 Term 1, PGP 2023-25

 Prof. Athira A 1

Accounting for decisions – Term 1 2023

 COURSE OBJECTIVES
Module
I
✔ Module
II
✔ Module
III

Understand the
Understand the terms and Use financial
process by concepts
info to make
which financial underlying
statements are published internal
created financial decisions
statements

Chapter 1
Managerial Accounting ✔ Chapter 2 ✔ Chapter 3 ✔ Chapter 4
Cost-Volume-
in information age Job order costing Cost allocation and
Profit Analysis
Activity-Based
costing 2
Accounting for decisions – Term 1 2023
* Cover only those portions mentioned in the course outline
 CHAPTER 4
COST-VOLUME-PROFIT ANALYSIS
3

Accounting for decisions – Term 1 2023

 LEARNING OBJECTIVES
• Understand how companies identify sales required to break even

• Understand concepts associated with Cost-Volume-Profit analysis

Accounting for decisions – Term 1 2023 4

TOPICS AND PAGES
 Common Cost Behavior Patterns 1-5

 Cost-Volume-Profit Analysis 13-17

Accounting for decisions – Term 1 2023 5

 COST-VOLUME-PROFIT ANALYSIS
 CVP is the analysis of how costs and profits change when volume changes

 It helps to make various business decisions, such as:-

 How much to produce to cover up costs?

 What level of profit should be expected in the coming year?
 How much to sell to get a desired level of profit?
 What is the margin of safety?

 It is important to know fixed v/s variable to do CVP analysis

Decide the costs, volume, and price for a desired profit

Accounting for decisions – Term 1 2023 6

 COMMON COST BEHAVIOR PATTERNS
• Variable costs are costs that change in proportion to changes in volume or activity. If activity increases by
10 percent, variable costs are assumed to increase by 10 percent.

• Fixed costs are costs that do not change in response to changes in activity levels.
• Discretionary fixed costs are those fixed costs that management can easily change in the short run.
Examples include advertising, research and development, and repair and maintenance costs.
• Committed fixed costs, however, are those fixed costs that cannot be easily changed in a relatively
short period of time. Such costs include rent, depreciation of buildings and equipment, and insurance
related to buildings and equipment.

• Mixed costs are costs that contain both a variable cost element and a fixed cost element.
These costs are sometimes referred to as semi-variable costs. For example, a salesperson may be paid
$80,000 per year (fixed amount) plus commissions equal to 1 percent of sales (variable amount).

• Step costs are those costs that are fixed for a range of volume but increase to a higher level
when the upper bound of the range is exceeded. Example:- additional supervisor or an additional machine
to increase the production beyond the relevant range.

Accounting for decisions – Term 1 2023 7

ESTIMATING FIXED AND VARIABLE COSTS
Account analysis

 Managers use professional judgment to classify costs as either fixed or variable.

 E.g.:- Transportation cost, power consumption.

Regression Analysis

 Regression analysis is a statistical technique that uses all the available data points to

estimate the intercept and slope of a cost equation.

 y=c+mx+∈

 y represents the total costs

 c represents the intercept (fixed cost)
 m represents the slope (variable cost)
Accounting for decisions – Term 1 2023 8
 ESTIMATING FIXED AND VARIABLE COSTS
 High-Low method

 This method fits a straight line to the data

points representing the highest and lowest
levels of activity.
 The slope of the line is the estimate of
variable cost, and the intercept is the
estimate of fixed cost.
 Estimate of variable cost =

Cost at highest level of activity − Cost at lowest level of activity

Highest level of activity − Lowest level of activity

, , , ,
= 100/ unit
,
9
TEST YOUR UNDERSTANDING..! (1)
During the past year, Island Air flew 15,000 miles in August (its busiest month) and had total
costs of $300,000. In November (its least busy month), the company flew 5,000 miles and had
$200,000 of costs. Using the high-low method, estimate the total fixed cost per month.

 Estimate of variable cost =

Cost at highest level of activity − Cost at lowest level of activity

Highest level of activity − Lowest level of activity

3,00,000 − 2,00,000
15000 − 5000

VC / unit= 10
Fixed Cost = Total cost – Variable cost
Fixed cost = 2,00,000- (10*5000)
=1,50,000
10
CVP ANALYSIS

CVP analysis helps to find out:-

 Break-even point (BEP)
 Margin of safety (MOS)
 Contribution margin and Contribution margin ratio
 Units to achieve target profit

11
PROFIT EQUATION IN CVP ANALYSIS

where:
x = no. of units sold
SP = sales price per unit
VC = variable cost per unit
TFC = total fixed costs

12
CONTRIBUTION MARGIN
Contribution margin

 Indicates the amount of incremental (marginal) profit* generated by selling an additional unit.
 Contribution margin per unit = SP - VC
 Total contribution margin = 𝐒𝐏 × 𝐱 − 𝐕𝐂 × 𝐱 OR
 Total contribution margin = 𝐓𝐅𝐂 + 𝐏𝐫𝐨𝐟𝐢𝐭

Contribution margin Ratio

 Contribution margin ratio measures the amount of incremental (marginal) profit generated
by an additional rupee of sales.

