Hbc611 Evatopic3&4 Cvp& ABC Bb

7/29/2019 Hbc611 Evatopic3&4 Cvp& ABC Bb

1/15

HBC611: Managerial Accounting

Topic 3

Cost Volume Profi t Analysis(Reference: Chapter 3HDFR & I)Topic 4

Cost Allocation &Activity Based Costing

(Reference: Chapter 4&5HDFR & I)

Convenor: Dr. Eva Elijido-Ten

Dr. Eva Elijido-Ten2

Lecture Objectives Topic 3

To appreciate the benefits of a management

information system that classifies costs into fixed andvariable

To understand how the contribution approach may beused for managerial planning and decision making.

To understand the manner in which the relationshipsbetween revenues, costs and profits may be modelledand used as an aid to managerial planning anddecision making in both single and multi productcontexts.

To calculate both operating leverage and margin ofsafety and explain how they are used.


Chapter 3:Cost-Volume-Profit Analysis

CVP Analysis looks at thebehaviour of total revenues,

total costs and operatingincome as changes occur inthe level of output, sellingprice, variable costs per unitand fixed costs

CVP Analysis is

useful forplanning, andobserving thesensitivity ofprofit to changesin costs andvolume.


CVP Assumptions

1) It is possible to divide costs into F & V elements

2) VC are proportional to Volume

3) FC are constant over the output range

4) Sales Prices remain unchanged

5) Expected levels of efficiency & productivity areunchanged

6) Volume is the only factor affecting costs

7) A Single Product is produced or Constant Sales Mix

8) Production = Sales


2/15


Three C-V-P Methods1. Graphical Method

2. Contribution Margin Method

3. Equation Method

Breakeven Point occurs where profit = 0

Lecture Illustration 1:

Assume that Teddys Electronics which produces and sellscalculators for $50 per unit has the following cost structure:Total Fixed Costs = $300,000 (Mfg & Selling)

Variable Costs per Unit = $35 (Mfg & Selling).

Calculate the breakeven point .


Steps Using the Graphical Method

1. Graph Total Costs (Fixed & Variable) for the levels of sales units

2. Graph Total Revenue for the levels of sales units3. Identify the point of intersection of Total Revenue and Total Cost

lines - the breakeven point (where neither a profit nor a loss ismade).

4. Read from the graph either the Sales Volume in units (x axis)required to breakeven, or the Sales Revenue (y axis) required tobreakeven.The graph can also be used to calculate the amount of profit(loss) that could be earned at a particular level of sales above(below) breakeven sales. (Measure the vertical distance betweencost and revenue lines)


Graphical Method

Volume(Sales Units)

$

$300,000

$1m

Sales Revenue Total Costs

Fixed Costs

Variable costs

Breakeven

Point (BEP)

20,000 units


Contribution Margin Method

Contribution Margin is simply the difference between salesrevenue minus all variable costs (both manufacturing and selling)

CM = Sales Variable Cost.

This amount contributes first towards covering fixed costsand then towards a profit.

To calculate theUnit Contribution Margin (UCM)UCM = USP - UVC

$50 - $35 = $15

=>This means that $15 from each unit sold will contribute toward covering the

fixed costs of $300,000, and once that is covered, will contribute at a rate of$15 per unit to profit)


3/15


Break-even Point (BEP)

Calculate the No. of Units required to be sold in order to break-

even (BEP in units)

BEP(units) = Total Fixed Cost = $300000 = 20,000unit sUCM $15

We can also calculateContribution Margin Ratio(CMR) toenable calculation of the Sales Dollars required to breakeven

CMR = USP - UVC = $50 - $35 = $0.30 or30%

USP 50=>This means that 30 cents from every dollar of sales will contributetowards covering fixed costs and then to earning a profit.


Targeted Sales & CMR

What Sales Revenue is required to breakeven?

