Transcript Notes

Accounting for Executives
Week 8
6/5/2010 (Fri)
Lecture 8
Learning Objectives
Explain the concept of marginal (variable) costing and
absorption (full) costing
2. Use CVP analysis to compute breakeven point
3. Use CVP analysis for profit planning and graph relations
4. Use CVP methods to perform sensitivity analysis
1.
Objective 1
Explain the concept of marginal
costing and absorption costing
Marginal Costing (Variable Costing)
 Marginal cost (變動成本) is defined as the cost of one
unit of product or service which would be avoided if that
unit were not produced or provided.
 The marginal costs consist of the variable costs of
production, namely the direct material cost, the direct
labor cost, the variable production overhead and the
variable costs of selling, distribution and administration.
 A marginal costing approach attempts to identify the
cost of producing one extra unit of output and is defined
as the accounting system in which variable costs are
charged to cost units and the fixed costs of the period
are written off in full against the aggregate contribution.
Absorption Costing (Full Costing)
 Absorption costing (全部成本法) is a method of
costing that, in addition to direct costs, assigns all,
or a proportion of, production overheads costs to
cost units by means of one or a number of overhead
absorption rates
 Absorption costing calculates the unit cost of an
item taking into account all costs, fixed and variable,
direct and indirect.
 Indirect or fixed costs are allocated to or absorbed
by the products made
Marginal costing
Example
A product manufactured by ABC CO. with a total cost of
$20 per unit, which has a selling price in the market $30.
Among the total cost 60% is determined to be variable cost.
The company has a budgeted production of 20,000 units in
the current year and the budgeted overheads for the year
are $160,000.
Required
(a) Calculate the Overhead absorption rate for the product.
(b) Calculate the budgeted profit for the company by using
absorption costing.
(c) Calculate the budgeted profit for the company by using
marginal costing.
Marginal Costing
Answer
(a) OH absorption rate: Budgeted OH  Budgeted Units
= $160,000  20,000
= $ 8 per unit
Contribution : Selling price - Variable cost
=$30 - $20 X 60%
=$30 - $12
=$18 per unit
Marginal Costing
Answer (continue)
(b) Profit under Absorption costing
Sales : 20,000 X $30
=$ 600,000 (1)
Cost of Sales: 20,000 X $20 =$ 400,000 (2)
Budgeted Profit (1) - (2)
=$ 200,000
(c ) Profit under Marginal costing
Sales: 20,000 X $30
=$600,000(4)
Cost of Sales: Var. cost $20 X 60% X 20,000 =$240,000(5)
Fixed cost
=$160,000(6)
Budgeted Profit (4)- (5)-(6)
=$200,000
Marginal vs Absorption Costing
Using the above-mentioned example, what will be the profit
for ABC Co. under both costing methods if the actual
sales turn out to be 16,000 units.
Answer
(a) Absorption Costing
Profit under Absorption costing
Sales : 16,000 X $30
=$ 480,000 (1)
Cost of Sales: 16,000 X $20
=$ 320,000 (2)
Adjustment for under absorption =$ 32,000 (3)
Budgeted Profit (1) - (2)- (3)
=$ 128,000
Marginal vs Absorption Costing
(b) Profit under Marginal costing
Sales: 16,000 X $30
Cost of Sales: Var.cost $20X60%X16,000
Fixed cost
Budgeted Profit (4)- (5) -(6)
=$480,000(4)
=$192,000(5)
=$160,000(6)
=$128,000
Comparison between absorption and
marginal costing
 The marginal costing method is based on the
assumption that the process of full allocation of costs as
exemplified in overhead absorption is a waste of time.
 It is argued that the only analysis that is required is that
for variable and fixed cost. This approach is likely to be
easier and less subject to the inaccuracies of the
allocation and apportionment process.
 Proponents of marginal costing argue that full costing is
out of date in competitive markets where price is more
likely to be determined by consumer demand rather than
what the producer believes the product is worth.
Comparison between absorption and
marginal costing
 Marginal costing presents information in a simple way
with analysis mainly restricted to variable costs, with
fixed costs dealt with as an additional, unallocated sum.
 Overhead absorption does involve arbitrary allocation of
costs to a product or service but firms need to ensure
that in the long term all costs are covered if a firm is to
make a profit.