𝐒𝐏 𝐕𝐂
Contribution margin ratio =
𝐒𝐏

*usually indicates the incremental profit for a firm already under break-even (the profit after covering the 13
variable cost)
EXERCISE 4-13, PAGE 4-32
Exercise 4-13. Rhetorix, Inc., produces stereo speakers. The selling price per pair of speakers is
$1,000. The variable cost of production is $300, the expected sales are 100 units, and the fixed cost
per month is $49,000.

Required

a. Calculate the contribution margin associated with a pair of speakers

b. Calculate the contribution margin ratio for Rhetorix associated with a pair of speakers.
c. In October, the company had sales that were $10,000 higher than planned. What is the expected
marginal effect on profit related to the additional sales?

Answer:
a. 1000-300 = 700
b. 700/1000 = 0.70
c. Profit increases by 10,000*0.70 = 7,000 $

14
BREAK-EVEN POINT
 The breakeven point is the number of units that must be sold for a company to break
even—to neither earn a profit nor incur a loss.

𝐓𝐅𝐂
𝐒𝐏 𝐕𝐂 Contribution margin per unit

X = break-even quantity

 E.g.:- Code Connect sells 2,500 units for $200 per unit. Mary uses account analysis and estimates that
variable production costs will be $81.50 per unit and fixed production costs will be $102,000 per
month. Salaries for sales staff are $ 200,000. There are 2 staff members in the sales team. Each of their
salaries has a fixed component of $ 75,000 and a variable component based on the number of units
they sell.
 How many units must be sold to break even in a given month?

𝐓𝐅𝐂 𝟏𝟎𝟐𝟎𝟎𝟎 𝟏𝟓𝟎𝟎𝟎𝟎

𝐱 = 𝐒𝐏 𝐕𝐂
= 𝟐𝟎𝟎 (𝟖𝟏.𝟓𝟎 𝟐𝟎)
= 2558 units 15
 MARGIN OF SAFETY
 The margin of safety is the difference between the expected level of sales and break-even
sales
 Indicates how close the existing level of sale is to the breakeven level.

Margin of safety = Expected sales - Break-even sales

 Margin of safety ratio

Margin of safety ratio =

 Indicates how much sales would have to drop for the product before the product show a loss

16
 EXERCISE 4-14, PAGE 4-32
 Exercise 4-14. Rhetorix, Inc. produces stereo speakers. The selling price per pair of speakers is $1,000.
The variable cost of production is $300 and the fixed cost per month is $49,000. For November, the
company expects to sell 125 pairs of speakers.

Required

a. Calculate expected profit.

b. Calculate the margin of safety in dollars. (Round any percentage to two decimal places and
round dollar answers to the nearest dollar.)
c. The variable cost is expected to go up by $ 20. If the company does not wish to increase the
selling price, how many units should they sell to maintain the profit of the month as
calculated in (a).

Answer:
a. (1000-300)*125 – 49,000 = 38,500
b. BEP sales = (49,000/700)*1000 =70,000
MOS = expected sales – BEP sales = 1,25,000 – 70,000
c. Target sales (in units) = (38500+49000)/(1000-320) = 128.6 units
17
PROFIT GRAPH AND BREAK-EVEN POINT

18
UNITS NEEDED TO ACHIEVE PROFIT TARGET
 The number of units needed to achieve a specified or target level of profit.

𝐓𝐅𝐂 𝐓𝐚𝐫𝐠𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭

OR
𝐒𝐏 𝐕𝐂

𝐓𝐅𝐂 𝐓𝐚𝐫𝐠𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭

𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭

X = unit sales needed to achieve a specified profit

• Sales in rupees needed to achieve Profit target =

• What-if analysis
• Examines what will happen if fixed/variable/selling price changes.

19
TEST YOUR UNDERSTANDING (2)
Matthews Consulting charges $300 per hour. It has fixed costs of $600,000 per month and
no variable costs. How many hours must the company work to earn a monthly profit
of $900,000?

𝐓𝐅𝐂 𝐓𝐚𝐫𝐠𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭

𝐒𝐏 𝐕𝐂

𝟔,𝟎𝟎,𝟎𝟎𝟎 𝟗,𝟎𝟎,𝟎𝟎𝟎
𝟑𝟎𝟎

X = 5000

20
EXERCISE 4.3, PAGE 4.-29

𝐓𝐅𝐂
𝐁𝐄𝐏 𝐮𝐧𝐢𝐭𝐬 =
𝐒𝐏 − 𝐕𝐂
𝟐𝟎𝟎𝟎𝟎
= = 𝟏𝟎, 𝟎𝟎𝟎
𝟔 𝟒

𝟐𝟎,𝟎𝟎𝟎 𝟏𝟎,𝟎𝟎𝟎
𝐓𝐨 𝐠𝐞𝐭 𝐭𝐚𝐫𝐠𝐞𝐭 𝐩𝐫𝐨𝐟𝐢𝐭𝐬 (𝐮𝐧𝐢𝐭𝐬) = =15000 units
𝟔 𝟒

21
IN-CLASS PROBLEM:- 4.12, PAGE 4-38

22
IN-CLASS PROBLEM:- 4.12, PAGE 4-38
a) Contribution margin per unit = (Sales – Variable cost) = 460

CM ratio = = = 0.3833

The company makes an incremental profit of $460 for each new unit sold or 38.33%
profit for additional $1 in sales

