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1. Managerial Accounting- Key Syllabus Areas 23/04/2024 Prof Dr Indra Devi

2. Managerial Accounting & Overview of Key Syllabus 23/04/2024 Prof Dr Indra Devi

3. Cost Concepts and Cost Classifications 23/04/2024 Prof Dr Indra Devi

4. LEARNING OUTCOMES By the end of this topic, you should be able to: 1. Define cost and how costs are assigned to products and services; 2. Classify cost; 3. Prepare cost estimation methods; and 4. Prepare costs of manufacturing products and the various costs behaviour. 23/04/2024 Prof Dr Indra Devi

5. Introduction: Costing terms and Concepts Terms Explanation Costs accumulation identifying, measuring and recording cost information Costs assignment assigning costs to cost objects.   Cost classification arrangement of costs items into logical groups. Costs Expenditure incurred for producing goods or services Cost object Any item or activity that separate measurement of costs can be traced 23/04/2024 Prof Dr Indra Devi

6. Costs classification 23/04/2024 Prof Dr Indra Devi

7. Cost for Stock Valuation and Profit Determination Product costs- manufacturing costs Period costs- Non- Manufacturing costs Prime costs Production overhead Administration expense Selling and distribution expense Direct material Direct labour Direct expenses Indirect material Indirect labour Indirect expenses Costs for stock valuation and profit determination 23/04/2024 Prof Dr Indra Devi

8. Product costing: Manufacturing Costs Manufacturing costs are often combined as follows: Prime Cost Conversion Cost Direct Material Direct Labor Manufacturing Overhead 23/04/2024 Prof Dr Indra Devi

9. Elements of Manufacturing Costs Cost elements RM Direct materials X Direct labour X Prime costs X Manufacturing overhead X Total manufacturing costs/ Full costs XX 23/04/2024 Prof Dr Indra Devi

10. Example 1 Prime Furniture Sdn Bhd specialises in living room leather furniture products. During the month of March, the company purchased RM105,000 of raw materials. Direct labour hours worked during the period was 4,000 hours. The workers were paid RM10 per hour. Direct expenses (high performance glue etc ) of RM11,000 was incurred. Manufacturing overhead for the month was RM36,000. Each set of leather sofa was sold for RM5,500. Prime Furniture also incurred selling costs including sales commission of RM125,000 and administration costs of RM18,000. Stock information for the period is as follows:   1 March 2017 31 March 2017 Raw material stock RM12,000 RM25,000 Work in process stock RM25,000 RM12,000 Finished Goods stock RM5,500 RM13,000 23/04/2024 Prof Dr Indra Devi

11. Required: Determine the cost of raw materials consumed in production and the prime costs. Calculate the cost of goods sold manufactured for the month of March. Calculate the cost of one set of leather sofa, assuming 75 were completed during March. Prepare a cost of goods sold statement for the month of March. Determine the number of units sold in the month of March Prepare an income statement for the month of March. 23/04/2024 Prof Dr Indra Devi

12. Schedule of Cost of Goods Manufactured Illustration 1   Solution RM RM Raw materials stock at 1 March 201X   12,000   Raw materials purchased   105,000       117,000   Less Raw materials stock at 31 March 20X1   25,000   Cost of raw materials consumed (a)   92,000 Direct labour     40,000 Direct expenses     11,000 Prime costs (a)   143,000 Manufacturing overhead     36,000       179,000 Work in process stock at 1 March 201X   25,000   Less Work in process stock at 31 March 201X   12,000 13,000 Cost of goods manufactured for March (b)   192,000 Unit cost of one set (c )   192,000/75= RM2,560 Prime Furniture Bhd Costs of raw materials consumed and costs of goods manufactured statement 23/04/2024 Prof Dr Indra Devi

13. Prime Furniture Bhd Costs of goods sold statement Schedule of Cost of Goods Sold Statement Illustration 2   Solution RM RM Finished goods stock at 1 March 201X   5,500   Cost of goods manufactured for March   192,000       197,500   Finished goods stock at 31 March 201X   13,000   Cost of goods sold (d)   184,500 Number of units sold (e)   184,500/2,560=72 units 23/04/2024 Prof Dr Indra Devi

14. Income Statement Example 2.2   Solution RM RM Sales Revenue (72 x RM5,500)     396,000 Cost of goods sold     184,500 Gross margin     211,500 Less:       Selling expenses   125,000   Administration expenses   18,000 143,000 Net Margin (f)   68,500 23/04/2024 Prof Dr Indra Devi