To break even, CMR only need to cover TFC:

BEP ($) = Total Fixed Costs =$300,000= $1mCMR .30

How much Sales$ is required to achieve a target operating income(TOI) of $150,000

Target Sales$ = TOI + TFC = $450,000= $1.5m

CMR .30

The CMR can be calculated from unit or total sales prices and unit or totalvariable costs, respectively.

Know your Variable Cost Ratio (VCR) once CMR is known

=> if CMR is .30, then VCR is .70 (VCR = 1 CMR)

ie., seventy cents in every dollar of sales is used to cover the variablecosts of manufacture and sale


Equation Method

The Equation: CM Costing or Variable Costing

Sales - VC - FC = Operating Income

BEP occurs when Revenues cover Expenses orwhen Operating Income = 0

Let Q = the quantity of Sales Units required tobreakeven

Then, 50*Q - 35*Q - 300,000 = 015Q = 300,000

Q = 300,000 / 15Q = 20,000 units


Extensions of the Basic Model We can also use the equation method to calculate Targeted

Sales (in units) if we want to earn a Targeted Profit of $150,000(as in previous example)

Question:

How many calculators should Teddys Electronics have toproduce and sell in order to achieve a Target Operating Incomebefore taxof $150,000?50Q - 35Q - 300,000 = $150,000

15Q 300,000 = $150,000

Q = 150,000 + 300,000

15

Target Sales (units)= 30,000 calculators

Target Sales$ = 30,000 * $50 = $1,500,000or

Target Sales$ = (FC + TP) / CMR = $450,000/.3 = $1,500,000


4/15


Effect of Tax

Sales - Total VC - Total FC = TOI

Where, TOI = Target Operating Income before tax.If NI = Net Income after tax, then the relationship between the two terms is:

OI = N I ( This is often referred to as grossing up)(1 -t)

Assume a tax rate of 30% and an after tax income of $105,000 is required, howmany units need to be sold?(You need to gross up the income to a before taxbasis)

50Q - 35Q - 300000 = 105000/(1 - .3)

15Q 300,000 = 150,000Q = (150,000 + 300,000)/15

= 30,000 units

NI of $105000 = OI

of $150,000 with a

tax rate of 30%


CVP Analysis & Risk:Margin of Safety

Difference between the budgeted sales revenue (or units) andthe break-even sales revenue (or units)

Distance between current level of Sales and Break Even point e.g. If Teddys Electronics achieved their targeted operating income of

$150,000, they would have sold 30,000 calculators

BE = 20,000 calculators

margin of safety is 10,000 calculators

OR:

10,000/30,000 = 33 1/3 % margin of safety

$500,000/$1,500,000 = 33 1/3 % margin of safety

Gives a feel for how close projected operations are to thebreak-even point


CVP Analysis & Risk:Extent of Operating Leverage Summarises the risk-return trade-off of alternative cost

structures

The extent to which an organisation uses fixed costs in its coststructure.

Leverage provided by increasing fixed costs and loweringvariable costs.

Result = pro fit will increase by a greater amount as thelevel activity changes

The greater the % of FC, the greater the impact on profitfrom a given % change in sales revenue

High fixed costs => high OL Degree of OL = Total Contribution Margin

Operating Income


Measuring Operating Leverage

= Contribution Margin

Profit Before Tax

$15 * 30,000

$150,000 = factor of 3

% change in sales x operating leverage factor = %change in net profit

If 20% increase in sales 0.2 x 3

= 60% change in pro fit.

So, $150,000 x .6 = $90,000 increase in profit figure.


5/15


Labour vs machine intensiveoperations

More highly automated processes:

higher operating leverage

higher break even point

and lower safety margin

Hi-tech designed for greater throughput and potentiallyhigher profits

risk if high demand not realised, of not covering higher fixedcosts


Lecture Illustration 2: Al l face 20% increase in sales

Operating leverage% profit

Coy A: 200,000/50,000= 4 => (.2x4) = .8

Coy B: 100,000/50,000= 2 => (.2x2) = .4

Coy C: 450,000/50,000= 9 => (.2x9) = 1.8

Coy. C has the highestincrease in profit due tohighest operating leveragebecause it has the highestfixed costs.