,
b) Breakeven point (units) = = = 653 units
Margin of safety (units) = Expected sales in units – BEP (units) = 1,600 – 653 = 947
units

MoS (dollar) = 947 * 1200 = 11,36,400

, ,
c) Units to sell for $500,000 profit = = = 1,740 units
$ sales for $500,000 profit = 1740*1200 =2088000
23
IN-CLASS PROBLEM:- 4.12, PAGE 4-38
,
d) Additional units sold = = = 250 units
,

New VC = $740 × 1,600 + 250 = $1,369,000

New profit = 2,220,000 − 1,369,000 − 375,000 = $476,000
New profit > current profit ($436,000)  advertising seems worth doing

24
ILLUSTRATIONS
• In-class problem:- Problem 4.12 page 4-38; Exercise 4.3; Exercise 4-13, page 4-32,
Exercise 4-14, page 4-32; additional question, test your understanding -1 and 2
• Additional questions:- Review problem 1

25
A QUICK SUMMARY
 Profit equation in CVP analysis

 BEP sales and units

 MOS
 Contribution margin and ratio
 Target sales

Accounting for decisions – Term 1 2023 26

 COURSE OBJECTIVES
Module
I
✔ Module
II
✔ Module
III
✔

Understand the Understand the Use financial

process by which terms and concepts
info to make
financial underlying
statements are published financial internal
created statements decisions

27
Accounting for decisions – Term 1 2023
* Cover only those portions mentioned in the course outline
 END TERM EXAMINATION
Syllabus for end-term
Financial Accounting
Chapter 6: Only de-recognition of PPE (all except exchanging assets)
Chapter 7: Trade Receivables
Chapter 9:Operating Liabilities
Chapter 11: Equity
Chapter 12: Balance sheet and statement of profit and loss
Chapter 13: Statement of Cash Flows
Managerial Accounting
Chapter 1: Managerial Accounting in Information Age
Chapter 2: Job order costing
Chapter 3: Cost allocation and Activity-Based costing
Chapter 4: Cost-Volume-Profit Analysis 28
 TOPICS COVERED – IN DETAIL
Chapters Chapter name Topic Pages
Derecognition of PPE (all except exchanging
Chapter 6 241-243
Long-lived Assets assets)
Trade receivables 275
Chapter 7 Trade Receivables
Credit Losses 275-279
Liabilities in perspective 347
Operating Liabilities and Financial Liabilities 347-348
Operating
Chapter 9 Current Liabilities 348
Liabilities
Definite Liabilities and Estimated Liabilities
348-350
(exclude Goods and services tax payable)
The Corporate organization 402-403
Accounting for Share Capital 404-406
Chapter 11 Equity Buyback of shares 413
Bonus shares 415-416
Earnings per share (basic EPS only) 420-421
29
 TOPICS COVERED – IN DETAIL
Chapters Chapter name Topic Pages
Objectives of financial statement analysis 444

Profitability analysis 450-455

Balance sheet and
Chapter 12 statement of profit Liquidity analysis 455-458
and loss
Solvency Analysis (exclude operating leverage) 458-461

Capital Market Ratios (only PE Ratio) 461-464

Statement of Cash Flows in Perspective 483

Purpose and Structure of the Statement of Cash
Statement of Cash 483-488
Chapter 13 Flows
flows
Computing Net Cash Flow from Operating
491-493
Activities (only indirect method)

30
 TOPICS COVERED – IN DETAIL
Chapters Chapter name Topic Pages
Goal of Managerial Accounting 2-5
Managerial
Managerial Accounting 5-6
Chapter 1 Accounting in
Cost Terms 7-10
information age
Two Key Ideas 10-12
Cost Classifications 2-5
Flow of Product Costs 7-8
Income Statement Presentation 8-9
Chapter 2 Job order costing
Types of Costing Systems 10
Overview of Job Costs 10-12
Job-order Costing System 10-22
Purpose of Cost Allocation 1-4
Cost allocation
Process of Cost Allocation 5-9
Chapter 3 and Activity-Based
Problems with Cost Allocation 9-13
costing
Activity-based Costing 13-21
Cost-Volume- Common Cost Behavior Patterns 1-5
Chapter 4
Profit Analysis Cost-Volume-Profit Analysis 13-17
31
 Limitations of accounting..?
• Accounting fails to account for the
• Human resources (employees)
• Honesty
• Hard work
• Trust
• Collegiality

• While looking back to your life, do not forget to account for:-

• Friends, family
• Honesty Assets
• Love
• Trust

• Toxicity
• Envy Liabilities
• Ego
“Life's balance sheet is measured not by possessions, but by the quality of moments lived and shared”

All the very best..! 32

 THANK YOU…!

Accounting for decisions – Term 1 2023 33