15. Costs for Decision Making Cost for decision making –Cost Behaviour Fixed costs Semi-variable costs Unit fixed costs Total fixed costs Variable costs Unit variable costs expenses Total variable costs Fixed element Variable element 23/04/2024 Prof Dr Indra Devi

16. Fixed Costs Units produced Fixed costs per unit RM 30,000 1 30,000 10 3,000 100 30 1000 3 23/04/2024 Prof Dr Indra Devi

17. Variable costs Total Variable Cost RM25,000 RM50,000 RM75,000 ÷ Units Produced 5,000 10,000 15,000 Variable Cost per Unit RM5.00 RM5.00 RM5.00 23/04/2024 Prof Dr Indra Devi

18. Semi variable costs Semi-variable costs have properties of both variable and fixed elements attached to the total costs For semi-variable costs, the distinction between the fixed and variable costs element is important for decision-making purposes. Cost estimation methods such as high-low method, scatter diagram and regression analysis are used to separate the fixed and variable elements in semi-variable costs. The high/low method   is a ‘method of estimating cost behaviour by comparing the total cost associated with two different level of outputs. The difference in costs is assumed to be caused by the variable costs increasing, allowing unit variable costs to be calculated. Following from this, since total costs is known, the fixed costs can be derived” (CIMA Official Terminology).   High/low method is a ‘method of estimating cost behaviour by comparing the total cost associated with two different level of outputs. 23/04/2024 Prof Dr Indra Devi

19. Example 1 The total cost of maintenance at Zack Sdn Bhd consists of both fixed and variable costs. The following information relates to the last four months: Hours worked Total cost RM Month 1 9,300 115,000 Month 2 9,200 113,600 Month 3 9,400 116,000 Month 4 9,600 116,800 Required: Using the high- low method, estimate the total cost for Zack if 10,000 hours were worked in Month 5. 23/04/2024 Prof Dr Indra Devi

20. Solution Step 1 From the previous four months costs, the following two periods are selected: The period with the highest volume (hours) of activity and its corresponding costs; and The period with the lowest level of activity and its corresponding costs Step 2 The difference between the two costs at the two levels of activities will be the variable costs. Step 3 Thus, the variable costs per unit may be calculated by dividing the difference in total costs by the difference in activity levels. Subsequently the fixed costs can be determined by substituting the variable costs per unit into the formula, Total Costs (TC)= Fixed Cost (FC) + (Variable Cost (VC) per unit x Volume), where total costs must correspond to either the high level or the low level of activity.   23/04/2024 Prof Dr Indra Devi

21. Solution In the example above this will be: Hours worked RM Highest activity 9,600 116,800 Lowest activity 9,200 113,600 400 3,200  VC per unit = RM3200/400 = RM8 TC= FC + (VC per unit x Volume) RM116,800= FC + (RM8 x 9600) FC = RM116,800-RM76,800 = RM40,000.   Therefore, if 10,000 hours were worked, then the total cost for Month 5 will be: TC= RM40,000 + RM8 x 10,000 = RM120,000   23/04/2024 Prof Dr Indra Devi

22. Costs for Planning and Control Controllable costs- Within the control of managers Uncontrollable costs- Beyond the control of managers Planning and control costs 23/04/2024 Prof Dr Indra Devi

23. Managerial Accounting- Topic 3 Activity Based costing versus Traditional Overhead costing 23/04/2024 Prof Dr Indra Devi

24. LEARNING OUTCOMES By the end of this topic, you should be able to: Assign overheads to the various cost pool Calculate the cost driver rates Compare the traditional approach of costing for products and services, with the ABC approach Explain the limitations of ABC 23/04/2024 Prof Dr Indra Devi

25. Traditional Methods Overheads Absorption According to CIMA, absorption of overheads cost is ‘the allotment of overheads to cost units.’ It is also called recovery charge or application of overheads. Absorption of overheads may be done on the following basis: (a) Data from previous or historical, (b) Anticipated volume or unit produced, and (c) Normal volume of output or capacity. The base rate at which the overhead cost is allocated to the product is known as the overheads rate. The rate may be historical or predetermined. 23/04/2024 Prof Dr Indra Devi

26. Methods of Absorption Units Produced Overheads are absorbed into cost units by sharing out overhead costs of a production department for the period amongst the products or cost units actually produced in the period. The most common method used is to divide the estimated production overheads by the number of units expected to be produced in the period . This method is known as unit method or output method. 23/04/2024 Prof Dr Indra Devi

