== $360,000$360,000 ÷÷ $12$12== 30,000 units per month30,000 units per month

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b. Breakb. Break--even point (in $ sales) even point (in $ sales) == BE units x unit selling priceBE units x unit selling price

2020


b. Breakb. Break--even point (in $ sales) even point (in $ sales) == BE units x unit selling priceBE units x unit selling price== 30,000 x $3030,000 x $30== $900,000 $900,000

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c. C/S ratioc. C/S ratio= Unit contribution = Unit contribution ÷÷ unit selling price x 100%unit selling price x 100%

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c. C/S ratioc. C/S ratio= Unit contribution = Unit contribution ÷÷ unit selling price x 100%unit selling price x 100%== $(12 $(12 ÷÷ 30) 30) x100%x100%== 40%40%

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Use the information in Example 1. The general Use the information in Example 1. The general manager of manager of ChaiChai Wan Limited plans to make and Wan Limited plans to make and sell 40,000 wooden chairs next month. sell 40,000 wooden chairs next month.

Required:Required:a. Calculate and explain the margin of safety (in a. Calculate and explain the margin of safety (in

units, in dollar sales and in %) for next month.units, in dollar sales and in %) for next month.b. If the general manager wants to achieve a b. If the general manager wants to achieve a

profit of $300,000 next month, what number profit of $300,000 next month, what number of units will need to be sold? of units will need to be sold?

c. What level of sales will achieve a profit of c. What level of sales will achieve a profit of $300,000 next month?$300,000 next month?

2424


Solution:Solution:

a.a. Margin of safety (in units)Margin of safety (in units)= Planned sales (in units) = Planned sales (in units) –– BreakBreak--even even

point (in units)point (in units)

2525


Solution:Solution:

a.a. Margin of safety (in units)Margin of safety (in units)= Planned sales (in units) = Planned sales (in units) –– BreakBreak--even even

point (in units)point (in units)= (40,000 = (40,000 –– 30,000) units 30,000) units = 10,000 units= 10,000 units

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Solution:Solution:

a.a. Margin of safety (in sales)Margin of safety (in sales)= Planned sales (in $) = Planned sales (in $) –– BreakBreak--even even

point (in $)point (in $)

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Solution:Solution:

a.a. Margin of safety (in $ sales)Margin of safety (in $ sales)= Planned sales (in $) = Planned sales (in $) –– BreakBreak--even even

point (in $)point (in $)== $1,200,000 $1,200,000 -- $900,000 $900,000 = $300,000= $300,000

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Solution:Solution:a.a. Margin of safety (in %)Margin of safety (in %)

= [Planned sales (in units/$) = [Planned sales (in units/$) –– BreakBreak--even even point (in units/$)] point (in units/$)] ÷÷ Planned sales (in Planned sales (in units/$)units/$) x 100% x 100%

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Solution:Solution:a.a. Margin of safety (in %)Margin of safety (in %)

= [Planned sales (in units/$) = [Planned sales (in units/$) –– BreakBreak--even even point (in units/$)] point (in units/$)] ÷÷ Planned sales (in Planned sales (in units/$)units/$) x 100% x 100%

=(10,000 =(10,000 ÷÷ 4040,000) units x 100% ,000) units x 100% = 25%, OR= 25%, OR= $(300,000 = $(300,000 ÷÷ 1,200,000) x 100% 1,200,000) x 100% = 25%= 25%

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The margin of safety in next month is 10,000 The margin of safety in next month is 10,000 units (or sales value $300,000) or 25%. It units (or sales value $300,000) or 25%. It means that if the actual volume of sales drop means that if the actual volume of sales drop more than 10,000 units (or sales value $300,000) more than 10,000 units (or sales value $300,000) or 25% from its planned sales of 40,000 units, or 25% from its planned sales of 40,000 units, the company will suffer a loss.the company will suffer a loss.

