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Managerial Accounting. Week 5 Notes David B. Hamm, MBA, CPA June, 2002 Revised Nov. 2003 & June 2004. Cost-Volume-Profit Analysis (1).

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managerial accounting

ManagerialAccounting

Week 5 Notes

David B. Hamm, MBA, CPA

June, 2002

Revised Nov. 2003 & June 2004

cost volume profit analysis 1
Cost-Volume-Profit Analysis (1)
  • Because of the unique patterns of fixed and variable costs, we can use these patterns to assist us in forecasting costs and planning optimal production activities.
  • This can be done graphically by plotting FC and VC for various production levels, or can be done with simple algebra
  • Break even costs: S = VC + FC where S=PxQ and VC=Cost x Q
c v p analysis 2
C-V-P Analysis (2)
  • Illustration: Selling price= $10 per unit, VC=$6 per unit, and FC=$100,000. What is break even sales level?
  • Formula 10q = 6q + 100,000
  • Thus: 4q = 100,000 (contribution margin is S – VC or $4 per unit)
  • q = 25,000 units (to break even)
c v p analysis 3
C-V-P Analysis (3)
  • Suppose we desire a $2 profit per unit? Just add to the formula:
    • Sales = VC + FC + Profit, or
    • 10q = 6q + 100,000 + 2q
    • 2q = 100,000
    • q = 50,000 units required sales to make a $2 profit per unit sold
estimating costs high low
Estimating Costs: High-Low
  • Previous data assumed FC and VC were easily obtained, but what if costs are “mixed”—elements of both fixed and variable costs combined?
  • Linear regression—most accurate method to break out costs
  • High-Low: quick method to estimate variable and fixed cost portions
high low illustration 1
High-Low: Illustration (1)

There is a clear relationship between quantity and cost, but it is not yet specified

high low illustration 2
High-Low: Illustration (2)

Thus VC estimated = $30 per unit and VC estimate =$120 K

or Total costs = $30q + $120,000

segment reporting
Segment Reporting
  • Many firms today offer multiple products or are conglomerates of divisions or other entities selling differentiated products or services.
    • Sometimes this is done to capitalize on seasonal activities and seasonal cash flows (offsetting ‘downtime’ of one product with another product’s ‘uptime’)
segment reporting continued
Segment Reporting (continued)
  • Some joint costs (facilities, top management etc.) may be allocable to multiple segments.
  • But—preparing reports that assign only “controllable” costs to each segment will better evaluate each segment’s profitability.
segment reporting example
Segment Reporting Example

Pause for Segment Illustration/ Problem

standard costs brief overview
Standard Costs (brief overview)
  • In the budgeting process, “standard costs” may be assigned to materials, labor, overhead cost components
  • Standard costs are then compared to actual costs, and variances are evaluated, for planning and control purposes
standard costs continued
Standard Costs (continued)
  • Types of variances
    • Price/Rate variances—measure effectiveness of volume purchasing, etc.
    • Quantity/Efficiency variances—measure effectiveness of production, reducing waste, etc.
    • Volume variances (may depend upon orders, etc. and may not be controllable)
    • See Module Note 14 for more detail
standard costs conclusion
Standard Costs (conclusion)
  • Standards can be based upon
    • “Ideal” performance—probably not attainable and failure to achieve may be discouraging
    • “Attainable” performance—a higher, yet achievable goal
    • Past performance—may not be an incentive for improvements
capital budgeting
Capital Budgeting
  • Proposed capital expenditures represent costs to be allocated over multiple accounting periods
  • We should, appropriately, consider the time value of money (present value analysis) when evaluating proposed capital expenditures
capital budgeting continued
Capital Budgeting (continued)
  • Net Present Value analysis (NPV):
    • Requires the following
      • The amount to be invested (current)
      • Expected cash returns over investment’s life
      • An interest rate (cost of capital)
    • Is the present value of future cash flows, discounted by cost of capital, at least equal to the current cost of the investment?
    • If yes, then the investment should be made
capital budgeting continued1
Capital Budgeting (continued)
  • Internal Rate of Return (IRR)
    • Calculate the interest rate at which the present value of future cash flows equals the investment required.
    • This is the investment’s ROI or internal rate of return (IRR)
    • (Difficult to do without a computer)
    • If IRR = or > cost of capital, do the investment. If not, don’t.
using excel npv function
Using Excel =NPV Function:

=NPV function inputs data and interest rate and calculates discount automatically for the given periods. No need to refer to a present value table and make individual years’ calculations.

capital budgeting exercise
Capital Budgeting Exercise

Pause to work capital budget problem in class & review.

solution for npv exercise
Solution for NPV Exercise
  • NPV of savings exceeds current cost, so investment should be undertaken
final project for managerial accounting module
Final Project for Managerial Accounting Module:
  • Develop a Master Budget report for a calendar or fiscal year for a fictional company.
    • May be based on a real firm but must be your creation—no “real” firms allowed
    • May be for profit, not-for-profit, corporation, partnership, proprietorship—your choice!
    • Any industry you choose—manufacturing, service, etc.
final project continued
Final Project (continued)
  • Report should begin with 4-5 page narrative (word processed, double –spaced)
    • Identify your firm, location, industry, owners, no. of employees, etc.
    • Key sources of financing (investors, loans, etc.)
    • SWOT analysis
      • Strengths—what firm does and does well
      • Weaknesses—problem areas, concerns
      • Opportunities—new markets, etc,
      • Threats—competition, regulation, etc.
final project continued1
Final Project (continued):
  • Brief written summary of budget figures and summary paragraph regarding plans for the future
  • Appendix—your spreadsheets of budgets for the next year containing (at least)
    • Sales budget
    • Production budget(s) to support sales
    • Cash Budget
    • Pro-forma Income Statement
  • Your budgets should correspond to your narrative—if you’re a service business, don’t show your budget manufacturing widgets, etc. Numbers should be “realistic”.
final project conclusion
Final Project (conclusion):
  • An “A” paper will also include a capital budget proposal with a Net Present Value analysis included (you may decide to implement or not implement the proposal, but include the analysis)
  • Due date—two weeks from end of module
  • See DBH if you have questions
end of module
END OF MODULE!

You’ve made it to the mountain-top! Enjoy the view!