27. Example 5.5 ABC Bhd estimates to produce 40,000 units of Product X and the standard production overheads for the next month is estimated to be RM80,000. What is the overheads absorption rate based on the standard number of units to be produced? Overheads absorption rate (OAR ) = RM80,000 40,000 units = RM2 per unit Each unit of Product X produced absorbed RM2 of overheads. In order to use this method, the product must be identical or similar. Methods of Absorption (cont.) 23/04/2024 Prof Dr Indra Devi

28. Methods of Absorption (cont.) Time Basis Most overheads do not depend on the number of units produced. They are more dependent on the time that is worked in a particular department to produce the units. The two main measures of time in a production department are labour hours and machine hours. 23/04/2024 Prof Dr Indra Devi

29. Methods of Absorption (cont.) Example 5.6 Labour hours basis ABC Bhd produces Product X, which incurs expected overheads of RM80,000 per annum . The estimated number of labour hours worked in the department is 80,000 . What is the overheads absorption rate per labour hour? Overheads absorption rate (OAR) = RM80,000 80,000 hrs = RM1 per labour hour 23/04/2024 Prof Dr Indra Devi

30. Methods of Absorption (cont.) If the company takes 2 hours to produce Product X, what will be the amount of overheads charged to Product X? Production Overhead for each Product X = 2 hours × RM1 per hour = RM2 per unit Machine hours basis The machine hour base is used when the production uses more machine hours or automated production compared to labour in producing the products. 23/04/2024 Prof Dr Indra Devi

31. Further Methods of Overheads Absorption Blanket Overheads Absorption In the blanket overheads absorption, it does not require any allocation and apportionment of overhead to cost centres . The total production overheads of the organization are absorbed on a single absorption basis. This method is used only if the company produces a single product. 23/04/2024 Prof Dr Indra Devi

32. Further Methods of Overheads Absorption (cont.) Departmental Overheads Absorption Departmental overheads absorption is where the total production overheads for each department is determined using allocation and apportionment of overheads. For each department, overheads are absorbed into the products based on the most suitable or appropriate basis. For example, a labour intensive department will use labour hours as the basis of absorption and a capital intensive department will use machine hours as a basis of absorption. 23/04/2024 Prof Dr Indra Devi

33. ABC is a costing method whereby overhead costs are assigned to activities, instead of assigning them to products and services. This will enable such costs to be traced back to the activities that drive the costs. ABC is based on the concept that products consume activities. Activity-Based Costing (ABC) 23/04/2024 Prof Dr Indra Devi

34. Activity-Based Costing (ABC) (cont.) The Basics of the ABC System Recognizing a few classification of major activities and pooling their costs. Cost pools are the groups of overhead costs of various categories in which the costs can be associated with the activities. For example, inspection costs, machining costs and setting-up costs. 23/04/2024 Prof Dr Indra Devi

35. Establishing the cost drivers. Cost driver or activity driver is the unit of an activity that causes the change of an activity cost. A cost driver is any activity that causes a cost to be incurred. A cost driver rate is the rate of overheads expressed in terms of units of activities that will be charged to the products and services. Cost driver rate is a predetermined rate for each cost pool that must be calculated as follows: Cost driver rate = Activity-Based Costing (ABC) (cont.) Cost pool Basis of activity driver 23/04/2024 Prof Dr Indra Devi

36. Application of costs to products and services. Once the cost driver rate is calculated, it is multiplied by the consumption rate of the cost driver. The total derived as in (4) above will then be divided by the volume of products or services, in order to get the overhead rate per unit for the particular cost driver. Activity-Based Costing (ABC) (cont.) 23/04/2024 Prof Dr Indra Devi

37. Activity Based Costing Activity Based Costing is 'an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities, and activities to cost objects based on consumption estimates. The latter utilise cost drivers to attach activity costs to outputs'. CIMA Official Terminology Activities occur at four levels: Unit level activities are performed each time a unit of product is produced. They are consumed in direct proportion to the number of units produce Eg energy costs, direct labour and direct material expenses Batch related activities are performed each time a batch is produced. The cost of batch related activities varies with the number of batches made, but is common (or fixed) for all the units within the batch. Product sustaining activities are performed to support different products in the product line. They are performed to enable different products to be produced and sold, but the resources consumed are independent of how many units or batches are being produced. Facility sustaining activities. Some costs cannot be related to a particular product line, instead they are related to maintaining buildings and the facilities. 23/04/2024 Prof Dr Indra Devi