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b. Number of units for target profitb. Number of units for target profit= (Fixed costs + target profit) = (Fixed costs + target profit) ÷÷ unit contributionunit contribution

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b. Number of units for target profitb. Number of units for target profit= (Fixed costs + target profit) = (Fixed costs + target profit) ÷÷ unit contributionunit contribution== $(360,000 + 300,000) $(360,000 + 300,000) ÷÷ $12$12== 55,000 units55,000 units

3333


c. Sales for units for target profitc. Sales for units for target profit= (Fixed costs + target profit) = (Fixed costs + target profit) ÷÷ unit unit

contribution x unit contribution x unit selling price selling price

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c. Sales for units for target profitc. Sales for units for target profit= (Fixed costs + target profit) = (Fixed costs + target profit) ÷÷ unit unit

contribution x unit contribution x unit selling price selling price == $(360,000 + 300,000) $(360,000 + 300,000) ÷÷ $12 x $30$12 x $30== $1,650,000 $1,650,000

3535

BreakBreak--even chart, contribution chart even chart, contribution chart and profitand profit--volume chart volume chart

•• Alternatively, CVP analysis can be conducted by Alternatively, CVP analysis can be conducted by the graphical approach. the graphical approach.

•• The graphical approach may be preferable where The graphical approach may be preferable where a simple overview is sufficient or where there is a a simple overview is sufficient or where there is a need to avoid a detailed numerical approach that need to avoid a detailed numerical approach that may not easily be understood by nonmay not easily be understood by non--financial financial users.users.

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BreakBreak--even chart even chart (1)(1)

BreakBreak--even charteven chartA breakA break--even chart can be drawn in the followingeven chart can be drawn in the followingsteps:steps:a.a. Draw the horizontal and vertical axes. Draw the horizontal and vertical axes.

The horizontal axis shows the levels of activity The horizontal axis shows the levels of activity expressed as sales units and the vertical axis expressed as sales units and the vertical axis shows the values in dollars for costs and shows the values in dollars for costs and revenue.revenue.

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BreakBreak--even charteven chart

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1,200

1,500

300

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900

1,000 2,000 3,000 4,000 5,000

Activity (Sales units)

Sales revenue/Costs ($’000)

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b.b. Draw the fixed costs line and then the total Draw the fixed costs line and then the total costs line. costs line.

The fixed costs line will be a straight line parallel The fixed costs line will be a straight line parallel to the horizontal axis at the level of the fixed to the horizontal axis at the level of the fixed costs. costs.

The total costs line, which comprises both fixed The total costs line, which comprises both fixed and variable costs, will start where the fixed and variable costs, will start where the fixed costs line intersects the vertical axis and will be costs line intersects the vertical axis and will be a straight line sloping upward at an angle a straight line sloping upward at an angle depending on the proportion of variable costs in depending on the proportion of variable costs in total costs.total costs.

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1,500

300

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1,000 2,000 3,000 4,000 5,000



Total costs

Variable costs

Fixed costs

Fixed costs

4040


c.c. Draw the revenue line, which will be a straight Draw the revenue line, which will be a straight line from the point of origin sloping upwards at line from the point of origin sloping upwards at an angle determined by the selling price.an angle determined by the selling price.

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1,500

300

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1,000 2,000 3,000 4,000 5,000



Total costsVariable

costs

Fixed costs

Sales

Fixed costs

4242


d. The breakd. The break--even point (in units and in $ sales) even point (in units and in $ sales) can be determined as the intercan be determined as the inter--section of the section of the total cost line and the revenue line.total cost line and the revenue line.

The profit generated from sales above the breakThe profit generated from sales above the break--even point and the loss suffered from sales below even point and the loss suffered from sales below the breakthe break--even point can easily be determined in even point can easily be determined in the chart. the chart.

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0

1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000



Total costsVariable

costs

Fixed costs

Profit

Loss

Profit

Sales

Fixed costs

Break-even point

4444


e. The margin of safety (in units and in $ sales) can e. The margin of safety (in units and in $ sales) can be determined as the difference between the be determined as the difference between the budgeted sales (in units and in $) and the breakbudgeted sales (in units and in $) and the break--even (in units and in $).even (in units and in $).