Objective 2
Use CVP analysis to compute
breakeven point
Assumptions
1. Expenses can be classified as either variable
or fixed
2. The only factor that affects costs is change in
volume
CVP = Cost-Volume-Profit
Breakeven Point
 Sales level at which operating income is zero
 Sales above breakeven result in a profit
 Sales below breakeven result in a loss
Income Statement Approach
Contribution Margin Income Statement
Sales
- Variable Costs
Contribution Margin
- Fixed Costs
Operating Income
Contribution Margin Approach
Breakeven units sold =
Fixed costs+ target profit
Contribution margin per unit
Contribution Margin Ratio
Contribution margin ÷ Sales revenue
Breakeven sales dollars =
Fixed costs + Operating profit = 0
Contribution margin ratio
Example 1
Contribution margin ÷ Sales revenue
$187,500 ÷ $312,500 = 60%
Example 2
Aussie Travel
Contribution Margin Income Statement
Three Months Ended March 31, 2009
Sales revenue
$250,000
Variable Costs (40%)
(100,000)
Contribution Margin (60%)
$150,000
Fixed Costs
(170,000)
Operating Income
$(20,000)
$360,000
(144,000)
$216,000
(170,000)
$46,000
Example 2
Breakeven sales dollars =
Fixed costs + Operating income
Contribution margin ratio
$170,000 + $0
.60
$283,333
Example 3
1. Contribution margin = Sales–Variable costs
= $1.70 - $0.85
= $0.85
2. Breakeven units sold =
Fixed costs + Operating income
Contribution margin per unit
($85,000 + $0) / $0.85 = 100,000 units
100,000 units x $1.70 = $170,000
Objective 3
Use CVP analysis for profit planning
and graph relations
Plan Profits
Example: The following information is available for Conte Company
Sale price per unit
Variable costs per unit
Total fixed costs
Target operating income
$30
21
$180,000
$90,000
How many units must be sold to meet the targeted operating income?
Plan Profits
Sales – variable costs – fixed costs = operating income
$30x – $21x - $180,000 = $90,000
$9x = $270,000
x = 30,000 units
Preparing a CVP Chart
Step 1:
 Choose a sales volume
 Plot point for total sales revenue
 Draw sales revenue line from origin
Preparing a CVP Chart
$20,000
Dollars
$15,000
•
$10,000
Revenues
$5,000
$0
0
500
1,000
Volume of Units
1,500
Preparing a CVP Chart
Step 2: Draw the fixed cost line
Preparing a CVP Chart
$20,000
Dollars
$15,000
Revenues
Fixed costs
$10,000
$5,000
$0
0
500
1,000 1,500
Volume of Units
Preparing a CVP Chart
Step 3: Draw the total cost line ( fixed plus variable)
Preparing a CVP Chart
$20,000
Dollars
$15,000
Revenues
Fixed costs
Total cost
$10,000
$5,000
$0
0
500
1,000 1,500
Volume of Units
Preparing a CVP Chart
Step 4: Identify the breakeven point and the areas of
operating income and loss
Preparing a CVP Chart
$20,000
Breakeven point
Dollars
$15,000
Profit
$10,000
$5,000
Loss
$0
0
500
1,000
Volume of Units
1,500
Breakeven point
$70,000
$60,000
Dollars
$50,000
$40,000
Fixed Costs
$30,000
$20,000
$10,000
$0
0
100
200
300 400
500
Volume of Units
600
700
Objective 4
Use CVP methods to perform
sensitivity analysis
Sensitivity Analysis
 “What if” analysis
 What if the sales price changes?
 What if costs change?
Example 4
Sale price per student
Variable costs per student
Total fixed costs
1.
Contribution margin per unit:
$200 – 120 = $80
Breakeven point:
$50,000 ÷ $80 = 625 students
$200
120
$50,000
Example 4
Sale price per student
Variable costs per student
Total fixed costs
2.
Contribution margin per unit:
$180 – 120 = $60
Breakeven point:
$50,000 ÷ $60 = 833 students
$180
120
$50,000
Example 4
Sale price per student
Variable costs per student
Total fixed costs
2.
Contribution margin per unit:
$200 – 110 = $90
Breakeven point:
$50,000 ÷ $90 = 556 students
$200
110
$50,000
Example 4
Sale price per student
Variable costs per student
Total fixed costs
1.
Contribution margin per unit:
$200 – 120 = $80
Breakeven point:
$40,000 ÷ $80 = 500 students
$200
120
$40,000
Margin of Safety
 Excess of expected sales over breakeven sales
 Drop in sales that the company can absorb before
incurring a loss
Example 5
Margin of safety = Expected sales – breakeven sales
Expected sales:
Sales – variable costs – fixed costs = operating income
1x - .70x - $9,000 = $12,000
.30x = $21,000
x = $70,000
Example 5
Margin of safety = Expected sales – breakeven sales
Breakeven sales:
Sales – variable costs – fixed costs = operating income
1x - .70x - $9,000 = $0
.30x = $9,000
x = $30,000
Example 5
Margin of safety in dollars = Expected sales – breakeven sales
= $70,000 - $30,000
= $40,000
Margin of safety in % = (Expected sales – breakeven sales) ÷
Expected sales × 100%