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Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides.

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Presentation on theme: "Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides."— Presentation transcript:

1 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 1 Chapter 17 Cost volume profit analysis

2 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 2 Cost volume profit (CVP) analysis A technique used to determine the effects of changes in an organisations sales volume on its costs, revenue and profit Can be used in profit-seeking and not-for profit organisations

3 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 3 The break-even point The volume of sales where the total revenues and expenses are equal, and the operation breaks even Can be calculated for an entire organisation or individual projects or activities

4 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 4 Formulas

5 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 5 Terminology Contribution margin (or variable costing) statement ÙA reporting format where costs are reported by cost behaviour and a contribution margin is calculated Total contribution margin ÙThe difference between the sales revenue and the variable costs ÙThe amount available to cover fixed costs and then contribute to profits continued

6 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 6 Terminology Unit contribution margin ÙThe difference between the sales price per unit and variable cost per unit Contribution margin ratio ÙThe unit contribution margin divided by the unit sales price ÙThe proportion of each sales dollar available to cover fixed costs and earn a profit continued

7 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 7 Terminology Contribution margin percentage ÙThe unit contribution margin ratio multiplied by 100 ÙThe percentage of each sales dollar available to cover fixed costs and earn a profit

8 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 8 Cost volume profit (CVP) graph Shows how costs, revenue and profits change as sales volume changes Five steps ÙDraw the fixed expense line ÙDraw the total expense line ÙDraw the total revenue line ÙBreak-even pointwhere the total revenue and total expense lines intersect

9 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 9

10 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 10 Profit volume (PV) graph Shows the total amount of profit or loss at different sales volumes The graph intercept the vertical axis at the amount equal to the fixed costs The break-even point is the point at which the line crosses the horizontal axis

11 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 11

12 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 12 Target net profit A desired profit level determined by management Can be used within the break-even formula

13 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 13 CVP analysis and management decision making Common applications include ÙSafety margin ÙChanges in fixed expenses ÙChanges in the unit contribution margin ÙMultiple changes in key variables

14 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 14 Safety margin Difference between the budgeted sales revenue and the break-even sales revenue Gives a feel for how close projected operations are to the break-even point

15 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 15 Changes in fixed expenses When estimates of fixed costs are revised, the break-even point will change ÙPercentage change in fixed expenses will lead to similar increase in the break-even point (in units or dollars) Different fixed costs may apply to different levels of sales/production volume ÙMore than one break-even point

16 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 16 Changes in the unit contribution margin Change in unit variable expenses ÙChanges the unit contribution margin ÙA new break-even point ÙAn increase in unit variable expenses will increase the break-even point continued

17 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 17 Changes in the unit contribution margin Change in sales price ÙChanges the unit contribution margin ÙA new break-even point ÙAn increase in unit price will lower the break- even point

18 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 18 Multiple changes in key variables May involve ÙIncreasing unit prices ÙUndertaking an advertising campaign ÙHiring a new storage facility An incremental approach ÙFocuses on the difference in the total contribution margin, fixed expenses and profits under the two alternatives

19 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 19 CVP analysis with multiple products Sales mix ÙThe relative proportions of each type of product sold by the organisation Weighted average unit contribution margin ÙThe average of the products unit contribution margins, weighted by the sales mix

20 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 20 Including income taxes

21 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 21 Assumptions underlying CVP analysis The behaviour of total revenue is linear The behaviour of total costs is linear over a relevant range ÙCosts can be categorised as fixed, variable or semivariable ÙLabour productivity, production technology and market conditions do not change ÙThere are no capacity changes during the period under consideration continued

22 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 22 Assumptions underlying CVP analysis For both variable and fixed costs, sales volume is the only cost driver The sales mix remains constant over the relevant range In manufacturing firms, levels of inventory at the beginning and end of the period are the same

23 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 23 CVP analysis and long- term decisions CVP analysis is usually regarded a short- term or tactical decision tool Classification of costs as variable or fixed is usually based on cost behaviour over the short-term The financial impact of long-term decisions best analysed using capital budgeting techniques

24 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 24 Treating CVP analysis with caution CVP analysis is merely a simplified model The usefulness of CVP analysis may be greater in less complex smaller firms, or stand-alone projects For larger firms, CVP analysis can be valuable as a decision tool for the planning stages of new projects and ventures

25 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 25 An activity-based approach to CVP analysis ABC categorises activities as facility, product, batch or unit costs ÙFacility, product and batch activities are non- volume activity costs

26 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 26 Limiting assumption of using activity-based costs Batch costs are based on likely production levels New planned production levels lead to changes in the number of production batches, and changes in total non-volume activity costs -> new break-even or target profit volume

27 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 27 Sensitivity analysis and CVP analysis Sensitivity analysis ÙAn approach which examines how an outcome may change due to variations in the predicted data or underlying assumptions Can be run using spreadsheet software, such as Excel continued

28 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 28 continued

29 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 29 Sensitivity analysis and CVP analysis Goal seeking approaches ÙAllows the analyst to specify the outcome, so that software can specify the necessary inputs What-if analysis ÙThe analyst specifies changes in assumptions to examine the effect of these changes on the output

30 Copyright 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton Slides prepared by Kim Langfield-Smith 30


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