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0

1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000



Total costsVariable

costs

Fixed costs

Profit

Loss

Profit

Sales

Fixed costs

Margin of safety

Margin of safety

Break-even point

4646

Contribution chart Contribution chart (1)(1)

Contribution chartContribution chart

A contribution chart is an alternative form of A contribution chart is an alternative form of presenting the breakpresenting the break--even chart in that the even chart in that the variable costs line is drawn first instead of the variable costs line is drawn first instead of the fixed costs line. fixed costs line.

The contribution chart can show clearly the The contribution chart can show clearly the contribution for different level of activity and the contribution for different level of activity and the effect on profit for different level of sales. effect on profit for different level of sales.

4747


Contribution chartContribution chartA contribution chart can be drawn in the followingA contribution chart can be drawn in the followingsteps:steps:a.a. Draw the horizontal and vertical axes. Draw the horizontal and vertical axes.

The horizontal axis shows the levels of activity The horizontal axis shows the levels of activity expressed as sales units and the vertical axis expressed as sales units and the vertical axis shows the values in dollars for costs and shows the values in dollars for costs and revenue.revenue.

4848



0

1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000



4949


b.b. Draw the variable costs line and then the total Draw the variable costs line and then the total costs line. costs line.

The variable costs line start at the origin and will The variable costs line start at the origin and will be a straight line sloping upward at an angle be a straight line sloping upward at an angle depending on the level of the variable costs. depending on the level of the variable costs.

The total costs line, which comprises both The total costs line, which comprises both variable and fixed costs, will be a straight line variable and fixed costs, will be a straight line parallel to the variable costs line at the level of parallel to the variable costs line at the level of the fixed costs starting from the vertical axis.the fixed costs starting from the vertical axis.

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0

1,200

1,500

300

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1,000 2,000 3,000 4,000 5,000



Variable costs

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1,500

300

600

900

1,000 2,000 3,000 4,000 5,000

Total costs



Fixed costs

Variable costs

5252


c.c. Draw the revenue line, which will be a straight Draw the revenue line, which will be a straight line from the point of origin sloping upwards at line from the point of origin sloping upwards at an angle determined by the selling price.an angle determined by the selling price.

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0

1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000

Sales



Total costsFixed costs

Variable costs

5454


d. The breakd. The break--even point (in units and in $ sales) even point (in units and in $ sales) can be determined as the intercan be determined as the inter--section of the section of the total cost line and the revenue line.total cost line and the revenue line.


Contribution for different level of activity can also Contribution for different level of activity can also be determined in the chart. be determined in the chart.

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1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000

Total costs

Profit

Loss

Profit

Sales

Con

tribu

tion



Break-even point

Fixed costs

Variable costs

5656


e. The margin of safety (in units and in $ sales) can e. The margin of safety (in units and in $ sales) can be determined as the difference between the be determined as the difference between the budgeted sales (in units and in $) and the breakbudgeted sales (in units and in $) and the break--even (in units and in $).even (in units and in $).

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0

1,200

1,500

300

600

900

1,000 2,000 3,000 4,000 5,000

Total costs

Profit

Loss

Profit

Sales

Margin of safety

Margin of safety

Break-even point

Con

tribu

tion



Fixed costs

Variable costs

5858

ProfitProfit--volume chart volume chart (1)(1)

ProfitProfit--volume chartvolume chart

The profitThe profit--volume chart is a variation of the volume chart is a variation of the breakbreak--even chart, which can show the effect on even chart, which can show the effect on profit for different level of sales. profit for different level of sales.

The profitThe profit--volume chart concentrates on profit volume chart concentrates on profit and shows only a profit line. and shows only a profit line.

The horizontal axis shows the levels of activity The horizontal axis shows the levels of activity expressed as sales units and the vertical axis expressed as sales units and the vertical axis shows the profit or loss values in dollars.shows the profit or loss values in dollars.

5959


Profit volume chartProfit volume chartA profit volume chart can be drawn in the followingA profit volume chart can be drawn in the followingsteps:steps:a.a. Draw the horizontal and vertical axes. Draw the horizontal and vertical axes.

The horizontal axis shows the levels of activity The horizontal axis shows the levels of activity expressed as sales units and the vertical axis expressed as sales units and the vertical axis shows the profit or loss values in dollars.shows the profit or loss values in dollars.