38. ABC Steps Identify the organisation’s major activities Estimate the cost associated with each activity/determine the cost pool Identify the factors that affect each activity-cost drivers Determine the total amount of each factor /cost driver associated with each activity Calculate the cost driver rate Charge the overheads to products by applying the cost driver rates to the activity usage of the products 23/04/2024 Prof Dr Indra Devi

39. The following example helps us in understanding how ABC works. Example 5.10 The budgeted manufacturing overhead costs of B-Best Factory for the year 2014 are as follows: Designing Activity-Based Costing (cont.) 23/04/2024 Prof Dr Indra Devi

40. In the last 5 years, the business used the basis of direct labour hours to charge overheads. In the year 2013, the budgeted direct labour hours are 100,000 and the budgeted production of product M is 10,000 units. Required : (a) Calculate the appropriate absorption rates using traditional and ABC methods. (b) What is the product cost per unit if direct materials cost is RM50 per unit and direct labour is 2 hours per unit at RM15 per unit , under traditional and ABC methods? Designing Activity-Based Costing (cont.) 23/04/2024 Prof Dr Indra Devi

41. Designing Activity-Based Costing (cont.) 23/04/2024 Prof Dr Indra Devi

42. Designing Activity-Based Costing (cont.) 23/04/2024 Prof Dr Indra Devi

43. Designing Activity-Based Costing (cont.) Note: The illustration shows that the more the product uses the activities, the more it will be charged as the product consumes more of the activities and resources associated with the activities. Therefore, products which consume more should bear more of the activity costs. 23/04/2024 Prof Dr Indra Devi

44. Comparison of Traditional and ABC Product Costs Table 5.3 Comparison of Traditional (Absorption) Costing and ABC 23/04/2024 Prof Dr Indra Devi

45. The advantages of ABC are as follows: Pricing and decision-making are improved as product costs are calculated more accurately, resulting in improved pricing and decision-making in general. As the cost pools are identified, management will have better control over the items charged and might be able to reduce costs. ABC provides better incentive to link activities with cost behaviour . Advantages of ABC 23/04/2024 Prof Dr Indra Devi

46. Management will have a better understanding towards costs that are not driven by volume only. Budgets are better prepared as the management has a clearer view on various activities in detail. Activities that do not add value are identified which assists in cost control. Advantages of ABC (cont.) 23/04/2024 Prof Dr Indra Devi

47. Firstly, the division of overhead items is subjective and difficult since only a few categories of the cost pools are generally created by the decision-makers. Secondly, there is a tendency that the segregation and assigned overheads to the various cost pools might not be accurate as objective portions of an overhead item may not be certain. For example, the total rental of the factory may not be fairly allocated on the cost driver basis to various processes or activities, as measuring the usage of the rental might be judgemental. Limitations of ABC 23/04/2024 Prof Dr Indra Devi

48. It might be costly for companies which have adopted the traditional costing system, to invest and change their routine to an ABC system. This means recalculating using different procedures and retraining the staff with new knowledge. Limitations of ABC (cont.) 23/04/2024 Prof Dr Indra Devi

49. Usefulness of ABC The ABC method has several advantages given as follows: (a) Highlights those products, services, divisions as well as activities that are not performing and are leading to losses. (b) Facilitates using more of the inputs for products and divisions that are producing higher profits. (c) Exercises controls over the costs. (d) Facilitates fairer pricing of products and services, on a per unit basis. 23/04/2024 Prof Dr Indra Devi

50. Activity-based management is an organized method for planning and controlling. With the aim of managing the labour and overhead cost better, ABM employs the principle that it is the activities that drive the costs and therefore incur costs. On the other hand, the traditional cost systems put emphasis on the labour force and on the work done by the labour force. The foundation for ABM is found to be ‘ activity accounting ’ which provides reports for activities and the associated information in detail and in a proper template. Activity-Based Management (ABM) 23/04/2024 Prof Dr Indra Devi

51. Activity based management ( ABM) Activity Based Management is a ‘System of management which uses activity based cost information for a variety of purposes including cost reduction, cost modelling and customer profitability analysis.’ CIMA Official Terminology Activity-based management (ABM) is a method of identifying and evaluating activities that a business performs using activity-based costing to carry out a value chain analysis or a re-engineering initiative to improve strategic and operational decisions in an organization. Activity-based costing establishes relationships between overhead costs and activities so that overhead costs can be more precisely allocated to products, services, or customer segments. Activity-based management focuses on managing activities to reduce costs and improve customer value. 23/04/2024 Prof Dr Indra Devi

