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chapter 4

chapter 4. COST-VOLUME-PROFIT ANALYSIS. Cost Behaviour. Cost Driver an activity which influences how a cost is incurred kilometers traveled is a cost driver for gasoline costs Number of hours spent in a bar would be a cost driver for total costs of drinks. $. Variable Cost

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chapter 4

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  1. chapter 4 COST-VOLUME-PROFIT ANALYSIS

  2. Cost Behaviour Cost Driver • an activity which influences how a cost is incurred • kilometers traveled is a cost driver for gasoline costs • Number of hours spent in a bar would be a cost driver for total costs of drinks $ • Variable Cost • a cost which changes in direct proportion to changes in the cost driver • is constant per unit as volume changes • Fixed Cost • a cost which is not influenced by changes in the cost driver over the relevant range • per unit fixed costs change as volume changes Volume $ Volume

  3. Cost-Volume-Profit Analysis • The study of the relationships between revenues, costs, volume and profits Contribution Margin per unit Contribution Margin % (or CM per unit) (or CM%) = Revenue per unit = CM per unit / revenue per unit - variable cost per unit Break-Even Point in Units Break-Even Point in Dollars = Fixed costs / CM per unit = Fixed costs / CM%

  4. EXAMPLE #1 You make and sell cell phones. You plan to sell to your cell phones at $100 each this year. Your product costs include: Direct Materials per cell phone $20 Direct Labour per cell phone $10 Variable Factory Overhead per cell phone $30 Fixed Factory Overhead (Total) $20,000 Variable Selling expenses is a commission of $10 per cell phone; fixed selling & administrative expense totals $25,000. What is your break-even point in units and in dollars?

  5. Example (continued) First, we have to find the Variable costs (VC) and Fixed Costs (FC) VC = 20 + 10 + 30 + 10 = $70 per unit FC = 20,000 + 25,000 = $45,000

  6. Example (continued) Next we have to find the Contribution margin per unit. Contribution margin per unit = Revenue per unit – VC per unit = 100 – 70 = 30

  7. Example (continued) Now we can calculate Break-Even point in units Break-Even point in units = Fixed costs/CM per unit = 45,000/30 = 1,500 units

  8. Example (continued) Now, to find break-even point in dollars: Contribution margin % = CM per unit/revenue per unit = 30/100 = 30% Break-even point in dollars = Fixed costs/CM % = 45,000/30% = $150,000

  9. Example (continued) Just as a simple check: Break-even point in dollars = Break-even point in unit * revenue per unit $150,000= 1,500 * 100

  10. Cost-Volume-Profit Graph $ Break-even Point Sales Total Expenses Net income area Net loss area Volume

  11. Target Net Income Target Sales in Units = (Fixed costs + Target income) / CM per unit Target Sales in Dollars = (Fixed costs + Target income)/ CM%

  12. Example (continued) Using the information in the example above, suppose you set your target net income at $90,000, what are the sales you need to reach in units and in dollars?

  13. Example (continued) Target Sales in unit = (Fixed costs + Target income)/CM per unit = ( 45,000 + 90,000) /30 = 135,000/30 = 4,500

  14. Example (continued) Target Sales in dollars = (Fixed costs + Target income)/CM% = 135,000 / 30% =$450,000

  15. Sales Mix Analysis • Sales mix is defined as the relative proportions or combinations of quantities of different products that comprise total sales • If the proportions of the mix change, the cost-volume-profit relationships also change • A breakeven point is unique to a given sales mix

  16. EXAMPLE #2 Suppose you have 2 products: PS3; Selling price $200 and variable cost is $80 Xbox; Selling price $500 and variable cost is $310. Total Fixed costs are $120,000. Your sales mix is 7 PS3’s and 4 Xbox’s. Calculate break-even point in units and in dollars.