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0

600

1,000 2,000 3,000 4,000 5,000

400

Activity(Sales units)

Profit / Loss ($’000)

6161


b.b.Draw the profit/loss line, which will be a straight Draw the profit/loss line, which will be a straight line from vertical axis slopping upward at an line from vertical axis slopping upward at an angle depending on the level of profit (sales less angle depending on the level of profit (sales less total costs) starting at a loss equal to the fixed total costs) starting at a loss equal to the fixed costs (since there would be no revenue at zero costs (since there would be no revenue at zero sales).sales).

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1,000 2,000 3,000 4,000 5,000

400



6363


c. The breakc. The break--even point (in units and in $ sales) even point (in units and in $ sales) can be determined as the intercan be determined as the inter--section of the section of the total profit/loss line and the horizontal axis.total profit/loss line and the horizontal axis.


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600

1,000 2,000 3,000 4,000


Loss

Profit

Fixed costs

Profit

Con

tribu

tion5,000

400


6565


d. The margin of safety (in units and in $ profit) d. The margin of safety (in units and in $ profit) can be determined as the difference between the can be determined as the difference between the budgeted profit (in units and in $) and the breakbudgeted profit (in units and in $) and the break--even point (in units and in $).even point (in units and in $).

6666



0

600

1,000 2,000 3,000 4,000


Loss

Profit

Margin of safety

Margin of safety

Break-even point

Fixed costs

Profit

Con

tribu

tion5,000

400


6767

Example 3Example 3 (1)(1)

Example 3Example 3

ChaiChai Wan Limited also produces and sells wireless Wan Limited also produces and sells wireless computer keyboards. computer keyboards.

The company intends to produce and sell 5,000 The company intends to produce and sell 5,000 units per year. The unit sales price is $300 and units per year. The unit sales price is $300 and the unit variable cost is $100. Fixed costs are the unit variable cost is $100. Fixed costs are $600,000 a year.$600,000 a year.

6868


Required:Required:

Determine the breakDetermine the break--even point and the margin of even point and the margin of safety for wireless computer keyboards by safety for wireless computer keyboards by constructing: constructing:

a. breaka. break--even chart,even chart,b. contribution chart, andb. contribution chart, andc. profitc. profit--volume chart. volume chart.

6969


Solution:Solution:a. Breaka. Break--even charteven chart

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1,000 2,000 3,000 4,000 5,000

Fixed costs

Fixed costs



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0

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1,500

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1,000 2,000 3,000 4,000 5,000

Total costsVariable

costs

Fixed costs

Fixed costs



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0

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1,500

300

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900

1,000 2,000 3,000 4,000 5,000

Total costsVariable

costs

Fixed costs

Sales

Fixed costs



7373



0

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1,500

300

600

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1,000 2,000 3,000 4,000 5,000



Total costsVariable

costs

Fixed costs

Profit

Loss

Profit

Sales

Fixed costs

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0

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1,500

300

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1,000 2,000 3,000 4,000 5,000



Total costsVariable

costs

Fixed costs

Profit

Loss

Profit

Sales

Fixed costs

Margin of safety

Margin of safety

Break-even point

7575


From the breakFrom the break--even chart, we can easily get the even chart, we can easily get the following information:following information:

BreakBreak--even point: even point: 3,000 units, or $900,0003,000 units, or $900,000If sales are above $900,000 or 3,000 units, If sales are above $900,000 or 3,000 units, the company will make a profit.the company will make a profit.If sales are below $900,000 or 3,000 units, If sales are below $900,000 or 3,000 units, the company will suffer a loss. the company will suffer a loss.

7676


Margin of safety: Margin of safety:

(5,000 (5,000 -- 3,000) units = 2,000 units, or 3,000) units = 2,000 units, or $(1,200,000 $(1,200,000 –– 900,000) = $600,000900,000) = $600,000

If sales drop by not more than $600,000 or If sales drop by not more than $600,000 or 2,000 units, the company will make a profit.2,000 units, the company will make a profit.

If sales drop by more than $600,000 or 2,000 If sales drop by more than $600,000 or 2,000 units, the company will suffer a loss. units, the company will suffer a loss.