52. It shows resources, in a defined amount, as consumed by the value-add activity. ABM is a technique whereby activities are assessed to see if they use activity-based costing approach in order to allocate overheads. This is necessary so that strategies and operations are enhanced. As can be seen earlier, ABC relates costs with the activities that drive those costs so that the higher the usage of the activity, the higher the costs charged to the consuming products. Activity-Based Management (ABM) (cont.) 23/04/2024 Prof Dr Indra Devi

53. ABM takes it one step further by studying the activities that will reduce total costs yet increase value to the consumers. One flaw with ABM is that there will be several activities that would have its value embedded but does not carry monetary elements attached to the products. This means that the polite customer relations advisor cannot be seen as strengthening the value of product. Activity-Based Management (ABM) (cont.) 23/04/2024 Prof Dr Indra Devi

54. ABM ABM have five basic information outputs: The cost of activities and business processes. Since activities form the very core of what a business does, the basic output of the ABM system must be to provide relevant cost information about what a business does. (2) The cost of non value added activities. Identification of these wasteful activities is invaluable to management as it provides a crucial focal point for management. Activity based performance measures. Knowing the total cost of an activity is insufficient to measure activity performance. Activity measures of quality, cycle time, productivity and customer service may also be required to judge performance. Accurate product/service cost. Products and services are provided to markets and customers through various distribution channels or contractual relationships. Cost drivers. The final output from the ABM system is cost driver information. With this information it is possible to understand and manage these activity levels. 23/04/2024 Prof Dr Indra Devi

55. Activity-based budgeting is a structured method for the planning and budgeting the resources of an organization. ABB is basically activity accounting but set in a reverse approach. This means that ABB starts at the bottom, and hence at the bottom of the template or spreadsheet. Activity-Based Budgeting (ABB) 23/04/2024 Prof Dr Indra Devi

56. ABB attempts to name the activity, describe the components of the activity, divide the activity into first and second level, list the users of the activity, and determine the activity output measurement. For example, in a college, the lecturing activity accounts for the activities of educating students, providing consultancy hours, setting exam papers, marking papers and evaluating students ’ performance. Activity-Based Budgeting (ABB) (cont.) 23/04/2024 Prof Dr Indra Devi

57. Managerial Accounting-Absorption Costing versus Marginal costing 23/04/2024 Prof Dr Indra Devi

58. 23/04/2024 Prof Dr Indra Devi

59. AC PRODUCT COSTS/INVENTORY PRIME COST + Fixed Production overhead =AC Prime cost = variable production cost =MC 23/04/2024 Prof Dr Indra Devi

60. Learning Outcomes Explain the principles of variable costing system and absorption costing system Explain the differences between variable costing system and absorption costing system Prepare income statements using the variable costing and absorption costing systems Calculate and explain the treatment of over/under absorbed production overheads Explain the difference in profits between variable and absorption costing profit calculations Reconcile the profits between variable costing and absorption costing Explain the arguments for and against variable and absorption costing 23/04/2024 Prof Dr Indra Devi

61. Absorption Costing Absorption costing is used to determine the full production cost per unit. Total cost = prime cost + production overheads + non-production costs Production overheads are absorbed into cost units using suitable bases. OAR = budgeted overheads base Fixed overheads are treated as product cost. Fixed overheads are absorbed into the opening and closing inventories. 23/04/2024 Prof Dr Indra Devi

62. Over/under Absorbed Overheads Difference between the absorbed overheads and the actual overheads incurred Over-absorbed overheads: absorbed overheads are higher than actual overheads incurred Under-absorbed overheads: actual overheads incurred are higher than the overheads absorbed 23/04/2024 Prof Dr Indra Devi

63. Treatment of Over/under Absorbed Overheads Over-absorbed: Cost charged higher Deduct from cost of production Add to profit Under-absorbed: Cost charged lower Add to cost of production Deduct from profit 23/04/2024 Prof Dr Indra Devi

64. Marginal Costing (Variable Costing) Alternative method of costing, where only variable costs are charged to the cost units Fixed production overheads are treated as period costs and deducted in the period incurred 23/04/2024 Prof Dr Indra Devi

65. Contribution and Profit Contribution is an important measure in variable costing. Contribution = sales less than variable costs Profit = contribution less than fixed costs 23/04/2024 Prof Dr Indra Devi

