Learning outcome
1.
2.
CHAPTER 7:
MANAGEMENT ACCOUNTING
AND DECISION MAKING
3.
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Decision making in accounting management.
Assumptions and cost-volume-profit analysis /
breakeven / production level for target profit /
sensitivity analysis for uncertainty.
The concept of relevant cost and short term decision
making method.
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7.1 Definition : Management
Accounting
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7.2 Relationship between management
accounting, cost accounting and financial
accounting.
Identify, report and define accounting
information to determine startegy, planning
and control, decision making and resource
optimization.
1.
2.
3.
Use cost and financial data.
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Financial accounting – collecting financial data and
making the financial statement.
Cost accounting – prepare data for management
accounting.
Management accounting need to use data from cost
accounting and financial accounting to maka analysis
to assit management in planning, decision making
and control.
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7.4 Cost-Volume-Profit Analysis
7.3 Decision Making
◼
Decisions that need to be made regarding :
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Product price.
Break even quantity.
Competitive minimum per unit price.
The effect of changes in sales cost and price to the
breakeven point.
The acceptance of special offers (discounts)
Continuation and discontinuation of a product.
To make in-house or buy from external sources.
The choice of multi product mix w ith limited input
resources.
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Determine the relationship between cost, production
volume and profit for different level of production.
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Determine the effect of changes in policy and
strategy.
◼
As a guide to planning and short term decision for
minor changes to level of activities.
◼
Not suitable for long term analysis or major changes
to the level of activities.
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Relationship between cost-volume-profit may be shown
in the breakeven chart
◼
For cases where only volume influence cost and
income (assumption).
◼
Cost may be classified into 2 :
◼ Variable cost
◼ Fixed cost
Breakeven Chart
◼
Sales
Cost
(SR)
Total
cost
Fixed cost does not change with production volume.
Sales at
breakeven
◼
Total variable cost and total sales cost changes with
changes in production volume.
Fixed cost
Breakeven
Point
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Volume (unit)
8
8
4
Breakeven contribution
chart
Profit chart
SR
SR
Sales
Sales
Total
cost
(fixed +
variable)
Loss
Volume
(unit)
Break
ev en
point
Volume
(unit)
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9
Breakeven point (unit)
=
Fixed Cost
(Sale price/unit – variable cost/unit)
= Fixed cost/ contribution per unit
◼
Contribution/sales Ratio
(C/S Ratio )
= Contribution per unit x 100
Sale price per unit
◼
Breakeven point (SR)
= Breakeven point (unit) x unit sale price
= Fixed cost x unit sale price
Contribution per unit
= Fixed cost
C/S ratio
Profit
Variable cost
Break
ev en
point
◼
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Example 7.1: A company produces a product and sells
it at SR 20 per unit. Marginal cost is SR12 per unit and
fixed cost is SR120,000 per year.
◼
Activity level at target profit (unit) = Fixed cost + target profit
Contribution per unit
◼
Safety margin (unit)
◼
% safety margin
◼
= Current sale volume – Breakeven
point (unit)
= (Safety margin/sales) x 100%
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Calculate :
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Number of units for breakeven.
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Sales in SR to breakeven.
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Contribution to sales (C/S) ratio.
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Sales quantity that w ill generate SR40,000 profit per year.
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Sales in SR per year that w ill generate SR40,000 profit.
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If variable cost increases to SR13.00/unit and fixed cost
increases to SR140,000/year. Unit sale price has not
changed, w hat unit of sales is required to achieve target profit
of SR40,000 per year?
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Contribution to sales ratio (C/S).
Num ber of sales to breakeven.
C/S ratio
Breakeven point (unit) = .
Fixed cost
(Sale price/unit – variable cost/unit)
= Fixed cost/ contribution per unit
= SR120,000/ (20-12) SR per unit
= 15,000 unit
Sale units to generate profit of SR40,000 per year
Sales (RM) to breakeven.
Breakeven point (RM)
Activity level at target profit
(unit)
= Breakeven point (unit) x sale price per unit
= 15,000 unit x SR20
= SR300,000
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13
= Contribution per unit x 100
Sale price per unit
= SR8 x 100%
SR20
= 40%
=Fixed cost + target profit
Contribution per unit
= SR120,000 + SR40,000
SR8
= 20,000 units
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Sales (in SR) per year that generates SR40,000 profit.
Sales at target profit
= 20,000 units x SR20
= SR400,000
Breakeven Point Chart
Sales
Cost
(SR)
Variable cost increase to SR13.00/unit and fixed cost
increase to SR140,000/year but price/unit sale is
unchanged. what unit of sales is required to achieve
target profit of SR40,000 per year?
Variable
cost +
fixed
cost
Fixed cost
The number of sales required after these changes :
= SR140,000 + SR40,000
(SR20 – SR13)
= 25,714 units
Breakeven point
◼
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Solving may also be made through the use of
graphs.
Volume (unit)
Semi variable cost need to be divided into fixed and
variable cost.