Company A(AccuTime PtyLtd)Amount %

Company B(ManualSystem)Amount %

Company C(Auto. System)Amount %

Sales $500,000 100 $500,000 100 $500,000 100

VariableCosts

$300,000 60 $400,000 80 $50,000 10

Contrib.Margin

$200,000 40 $100,000 20 $450,000 90

FixedExpenses

$150,000 30 $50,000 10 $400,000 80

Net Profit $50,000 10 $50,000 10 $50,000 10


CVP analysis with multiple products

Sales mix

reflects the relative proportions of each type of product soldby the organisation

Weighted average unit contribution margin

the average of the products unit contribution margins,weighted by the sales mix

Break - even point =Fixed expenses

Weighted average unit contributi on margin


Multi-Product Scenario

CVP Analysis can also be used if a firm produces more than oneproduct HOWEVER, the analysis assumes a constant mix of

products are produced and sold.Lecture Illustration 3:Sweet Smell Companyproduces three types of perfume Adore,Beauty and Cutie. These are sold in the ratio of 1:5:4respectively. These products earn a contribution margin per unitof $60, $40 and $20 per bottle respectively.Fixed Costs for the Company total $5,100,000.Required:

Calculate how many units of each product must be sold tobreakeven?


6/15


Multi-Product Scenario (Cont) Budgeted sales ratio => 1:5:4

Calculate the weigh ted average CM:Adore 1/10 * $60 = 6

Beauty 5/10 * $40 = 20Cutie 4/10 * $20 = 8Weighted Ave. CM $34

Calculate the BEP in Bot tlesBEP = $5,100,000 = 150,000 bottles

34

Take the number of bottles and multiply by the respective

ratio for each perfumeAdore = 150000 * 1/10 = 15000Beauty = 150000 * 5/10 = 75000Cutie = 150000 * 4/10 = 60000

150,000

150,000

bottles

Topic 4: Cost Allocation& Activity Based Costing

Prepared by: Dr. Eva Elijido-Ten

Reference: Chapter 4&5 (H, D, F, R & I)


1. Describe the traditional cost allocation (otherwiseknown as functional-based cos ting) approaches.

2. Explain why functional-based costing approaches mayproduce distorted costs.

3. Identify the three overhead figures and learn how todeal with over/under applied overheads.

4. Understand how an activity-based costing systemworks for product/service costing.

4. Describe how activity-based costing can be used toanalyse customers and suppliers.

Topic 4: Objectives


Unit costis the total cost

associated with the units

produced divided by the

number of units produced.

Inventory

valuation

Income

determination

Providing input

to a variety of

decisions such

as

Pricing;

Make or buy;

Accept or

reject special

orders;

Continue or

drop a productline; etc.

Unit cost is used for:

Product costis often defined as

the sum of direct materials, direct

labor, and manufacturing

overhead. This definition is

required for external financial

reporting.


7/15


Cost Terminology: A Review Cost Object:Any item for which costs are separately

measured & assigned (eg., product, department, project oractivity).

Cost Assignment: Tracing accumulated costs to a costobject, orallocating accumulated costs to a cost object.

Cost Tracing: When costs are directly assigned to a costobject (as in Direct Cost)

Cost Allocation: When costs are shared across a number

of cost objects (as in Indirect Cost)

Cost Driver:The factor which causestotal cost to changeover a range of activity


Cost Concept Road Map

Total Costs

Manufacturing

Product Costs/Inventoriable Costs

Non-Manufacturing

Period Costs / Expensed

Materials

Labour

Overhead

Commercial,Distribution

and AdministrationPrime Costs

ConversionCosts

(Direct vs Indirect)(Fixed vs Variable)

(Fixed vs Variable)


Costing Approaches

Actual Cost ing - allocates : Indirect costs based on the actual indirect-cost

rates times the actual activity consumption

Normal Costing allocates: Indirect costs based on the budgeted indirect-cost

rates times the actual activity consumptionBoth methods allocate Direct costs to a cost object thesame way: by us ing actual direct-cost rates timesactual consumption


Measurement System: Indirect Costs

A predetermined

overhead rate is a rate

based on estimated data.