66. AC and VC: Impact on Profit Production equals to sales Profits will be the same Production exceeds sales AC system will show a higher profit than VC system Sales exceeds production VC system will show a higher profit than AC system 23/04/2024 Prof Dr Indra Devi

67. Difference in Profit between AC and VC Explained by the movement of fixed production overheads in the inventory levels Production fixed overheads: inventoried in AC  treated as product cost Production fixed overheads: expensed off in total in VC  treated as period costs 23/04/2024 Prof Dr Indra Devi

68. Arguments in Favour of Absorption Costing Fixed costs are a part of the total cost of production. Matching (accruals) concept is followed Consistent with the requirements of IAS 2 Possible to ascertain whether the product is profitable or not Reporting of high losses during off-season and high profits during peak season can be avoided 23/04/2024 Prof Dr Indra Devi

69. Arguments against AC Apportionment and absorption of overheads is arbitrary May encourage over production as reported income can be increased by increasing inventory levels If closing inventories are unsold: closing stocks with the absorbed fixed overheads from a previous period may have to be written off in a later accounting period Resulting in the current reported income to be overstated 23/04/2024 Prof Dr Indra Devi

70. Arguments in Favour of VC Simple system with no arbitrary apportionment and absorption of fixed overheads Fixed costs are charged against the revenues of the period in which they are incurred Appropriate to charge only the variable costs as they are directly attributable to the production units No need for managers to over produce More relevant information for short-term decision-making 23/04/2024 Prof Dr Indra Devi

71. Arguments against VC Information provided may be inadequate for product cost and product profitability Direct labour cost may not be variable if employees are paid fixed wages or salary Inappropriate to treat all fixed production overhead costs as fixed period costs 23/04/2024 Prof Dr Indra Devi

72. Key Points AC need to check for under/over absorbed overheads MC no under/over absorbed overheads as FOH are not absorbed into the products Difference in profit: due to FOH absorbed into the inventory with closing inventory: AC profit is higher compared to MC profit with opening inventory: MC profit is higher compared to AC profit 23/04/2024 Prof Dr Indra Devi

73. Managerial Accounting-Decision Making Cost-Volume-Profit Analysis 23/04/2024 Prof Dr Indra Devi

74. LEARNING OUTCOMES By the end of this topic, you should be able to: 1. Explain the assumptions and derivation of Cost-Volume-Profit (CVP); 2. Apply and account for changes in CVP variables and calculate its impacts; and 3. Apply multiple-product CVP and extension to the CVP. 23/04/2024 Prof Dr Indra Devi

75. CVP analysis CVP analysis is a tool used for planning and decision making. Emphasises the interrelationships between total revenues, total costs and operating income in response to changes in the volume of sales, the selling price, variable cost, and/or fixed costs of production. CVP analysis uses the contribution margin concept. Contribution  margin is defined as revenues minus variable expenses. C ontribution  margin contributes to recovery of fixed costs and any balance toward profits. 23/04/2024 Prof Dr Indra Devi

76. Contribution Margin Concept Contribution Margin (CM) CM = Total Sales − Total Variable Costs In order to make profit the contribution margin of a business must exceed its total fixed costs. Unit Contribution Margin (Unit CM) Unit CM = Selling price – Variable cost per unit Contribution Margin Ratio (CM Ratio) CM Ratio = Contribution Sales 23/04/2024 Prof Dr Indra Devi

77. Underlying Assumptions of CVP Analysis Sales price per unit is constant. Variable costs per unit are constant. Total fixed costs are constant. Everything produced is sold. Costs are only affected because activity changes. If a company sells more than one product, they are sold in the same mix. 23/04/2024 Prof Dr Indra Devi

78. The Break-Even Point (BEP) Break-even analysis, is a subset of  cost - volume - profit  ( CVP ) analysis.   The break-even point is defined as the point: When Zero profit are earned, or When Total Sales = Total Variable costs plus Fixed costs or When Total Contribution = Total Fixed costs Illustration: Sales RM350,000 Less: Variable costs 200,000 Contribution margin 150,000 Less: Fixed costs 150,000 Net Income RM 0___ Contribution =Fixed costs Total sales= total variable cost + fixed costs Zero profit 23/04/2024 Prof Dr Indra Devi

79. Determining BEP –Single Product Firm Three methods: Equation approach Contribution formula approach Graphical approach Illustration: A company has RM120,000 in fixed costs and variable cost per unit is RM150 and selling price is RM300 per unit. Determine the break even point 23/04/2024 Prof Dr Indra Devi