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Solution 8.2
Example 7.2
SR20 – SR8
= SR12
Total contribution = Fixed cost + Profit
RM12 x current production quantity = SR100,000 + SR500,000
Current production quantity
= SR600,000
SR12
= 50,000 units
(a) Contribution per unit
Acompany has – Variable cost is SR8/unit and sale price is
RM20/unit. Profit is SR500,000/year (after deducting SR100,000
fixed overhead).
Marketing manager is suggesting to reduction in sale price. It is
expected that sales will increase as follows:
Alternatives
1
2
3
Percentage in the
sale price reduction
10%
7.5%
5%
Alternatives
Sale price
=
1
2
SR20 x 90%
SR20 x 92.5%
= SR18
= SR 18.5
Total variable cost (8)
(8)
contribution per unit 10
10.5
Expected production 50,000x130%
5,000x120%
= 65,000
= 60,000
Total contribution
650,000
630,000
Minus fix cost
(100,000)
(100,000)
Net profit
550,000
530,000
Percentage in the
increase in sales
30%
20%
10%
Calculte the profit for each alternative and suggest the alternative
that the company should select.
3
SR20 x 95%
=SR19
(8)
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50,000x110%
= 55,000
605,000
(100,000)
505,000
Alternative 1 should be selected to generate the highest profit.
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7.5 Marginal costing and decision
making (short term)
7.5.1 Decision to accept or reject a
special order
Relevant Costs:
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Only relevant cost should be considered.
Historical costs and sunk costs is not relevant in
this analysis.
Special orders are usually at a lower price than the
normal sales price.
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Need to consider if company can use the extra unused capacity (assume fixed cost does not change).
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Need to identify contribution from the product.
Similar costs in every alternative may be ignored.
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Example:
Sales price of product A is SR0.20 per unit. Total production is 400,000 units
(80% of production capacity). Total production cost to produce 400,000 units
is $56,000 inclusive of fixed cost SR16,000.
A customer offer to a one-off purchase of 100,000 unit at SR0.13 per unit.
Should this offer be accepted?
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Factors to be considered before accepting
special offers:
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There is no other way to use the extra unused
capacity.
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May cause a reduction in market demand.
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Factory capacity may not be enough to increase
production to sell at normal price should the
opportunity arise.
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Is it true that fixed cost will not increase if this offer
is accepted?
Normal production
Variable cost per unit = (SR56,000 – SR16,000)/400,000 = SR0.10 per unit
Marginal Costing:
Sale (400,000 x 0.20)
- variable cost
contribution
- fixed cost
NET PROFIT
Extra income if offer is accepted:
Sale (100,000 x SR0.13)
Variable cost (100,000 x SR0.10)
Contribution
SR
80,000
(40,000)
40,000
(16,000)
24,000
SR13,000
(SR10,000)
SR3,000
Assumes that fixed cost is
assigned to normal
production.
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Example :
7.5.2 The decision to continue or
discontinue a product
Sales
Total cost
Profit (loss)
X
32
36
(4)
Product (SR x 1000)
Y
Z
Total
50
45
127
38
34
108
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Total cost consists of 2/3 variable cost and 1/3 fixed cost
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Should product X be discontinued because it shows loss.
For a company that produces multi products,
decision may have to be made to discontinue
a product that shows loss.
Operation statement based on marginal costing
Product (RM x 1000)
X
Y
Z
Sale
32
50
45
- Variable cost
24
25.333 22.667
Contribution
8
24.667 22.333
- Fixed cost (total accumulated)
Profit (loss)
2/3 x 36
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Total
127
72
55
36
19
1/3 x (36 + 38 + 34)
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If product X is discontinued, total profit is :
Contribution of product X
0
Contribution of product Y
SR24,667
Contribution of product Z
SR22,333
Total contribution
SR47,000
- Fixed cost
SR36,000)
Profit
SR11,000
If make X, Y and Z, profit
= SR19,000
If make Y and Z only, profit
= SR11,000
Profit gain / (reduce) if do not make X
= SR8,000
7.5.3 Decision to make or buy
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For products or component that are made to be sold or
used in the assembly of a product.
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Only need to compare between the price of buying from
a supplier with the variable cost of making the product.
◼
Fixed cost still need to be paid whether the component
is bought from supplier or self-made.
Suggestion : Continue making X.
Factors that need to be considered before accepting this suggestion;
1.
There is no other product that is more profitable than X.
2.
Fixed cost cannot be reduced.
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Example :
◼
A total of 50,000 units of product K is produced and cost data are as
follow s:
Material
Labour
Variable overhead
Fixed overhead
Total cost
SR2.50
SR1.25
SR1.75
SR3.50
SR9.00
External price of component
Cost if self-made
Savings (if self-made)
per unit
per unit
per unit
per unit
per unit
SR7.75 per unit
SR5.50 per unit*
SR2.25 per unit
*Variable cost = SR2.50+SR1.25+SR1.75 = SR5.50
Total loss if buy from supplier :
= 50,000 units x SR2.25 per unit = SR112,000
Product K may be bought from a supplier at the price of SR7.75 per
unit.
Should product K be discontinued and just buy it from the supplier
w hen needed?
It is suggested that the company continue making the component
themselves.
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Only variable cost is relevant because fixed cost still has not
changed.
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