Budgeted (estimated) cost

Estimated activity usage


8/15


Examples of Unit-Level Drivers

Units produced

Direct labor hours

Direct labor dollars

Machine-hours

Direct material dollars

What do you not ice are similar among these drivers?

They are all volume-based meaning ___________________


TeleFirs t, Inc. produces two telephones: acordless and a regular model. The company hasthe following actual and budgeted data:

Budgeted overhead $360,000

Expected activity (DLH) 100,000

Actual activity (DLH) 100,000Actual overhead $380,000

Example 1: TeleFirst, Inc.

Functional-Based Costing: Plantwide Rate


PredeterminedOverhead Rate =


Budgeted (estimated) cost

Estimated activity usagePredeterminedOverhead Rate =

$360,000

100,000 DLHPredeterminedOverhead Rate = $3.60 per DLH


The total overhead assigned

to actual production is

calledapplied overhead.

Applied

overhead =

Overhead ratex

Actual activity

output

= $3.60 x 100,000 DLH= $360,000



9/15


Cordless Regular

Prime costs $ 78,000 $ 738,000Overhead costs:

$3.60 x 10,000 36,000 ---

$3.60 x 90,000 --- 324,000

Total manufacturing costs $114,000 $1,062,000

Units produced 10,000 100,000

Unit cost $ 11.40 $ 10.62

Per-Unit Cost


Dr. Eva Elijido-Ten

Three figures for Overheads

Budgeted overhead => $360,000

Budgeted amount for overhead -use in determination of

predetermined rates

Actual overhead => $380,000

The amount of overhead actually incurred throughout the year

Applied overhead => $360,000

amount of overhead applied to products using predetermined rate($3.60 x 100,000 DLH = $360,000)

NOTE: Lets suppose that actual DLH used is 120,000 =>then applied OH will be: $432,000

$3.60 x 120,000 DLH = $432,000Cont.

34

Dr. Eva Elijido-Ten

Three figures for Overheads (Contd)

Budgeted Actual Applied

$360,000 $380,000 $432,000

35

If overhead is overapplied by $52,000 how would this betreated?

Account Balance % of Total Adjustment

Finished Goods $300,000 20% $10,400

Work in Process $150,000 10% $5,200

COGS $1,050,000 70% $36,400

Total $1,500,000 100% $52,000

This is referred to as pro-rata allocation of over/underapplied overhead.


Budgeted overhead $252,000 $108,000

Departmental DataFabrication Assembly

Expected and actual usage (dlh):

Cordless 7,000 3,000

Regular 13,000 77,000

20,000 80,000Expected and actual usage (mh.):

Cordless 4,000 1,000

Regular 36,000 9,000

40,000 10,000Example 1: TeleFirst, Inc.

Functional-Based Costing: Department Rates


10/15


Applied

overhead =($6.30 x actual mh) + ($1.35 x actual dlh)

= ($6.30 x 40,000) + ($1.35 x 80,000)

= $360,000

= $252,000 + $108,000



Example 1: TeleFirst, Inc.Per-Unit Cost: Departmental Rates

Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs:

($6.30 x 4,000) + ($1.35 x 3,000) 29,250 ---

($6.30 x 36,000) + (1.35 x 77,000) --- 330,750

Total manufacturing costs $107,250 $1,068,750Units produced 10,000 100,000

Unit cost $ 10.73 $ 10.69

Dr. Eva Elijido-Ten

Significant overhead costs allocated using one or two cost

pools Most or all overhead is considered unit-level

Products that consume different amounts of resources

Products that a firm should successfully make and sellconsistently show small profits

Operations staff disagreeing with accounting over

manufacturing and marketing costs

39

Signals that suggest that ABCimplementation could help a firm:


Non-unit activity drivers are

factors that measure the

consumption of non-unit

activities by products and other

cost objects.