80. Equation Approach: NI= Px -( a+bx ) Sales revenue – Variable expenses – Fixed expenses = Profit Unit selling price Sales volume in units × Unit variable expense Sales volume in units × (RM300 × X) (RM150 × X) – – RM120,000 = $0 (RM150 X) – RM120,000 = $0 X = 800 units to break even 23/04/2024 Prof Dr Indra Devi

81. Contribution-Margin Approach Consider the following information from Ramsey Sdn Bhd : Total RM Per Unit RM Percent % Sales (1,200 silver frames) 360, 000 300 100 Less: Variable cost 180,000 150 50 Contribution margin 180,000 150 50 Less: Fixed Cost 120,000 Net income 60,000 23/04/2024 Prof Dr Indra Devi

82. Contribution-Margin Approach Fixed expenses Unit contribution margin = Break-even point (in units) = RM120,000 RM150 = 800 silver frames 23/04/2024 Prof Dr Indra Devi

83. Contribution Margin (CM) Ratio Calculate the break-even point in sales Ringgit rather than units by using the contribution margin ratio. Contribution margin Sales = CM Ratio Fixed expense CM Ratio Break-even point (in sales RM) = RM120,000 RM150/RM300 = RM120,000 = RM240,000 RM150/RM300 23/04/2024 Prof Dr Indra Devi

84. Target Net Profit We can determine the number of silver frames that Ramsey Bhd must sell to earn a profit of RM150,000 using the contribution margin approach . Fixed expenses + Target profit Unit contribution margin = Units sold to earn the target profit = RM120,000 + RM150,000 = 1,800 silver frames RM150 23/04/2024 Prof Dr Indra Devi

85. Margin of Safety Margin of safety is a measure of risk. The difference between budgeted sales revenue and break-even sales revenue. It is that amount by which sales can drop before losses begin to be incurred. 23/04/2024 Prof Dr Indra Devi

86. Multi-product breakeven analysis Formulae Break even point = Fixed costs Weighted average unit contribution Break even revenue = Fixed costs Weighted average C/S ratio 23/04/2024 Prof Dr Indra Devi

87. SENSITIVITY ANALYSIS AND UNCERTAINTY   Sensitivity analysis  shows how the CVP model will change with changes in any of its variables (e.g., changes in fixed costs, variable costs, sales price, or sales mix). The focus is typically on how changes in any of the variables will affect profit. Sensitivity analysis may be able to provide answers to the following questions: How will profit change if the sales price increases by RM15 per unit or by 10 percent? How will profit change if sales volume decreases by 100 units or by 10 percent? How will profit change if fixed costs decrease by RM10,000 (30 percent) and variable cost increases to RM18 per unit (10 percent)? 23/04/2024 Prof Dr Indra Devi

88. Summary of Formulas for Single Product CVP analysis Break even point = Contribution/Sales ratio = Break even revenue = or Break even point  selling price/unit Margin of safety = Budgeted sales – Break even sales Margin of safety (%) = Output required for target profit = 23/04/2024 Prof Dr Indra Devi

89. Practice Question A company has fixed costs of RM11,400 and variable costs per unit of RM13. Required (a) If the selling price is RM16/unit at all levels, what is the break even point (in units)? (b) What is the break even in RM? (c) What is the C/S ratio? (d) If budgeted sales are 6,000 units, what is the margin of safety in units? What is the margin of safety as a %? What does this mean? (e) What is the sales volume (in units) required to make a profit of RM15,000? 23/04/2024 Prof Dr Indra Devi

90. Solution Contribution= RM16= RM13= RM3 BEP=3800units BEP (RM) =3800 x RM16= RM60,800 C/S ratio= 3/16= 0.1875 Margin of safety = 6,000- 3800= 2,200 units Margin of safety (%)= 2200 x 100 = 37% 6600 Target sales= 11,400 +15,000 = 8,800 units 3 23/04/2024 Prof Dr Indra Devi

91. Short Term Decision making 23/04/2024 Prof Dr Indra Devi

92. LEARNING OUTCOMES By the end of this topic, you should be able to: 1. Interpret information and the decision process; 2. Apply relevant cost in making decisions; 3. Apply the contribution approach & discuss its benefits; and 4. Apply short-term decision-making tools and make short-term decision making. 23/04/2024 Prof Dr Indra Devi

93. Relevant Costs and Irrelevant Costs Relevant costs Irrelevant costs Variable costs Opportunity costs Incremental costs Replacement costs Sunk costs General fixed overhead Non-cash items such depreciation and notional costs Costs for decision making 23/04/2024 Prof Dr Indra Devi