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b. Contribution chartb. Contribution chart

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Variable costs



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1,000 2,000 3,000 4,000 5,000

Total costsFixed costs

Variable costs



8080



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Total costs

Profit

Loss

Profit

Sales

Con

tribu

tion



Fixed costs

Variable costs

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0

1,200

1,500

300

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1,000 2,000 3,000 4,000 5,000

Total costs

Profit

Loss

Profit

Sales

Margin of safety

Margin of safety

Break-even point

Con

tribu

tion



Fixed costs

Variable costs

8282


The information you can get from the The information you can get from the contribution chart is similar to that from the contribution chart is similar to that from the breakbreak--even chart. even chart.

8383


c.c. ProfitProfit--volume chartvolume chart

0

600

1,000 2,000 3,000 4,000 5,000

400



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1,000 2,000 3,000 4,000 5,000

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0

600

1,000 2,000 3,000 4,000


Loss

Profit

Fixed costs

Profit

Con

tribu

tion5,000

400


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0

600

1,000 2,000 3,000 4,000


Loss

Profit

Margin of safety

Margin of safety

Break-even point

Fixed costs

Profit

Con

tribu

tion5,000

400


8787


From the profitFrom the profit--volume chart, we can easily get the following volume chart, we can easily get the following information:information:

At sales of 3,000 units: At sales of 3,000 units: The company will breakThe company will break--even with no profit and no loss. even with no profit and no loss.

At sales of 0 units:At sales of 0 units:The company will suffer a loss of $600,000.The company will suffer a loss of $600,000.

At target sales of 5,000 units:At target sales of 5,000 units:The company will make a profit of $400,000.The company will make a profit of $400,000.

The margin of safety is:The margin of safety is:2,000 (5,000 2,000 (5,000 –– 3,000) units, or3,000) units, or$400,000 ($200 x 2,000 units) contribution/profit$400,000 ($200 x 2,000 units) contribution/profit

8888

Effects of changes in costs, selling price and units sold on Effects of changes in costs, selling price and units sold on the breakthe break--even point and target profiteven point and target profit

•• CVP is a very useful management tool in that by CVP is a very useful management tool in that by varying the variable cost, fixed cost, selling price varying the variable cost, fixed cost, selling price and units sold, simple and quick estimates of and units sold, simple and quick estimates of breakbreak--even points and profitability can be made.even points and profitability can be made.

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Example 4 Example 4

One of the divisions of One of the divisions of ChaiChai Wan Limited Wan Limited produces and sells laser pointers. The following produces and sells laser pointers. The following information is extracted from its current yearinformation is extracted from its current year’’ssbudget:budget:Production and sales unitsProduction and sales units 60,000 units60,000 unitsSelling price per unitSelling price per unit $40$40Variable cost per unitVariable cost per unit $30$30Fixed costs per annumFixed costs per annum $400,000$400,000

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Required:Required:To calculate the following for To calculate the following for ChaiChai Wan Limited:Wan Limited:a.a. the breakthe break--even point (in units and $ sales), even point (in units and $ sales), b.b. the budgeted profit for current year, the budgeted profit for current year, c.c. the revised breakeven point (in units) and revised the revised breakeven point (in units) and revised

budgeted profit, under each the following independent budgeted profit, under each the following independent changes:changes:i.i. the variable cost increases by $2.the variable cost increases by $2.ii. the fixed costs decrease by 10% and sales volume ii. the fixed costs decrease by 10% and sales volume

increases by 5%, selling price and variable cost increases by 5%, selling price and variable cost remain unchanged.remain unchanged.

iii. the fixed costs and variable cost increase by 10%, iii. the fixed costs and variable cost increase by 10%, selling price decreases by 5% while sales volume selling price decreases by 5% while sales volume increases by 20%.increases by 20%.