Product diversity means that the

products consume overhead activitiesin systematically different proportions.


11/15


Unit-level activitiesare thosethat are performed each time aunit is produced.

Examples:

Power and machine hours areused each time a unit isproduced. Direct materials anddirect labor activities are also

unit-level activities, even thoughthey are not overhead costs.

Classification of Activities

Batch-level activitiesarethose that are performedeach time a batch ofproducts is produced.

Examples:

Setups, inspections,production scheduling,and material handling.


Product-level (sustaining)activitiesare those that areperformed as needed tosupport the various productsproduced by a company.These activities consumeinputs that develop productsor allow products to beproduced and sold.

Examples:Engineering changes, processengineering, and expediting.

Classification of Activities(continued)

Facility-level activitiesare those that sustain afactory's generalmanufacturingprocesses.Examples:

Plant management, landscaping,maintenance, security, property

taxes, and plant depreciation.

Dr. Eva Elijido-Ten

Steps in ABC

1. Define cost object

2. Determine activities

3. Cost those activities

4. Determine the appropriate cost driver

5. Determine the consumption of eachcost driver by the cost objects

6. Allocate the activity costs on that

basis

43 Dr. Eva Elijido-Ten44

Units produced per year 10,000 100,000 110,000

Prime costs $78,000 $738,000 $816,000

Direct labor hours 10,000 90,000 100,000

Machine hours 5,000 45,000 50,000

Production runs 20 10 30

Number of moves 60 30 90


Activity UsageMeasures

Product-Costing Data

Cordless Regular Total


12/15


Activity Activity Cost

Setups $120,000

Material handling 60,000

Machining 100,000

Testing 80,000

Total $360,000

Overhead Activities

Product-Costing Data



Product Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular ActivityActivity Phone Phone Driver

a a

b b

c c

d d

20/30 (cordless) and 10/30 (regular)

60/90 (cordless) and 30/90 (regular)

a


b


Product Diversity: Consumption Ratios

Setups 0.67 0.33 Production runs

Material

handling 0.67 0.33 Number of moves

Machining 0.10 0.90 Machine hours

Testing 0.10 0.90 Direct labor hours

Overhead Cordless Regular Activity

Activity Phone Phone Drivera a

b b

c c

d d

5,000/50,000 (cordless) and 45,000/50,000 (regular)

10,000/100,000 (cordless) and 90,000/100,000 (regular)

c


d


Setup rate: $120,000/30 =$4,000 per runMaterial-handling

rate: $60,000/90 = $666.67 per move

Machining rate: $100,000/50,000 = $2 per MH

Testing rate: $80,000/100,000 = $0.80 per DLH

Activity Rates



13/15


Cordless Regular

Prime costs $ 78,000 $ 738,000

Overhead costs :

Setups ($4,000 * 20; 10) 80,000 40,000

Material handling (666.67 * 60; 30) 40,000 20,000

Machining ($2 * 5,000; 45,000) 10,000 90,000

Testing (0.80 * 10,000; 90,000) 8,000 72,000

Total manufacturing costs $216,000 $ 960,000Units produced 10,000 100,000

Unit cost (total costs/units) $ 21.60 $ 9.60

Activity Rates



Plantwide rate $11.40 $10.62

Departmental rate 10.73 10.69

Activi ty rate 21.60 9.60

Comparison of Unit CostsCordless Regular


Dr. Eva Elijido-Ten

Costs and benefits of alternativeapproaches Plantwide and departmental overhead costing systems

tend to overcost high-volume relatively simple productsand undercost low-volume complex products

ABC systems using multiple cost drivers and overheadrates are more complicated and costly to operate, butproduce more accurate information for decision making

51

Cordless Regular

Plantwide rate $11.40 $10.62

Departmental rate 10.73 10.69Activi ty rate 21.60 9.60


ABC In Service And MerchandisingCompanies

The general approach to ABC in the service andmerchandising areas is very similar to the approach in

manufacturing. Costs are divided into homogeneous cost pools and

classified as output unit-level, batch level, product, orservice-sustaining and facility sustaining costs.