94. Qualitative and Quantitative Relevant Information Quantitative factors are factors with measurement in numeric terms and this may encompass not only financial information, for example, the cost of direct materials but also non-financial information, such as, percentage of down time in a manufacturing entity. Qualitative factors are also non-financial factors but measurement of these outcomes is more difficult and challenging as it involves ambiguity and perceptions, such as, customer satisfaction and loyalty, employee work satisfaction and morale, as well as, brand acceptance. 23/04/2024 Prof Dr Indra Devi

95. The contribution approach is used for various short term production decisions. Some of these decisions include: Adding or dropping a product line. Making or buying a component part. Accepting or rejecting a special order. Optimal Product mix plan where constraints exists Contribution Approach And Short Term Decisions 23/04/2024 Prof Dr Indra Devi

96. Acceptance of a Short-Term Special Order Special order selling price will be usually be lower than the normal selling price. So long as the special order selling price is more than the variable cost or relevant cost, the order should be accepted on financial grounds. Refer to Example 6.1 in the module to understand the financial implications of a special order. 23/04/2024 Prof Dr Indra Devi

97. Acceptance of Special order Example Company X (small) Produce markers Production capacity =100,000units Sales demand =80,000 units [spare capacity=20,000] Market price = $12 Variable cost of production = $8 Company AB (large) Produce markers Markers = Production capacity =200,000 Sales demand = 220,000 Special order for 20,000 units @$10 to Company X 23/04/2024 Prof Dr Indra Devi

98. Special order price= $10 Variable cost = $8 Contribution $2 Total contribution = $2 x 20,000= $40,000 Spare capacity available Contribution is positive. Therefore accept the special order. 23/04/2024 Prof Dr Indra Devi

99. Make-Buy Decisions If the total variable cost of making the component internally is greater that than the cost of buying, then it is obviously more economical to buy it from an outside supplier. However, If the company has a scarce resource, than the opportunity cost of using the scarce resource must be added to the variable cost of making the component. This decision concept is explained clearly with supportive figures in Example 6.2 of your course module. 23/04/2024 Prof Dr Indra Devi

100. Make or buy decision Example Components. Rule 1= Spare capacity is available Outside supplier’s Price $15 Variable cost of making $10 Savings if Make $5 Decision= Make 23/04/2024 Prof Dr Indra Devi

101. Rule 2= No spare capacity Outside supplier’s price CX $15 Variable cost of making $10 +Opportunity costs (W1)-2 lab hours x$5 ) $10 Relevant cost $20 Extra cost to make ($5) Decision= Buy component CX from Outside supplier Additional information Product A Contribution per unit = $20 4 labour hours Contribution per limiting factor= $20/4= $5 per hour 23/04/2024 Prof Dr Indra Devi

102. Product Mix Decisions with Capacity Constraints If there is a limiting factor then the rule is to maximise the contribution per limiting factor. Contribution per limiting factor is the contribution per unit of each product divided by the amount of the limiting factor used by each product. Based on the contribution per limiting factor the products are ranked in the order of profitability. The scarce resource is then allocated to the products in the order of the priorities. 23/04/2024 Prof Dr Indra Devi

103. Limiting factor decisions Example Product A B C Selling Price $15 $25 $18 Variable costs $10 $12 $8 Step 1: Calculate contribution per unit 5 13 10 Step 2: Identify the limiting factor & amount used Machine hours 2 4 4 Step 3: Calculate contribution per limiting factor 5/2 13/4 10/5 =$2.5 per MH $3.25 per MH $2 per MH Step4: Rank in order of profitability 2 1 3 23/04/2024 Prof Dr Indra Devi

104. Additional information Sales demand; A=3000 units B= 2000 units C= 5000 units Maximum machine hours available is 30,000 Hours Product B= 2000 units x4 (8,000) Balance hours 22,000 hours Product A= 3000 x 2 = (6,000) Balance 16,000 hours Therefore Product C= 16,000/ 4= 4000 units 23/04/2024 Prof Dr Indra Devi

105. Summary of Topic 1 In the first part of the video, we discussed: Cost concepts and terms Cost classification according to the three key objectives of managerial accounting. Elements of Manufacturing cost Cost profit analysis Break-even point Contribution margin, margin of safety and sensitivity analysis Short term decision making areas such as acceptance of special order, make or buy decisions and selecting the optimal production plan. Thank you 23/04/2024 Prof Dr Indra Devi