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Solution:Solution:a.a. Contribution per unit Contribution per unit

= Selling price = Selling price –– variable costvariable cost

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Solution:Solution:a.a. Contribution per unit Contribution per unit

= Selling price = Selling price –– variable costvariable cost= $40 = $40 -- $30$30= $10= $10

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Solution:Solution:a.a. BBreakreak--even point (in units) even point (in units)

= Fixed costs = Fixed costs ÷÷ Contribution per unitContribution per unit

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Solution:Solution:a.a. BBreakreak--even point (in units) even point (in units)

= Fixed costs = Fixed costs ÷÷ Contribution per unitContribution per unit= $400,000 = $400,000 ÷÷ $10$10= 40,000 units= 40,000 units

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Solution:Solution:a.a. BBreakreak--even point (in sales)even point (in sales)

= BE units x unit selling price = BE units x unit selling price

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Solution:Solution:a.a. BBreakreak--even point (in sales)even point (in sales)

= BE units x unit selling price = BE units x unit selling price = 40,000 x $40 = 40,000 x $40 = $1,600,000= $1,600,000

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b.b. Total contribution Total contribution $$Less: Fixed costsLess: Fixed costs ______________ProfitProfit ______________

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b.b. Total contribution ($10 x 60,000)Total contribution ($10 x 60,000) $600,000$600,000Less: Fixed costsLess: Fixed costs 400,000400,000ProfitProfit $200,000$200,000

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c.i. Revised c.i. Revised contribution per unit contribution per unit = Selling price = Selling price –– variable costvariable cost

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c.i. Revised c.i. Revised contribution per unit contribution per unit = Selling price = Selling price –– variable costvariable cost= $40 = $40 -- $32$32= $8= $8

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c.i. Breakc.i. Break--even point (in units)even point (in units)= Fixed costs = Fixed costs ÷÷ unit contributionunit contribution

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c.i. Breakc.i. Break--even point (in units)even point (in units)= Fixed costs = Fixed costs ÷÷ unit contributionunit contribution= $400,000 = $400,000 ÷÷ $8 $8 = 50,000 units= 50,000 units

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c.i. Total contribution c.i. Total contribution $$Less: Fixed costsLess: Fixed costs ______________ProfitProfit ______________

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c.i. Total contribution ($8 x 60,000) c.i. Total contribution ($8 x 60,000) $480,000$480,000Less: Fixed costsLess: Fixed costs 400,000400,000ProfitProfit $80,000$80,000

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ii.ii. Contribution per unit remains at $10Contribution per unit remains at $10

BreakBreak--even point (in units)even point (in units)= Revised fixed costs = Revised fixed costs ÷÷ unit contributionunit contribution

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ii.ii. Contribution per unit remains at $10Contribution per unit remains at $10

BreakBreak--even point (in units)even point (in units)= Revised fixed costs = Revised fixed costs ÷÷ unit contributionunit contribution= $400,000 x 90% = $400,000 x 90% ÷÷ $10$10= 36,000 units= 36,000 units

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ii.ii. Total contribution Total contribution $$Less: Fixed costs Less: Fixed costs ________________ProfitProfit ________________

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ii.ii. Total contribution ($10 x 60,000 x 105%)Total contribution ($10 x 60,000 x 105%) $630,000$630,000Less: Fixed costs ($400,000 x 90%)Less: Fixed costs ($400,000 x 90%) 360,000360,000ProfitProfit $270,000$270,000

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iii. Revised contribution per unitiii. Revised contribution per unit= Revised selling price per unit = Revised selling price per unit –– revised variable revised variable cost per unitcost per unit

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iii. Revised contribution per unitiii. Revised contribution per unit= Revised selling price per unit = Revised selling price per unit –– revised variable revised variable cost per unitcost per unit= $(40 x 95% = $(40 x 95% –– 30 x 110%) 30 x 110%) = $5= $5

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iii. Revised breakiii. Revised break--even point (in units) even point (in units) = Revised fixed costs = Revised fixed costs ÷÷ revised contribution perrevised contribution per

unitunit

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iii. Revised breakiii. Revised break--even point (in units) even point (in units) = Revised fixed costs = Revised fixed costs ÷÷ revised contribution perrevised contribution per

unitunit= $400,000 x 110% = $400,000 x 110% ÷÷ $5$5= 88,000 units= 88,000 units

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iii.iii. Total contribution Total contribution $$Less: Fixed costs Less: Fixed costs ________________Profit/(Loss)Profit/(Loss) ________________