  17. Example #2 (continued) Unit VC Unit Contribution Margin Sales Mix Contribution Margin Product Price PS3 $200 $80 (200-80) =$120 7 (7*120) =$840 4 (4*190) =760 Xbox 500 310 (500-310) =190 Total (840+780) =$1600

  18. Example #2 (continued) Break-even point in units = Fixed costs/Contribution Margin = 120,000 /1600 = 75 75*7 = 525 PS3’s 75*4 = 300 Xbox’s

  19. Example #2 (continued) Break-even point in dollars: 525 PS3’s *$200 = $105,000 300 Xbox’s *$500 = $150,000

  20. Margin of Safety Simply put, the units sold or revenue earned above the break-even volume. So, if the break-even point is 500 units and you are currently selling 1000 units, margin of safety is 500. Or, if the break-even point in dollar value is $5,000 and your revenue is $10,000, your margin of safety is $5,000.

  21. Degree of Operating Leverage Degree of operating leverage = Contribution margin/ operating income Note: Use TOTAL contribution margin not CM per unit

  22. Percentage change in operating income Percentage change in operating income = DOL * % change in sales

  23. chapter 5 JOB-ORDER COSTING

  24. Product Costing Process Costing Common in chemical, textiles, lumber, glass, food processing Accumulate costs by departments Produce for inventory Allocate costs to large number of nearly identical units Job Order Common in construction, print shops, unique goods Accumulate costs for specific jobs Produce for sale Allocate costs to products that are readily identifiable

  25. Job-Costing Cost Flows • Apply material, labour and overhead costs to work in process • As goods are produced, costs flow to finished goods inventory • When sold, costs shift to cost of goods sold Direct Material Inventory Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Use Material Buy Material Production Sales Labour Costs Overhead Control Account Over / under applied overhead (at year end) Overhead Costs

  26. Accounting for Factory Overhead Overhead Application (Overhead Absorption) • Allocation of overhead costs to products Budgeted Factory Overhead Rate • Calculated at the beginning of the year and used to apply overhead to products throughout the year Six Steps in Applying Overhead 1. Select a cost driver for overhead [usually labour] 2. Prepare a budget for yearly overhead costs and yearly volume of the cost driver 3. Calculate the budgeted factory overhead rate as Overhead rate = budgeted total overhead / budgeted cost driver 4. Obtain data on the actual units of cost driver 5. Apply overhead rate to products 6. At year end, account for difference between actual overhead costs and applied overhead costs

  27. Over / Under Application of Overhead • Overapplied: Applied > Actual • Underapplied: Applied < Actual • Dispose of over/under applied overhead at year end to Cost of Goods Sold • When underapplied, add to cost of goods sold • When overapplied, subtract from cost of goods sold

  28. EXAMPLE #3 At the beginning of October, you have 2 jobs in process and the following information is given to you. During the month of October, one more job is started, Job Awesome. The following direct materials and direct labour costs relate to the month of October: At the end of October, Jobs Good and Not bad were completed. Only Job Not bad was sold. On October 1, the balance in Finished Goods was zero. Prepare a brief job-order cost sheet for the 3 jobs. Determine ending balances in work in process and Finished goods. Calculate the cost of goods sold for October 31.

  29. Example #3 (Continued) Usually, to find the predetermined overhead rate, you would use estimated overhead and estimated direct labour cost. However, these are not given here. But you can use the applied overhead in the beginning of October for Jobs Good and Not Bad. Applied Overhead = Predetermined overhead rate * Actual Activity Level $6,000 = Predetermined overhead rate *$3,000 Predetermined overhead rate = $6,000 /$3,000 = 2 or 200% of direct labour costs

  30. Example #3 (Continued) Calculation of applied overhead: Job Good: 1,400 * 2 = $2,800 Job Not Bad: 1,800*2 = $3,600 Job Awesome: 1,500*2 = $3,000

  31. Example #3 (Continued) Job Good and Not bad are transferred out of work in process. (why?) So, the ending balance in work in process consists of only job 12. ($8,600) Both jobs are transferred to finished goods. But the only one remaining is Job Good. (Ending Balance is $15,200) As Job Not Bad was the only one sold, the cost of goods sold is $24,400.

