ACCT 102 Management Accounting Lecture 3 4

1. ACCT 102Management AccountingLecture 3 & 4

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3. 3 CVP Assumptions All costs are classified as fixed or variable with unit level activity cost drivers. The total cost function is linear within the relevant range. The total revenue function is linear within the relevant range. The analysis is for a single product, or the sales mix of multiple products is constant. There is only one activity cost driver: unit or dollar sales volume.

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28. 28 Margin of safety is the excess of a company�s actual sales above its BEP point (in units or dollars) It is the amount that sales can drop before it starts to make a loss. It can be expressed as: Units (actual units less break-even units) Dollars (actual sales in dollars less break-even sales in dollars), or Percentage (excess of units/sales dollar over breakeven units/sales dollar as a % of budgeted or actual units/sales dollar).

29. 29 Using data from Benchmark, assume that the sales for Benchmark is projected to be 4000 units. The margin of safety for Benchmark is: in units: 4,000 � 3,000 = 1,000 units in sales $: 32,000 � 24,000 = $8,000 in %: 1000/4,000 = 25% or 8,000/32,000 = 25%

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32. 32 Operating leverage provides information concerning the relationship between a company�s variable and fixed costs. Generally, companies that are highly labor intensive tend to have higher variable costs and lower fixed costs, and thus, low operating leverage. The reverse is also true for capital intensive companies.

33. 33 Characteristics of a highly leveraged company Generally have high contribution margin since their variable costs tend to be lower. However, the higher fixed costs would mean that the BEP would also be high. If selling price is relatively stable, the volume of sales would have high impact on profit/loss. A small increase in sales volume can have a major impact on profit/loss within a given relevant range. It is important to reduce operational leverage during periods of economic distress

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36. 36 Assumptions required: Sales mix is constant Fixed costs is not directly related to a particular product. If fixed costs are directly related to a particular product, then the fixed costs should be regarded as fixed costs of the product and included in the separate analysis related to it => 2 separate CVPs

37. 37 CM may be used to determine the break-even units volume or the units required to achieve a desired profit

38. 38 CM ratio may be used to determine the break-even dollar sales volume or the dollar sales volume required to achieve a desired profit

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41. 41 Major limitation of traditional CVP Exclusive use of unit level activity cost drivers, i.e. does not consider other categories of cost drivers High probability of significant errors in cost estimation and prediction (Refer to Lecture 2 notes) Expansion of CVP to incorporate non-unit activity cost drivers Difficult to develop graphical relationships Good way to begin is to make use of a contribution statement that incorporates a hierarchy of cost drivers

42. 42 Example: General Distribution Sales (Multiple products) $3,000,000 Number of sales orders 3,200 Number of customers 400 Cost hierarchy Unit level activities: COGS $0.80 per sales dollar Order level activities Cost of processing order $20 per order Customer level activities Mail, phone, sales visits� $200 per customer per year Facility level costs Depreciation, insurance� $120,000 per year

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