The cost pools correspond to key activities.

Costs are allocated to products or customers using activity

drivers or cost-allocation bases that have a cause-and-effect relationship with the cost in the cost pool.


14/15


Large Customer Ten Smaller Customers

(50% of sales) (50% of sales)Units purchased 500,000 500,000

Orders placed 2 200

Number of sales calls 10 210

Manufacturing cost $3,000,000 $3,000,000

Order-filling costs allocated $202,000 $202,000

Sales-force costs allocated $110,000 $110,000

Example 2: ABC Co.

Customer Costing versus Product Costing

The above allocation of costs may not be reflective of the costs incurred bythe respective customers => better to use ABC


Large Customer Ten Smaller Customers

(50% of sales) (50% of sales)Units purchased 500,000 500,000

Orders placed 2 200

Number of sales calls 10 210

Manufacturing cost $3,000,000 $3,000,000

Order-filling costs allocated $4,000 $400,000

Sales-force costs allocated $10,000 $210,000

Example 2: ABC Co.

Customer Costing versus Product Costing

The above allocation of costs is more reflective of the costs incurred by therespective customers => THEREFORE its better to use ABC


Example 3:ABC Co.

Murray Inc. Plata Associates

Part A 1 Part B2 Part A 1 Part B2Unit purchase price $20 $52 $24 $56

Units purchased 80,000 40,000 10,000 10,000

Failed units 1,600 380 10 10

Late shipments 60 40 0 0

Repair rate = $800,000 2,000 = $400 per failed part

Expediting rate = $200,000 100 = $2,000 per latedelivery

60 + 40

(1,600 + 380 + 10 + 10)

The purchasing manager of ABC Co. uses two suppliers,

Murray Inc. and Plata Associates, as the source of two

machine parts: Part A1 and Part B2.

Repairing products $800,000

Expediting products 200,000

Activities Costs


Example 3: ABC Co.(Continued)

Murray Inc. Plata Associates

Part A 1 Part B2 Part A 1 Part B2

Purchase cost $1,600,000 $2,080,000 $240,000 $560,000

Repairing products 640,000 152,000 4,000 4,000

Expediting products 120,000 80,000

Total costs $2,360,000 $2,312,000 $244,000 $564,000

Units 80,000 40,000 10,000 10,000

Total unit cost $ 29.50 $ 57.80 $ 24.40 $ 56.40


15/15


Lack of clear business purposeLack of senior management

commitmentDelegating the project to consultants

Poor ABC model design

Individual & organizationalresistance to change

Barriers to Implementing ABC


Cost Dimension

Activity-Based Management Model

Resources

(i.e. costs)

Process Dimension

Cost Driver

Analysis

Why?

Performance

Analysis

How well?

Cost Object

(Products &

Customers)

Activities

What?

Objective:Improve Cost

Assignment

Objective:

Cost Reduction

ABM model has twodimensions: a costdimension anda

process dimension.

Dr. Eva Elijido-Ten

Activity-Based Management

A method of management that used ABCas an integral part in critical decision-making situations, including:

Pricing & product-mix decisions

Cost reduction & process improvement decisions

Design decisions

Planning & managing activities

59 Dr. Eva Elijido-Ten 60

THE END

Hbc611 Evatopic3&4 Cvp& ABC Bb

Documents

Transcript of Hbc611 Evatopic3&4 Cvp& ABC Bb