  32. chapter 7 ACTIVITY BASED COSTING & MANAGEMENT

  33. Key Points to understand • What is ABC costing? • Difference between the ABC system of costing and the traditional way of costing.

  34. ABC Hierachy • Unit Level-costs varies with output and volume(variable costs) • Batch Level – Varies with the number of batches produced • Product Sustaining – Varies with the # of product lines • Facility sustaining – necessary to operate the plant facility

  35. ABC costing • Costs of overhead • Activities that take place to produce the goods • Objects where costs are assigned

  36. Steps in ABC Costing Step 1 Determine key activity centers, related cost drivers per activity and resources consumed per activity Step 2 Develop a process-based map identifying the interrelationships between key activities and resources consumed Step 3 Collect operational cost data traceable to each activity and the physical flow of cost-driver units . The traceable cost are divided by the sum of physical flows units to determine the cost per driver unit. Step 4 Calculate and interpret the new ABC information

  37. How to approach a question on ABC • Key points • First identify the different activities • Determine the Consumption rates using the formula : Amount of driver used for Product Total Driver Quantity • Determine the Activity Rates • Then calculate your costs

  38. Example #4 • Its not that Hard Inc. produces circuit boards for RIM. BlackB, BlackP and BlackT are produced with the following activity measures: Calculate the Total cost assigned to each circuit board using the Activity-Based Costing approach.

  39. First identify the different activities • Machine Setup • Machining • Assembly • Determine the Consumption Rates

  40. Consumption Rates a) Equipment Setup Total set up hours = 10 + 30 + 10 = 50 BlackB Set up hours for BlackB/Total Set up Hours 10/50=0.2

  41. Determine activity rates • Activity rates are obtained by dividing the activity cost by the total driver quantity. Set up Equipment Rate = 3600/6 = $600.

  42. Calculate the ABC costs per unit BlackB – Total Unit Cost = (0.5*600) + (0.2*78) +(0.2*45) = $324,60

  43. CHAPTER 9 PROFIT PLANNING

  44. Budgeting: The Overall Plan Management develops plans to achieve their goals: • What type of product to produce • What level of cost and quality • What level of price • What degree of advertising Budget • Formal quantitative expression of management's plans • What things are expected to look like for the upcoming period • Allows for systematic rather than chaotic reaction to change

  45. Master budgeting Process

  46. Tips • There are a lot of numbers in a budgeting question so make sure you keep up with numbers

  47. Types of Budgets • Operational budgets • Sales Budget • Production Budget • Direct Materials Purchases Budget • Direct Labour Budget • Overhead Budget • Selling and Distribution budget • Ending finished Goods Inventory Budget • Cost of Goods Sold budget • Cash Budget • Budgeted Balance Sheet

  48. Example #5(Operational Budgets) • Dom Sports produces institutional hockey sticks and table tennis tables. Projected Sales for the next quarter and beginning and ending inventory are as follows.

  49. 1 stick requires 1 shaft, 2 screws and 1 blade while 1 table requires 2 wooden tops and 3 metal legs and 16 screws. 1 shaft costs $13, screws cost $26/box of 5000,table tops cost $60 each and metal legs cost $36 each, blades cost $5 each. Stocks of raw materials is as follows.

  50. Assembly for tables requires 3 hours of direct labour for a batch of 10 tables while assembly for hockey sticks requires 8 hours for 1200 sticks. Packaging requires 1 labour hour for 1200 sticks while 2 hours is required for a batch of 10 tables. 1 labour hours costs - $15 • Prepare the following for the quarter: - Sales Budget for the Quarter - Production Budget - Direct Materials Budget - Direct Labour Budget

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