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iii. Total contribution ($5 x 60,000 x 120%) $360,000iii. Total contribution ($5 x 60,000 x 120%) $360,000Less: Fixed costs ($400,000 x 110%)Less: Fixed costs ($400,000 x 110%) 440,000440,000LossLoss (($80,000)$80,000)

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Limitations of CVP analysis Limitations of CVP analysis (1)(1)

•• CVP can provide very useful insights to the CVP can provide very useful insights to the relationship between fixed costs, variable costs relationship between fixed costs, variable costs and the volume of sales. However, there are and the volume of sales. However, there are major limitations which affect its usefulness.major limitations which affect its usefulness.

•• These limitations are shown in the following.These limitations are shown in the following.

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a.a. NonNon--linear relationships of unit variable cost and linear relationships of unit variable cost and selling price selling price

Unit variable cost and selling price are assumed Unit variable cost and selling price are assumed to be the same at all levels of output or sales to be the same at all levels of output or sales under the CVP. However, it may not be true in under the CVP. However, it may not be true in reality because of bulk purchase discounts from reality because of bulk purchase discounts from suppliers of raw materials or trade discounts suppliers of raw materials or trade discounts offered to customers to attract more sales. offered to customers to attract more sales.

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b.b. Step cost function Step cost function

Fixed costs remain fixed within a relevant range Fixed costs remain fixed within a relevant range and beyond that relevant range, it might and beyond that relevant range, it might become a step cost.become a step cost.

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c.c. Companies selling multiCompanies selling multi--products products

CVP analysis is quite helpful for companies CVP analysis is quite helpful for companies selling single product where the measure of selling single product where the measure of activity is simply the unit of output. For activity is simply the unit of output. For companies selling multicompanies selling multi--products, it is not easy products, it is not easy to split the fixed costs among the products. to split the fixed costs among the products. CVP cannot work properly unless there is a CVP cannot work properly unless there is a standard mix for the products of the company.standard mix for the products of the company.

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d.d. Inappropriateness for longInappropriateness for long--term planning term planning purpose purpose

CVP analysis has many applications in profit CVP analysis has many applications in profit planning and shortplanning and short--term decision making, where term decision making, where fixed costs do not change as a consequence of fixed costs do not change as a consequence of the decision taken. It is, however, not the decision taken. It is, however, not appropriate for longappropriate for long--term planning because all term planning because all costs, in the longcosts, in the long--run, are variable costs.run, are variable costs.

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Further readings Further readings (1)(1)

•• HorngrenHorngren et al, (2006), et al, (2006), Cost Accounting , A Cost Accounting , A Managerial EmphasisManagerial Emphasis, Pearson, 12th Edition, , Pearson, 12th Edition, Chapter 3.Chapter 3.

•• Drury, C. (2004), Drury, C. (2004), Management and Cost Management and Cost AccountingAccounting, London, Thomson, 6th Edition, , London, Thomson, 6th Edition, Chapter 8.Chapter 8.

•• Garrison et al, (2006), Garrison et al, (2006), Managerial AccountingManagerial Accounting, , McGrawMcGraw--Hill, 11th Edition, Chapter 6.Hill, 11th Edition, Chapter 6.

•• Li, T. M. and Ng, P. H. (2007), Li, T. M. and Ng, P. H. (2007), HKAL HKAL –– Principles Principles of Accounts (Volume 2)of Accounts (Volume 2), Pilot Publishing Company , Pilot Publishing Company Ltd, 2nd Edition, Chapter 24. Ltd, 2nd Edition, Chapter 24.

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Further readings Further readings (2)(2)

•• 王怡心王怡心 ((二二0000二年二年))，，管理會計管理會計，台北，台北::三民書局，三民書局，修訂二版，第七章修訂二版，第七章。

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End of the UnitEnd of the Unit

This is the end of Unit 8. This is the end of Unit 8. Please go to the Unit Please go to the Unit Assessment before Assessment before attempting the next unit.attempting the next unit.

EndEnd--ofof--unit Assessmentunit Assessment

unit 8 cost accounting & decision making 1 -...

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