short-term decisions
DESCRIPTION
Short-term decisions. Use of variable costing to make short-term decisions and to assess their effectiveness Cost-Profit-Volume analysis ( pl . Analiza "koszty-rozmiary produkcji-zysk ) CVP assumptions : All costs are divided into variable and fixed depending on the production volume - PowerPoint PPT PresentationTRANSCRIPT
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Short-term decisionsShort-term decisionsShort-term decisionsShort-term decisions
Use of variable costing to make short-term decisions and to assess their effectiveness
Cost-Profit-Volume analysis (pl. Analiza "koszty-rozmiary produkcji-zysk)
CVP assumptions:– All costs are divided into variable and fixed depending on the
production volume
– Operations of the enterprise fit into some level of significance
– Other variables (e.g. efficiency or production methods) do no have an impact on analysis
– Production equals sales
– Enterprise sells one product or the sales structure is fixed
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Variable costing - basis for the CVP analysisVariable costing - basis for the CVP analysisVariable costing - basis for the CVP analysisVariable costing - basis for the CVP analysis
P/L Statement using variable costing
Sales revenue
- Variable costs of goods sold (COGS)
- Variable costs of sales and administration
= Cover margin
- Fixed production costs
- Fixed costs of sales and administration
= Income from sales
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Data for the CVP exampleData for the CVP example (1) (1)Data for the CVP exampleData for the CVP example (1) (1)
Cost type AmountProduction (P)
Sales (S)Management (Z)
Fixed (S)Variable (Z)
MaterialsProduction (35 zł/unit)Office
70 000
2 000
P
Z
Z
S
LabourProduction - within working hours (10 zł/unit)Indirect productionSales commission (5% of salesAdministration and management
20 000
14 000
10 000
15 000
P
P
S
Z
Z
S
Z
S
AmortisationProduction equipmentOffice equipment
6 000
2 000
P
Z
S
S
Foreign services Rent /lease – Manufacturing building Rent /lease – The officeSeasonal maintenance and fixes – production equipment
6 000
4 000
4 000
P
Z
P
S
S
S
Other costsPromotions and marketing Business travel and representation budget
5 000
2 000
S
Z
S
S
TOTAL 160 000
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Data for the CVP example Data for the CVP example (2) (2) Data for the CVP example Data for the CVP example (2) (2)
P/L Statement under Total Costing P/L Statement under Variable Costing
Sales revenue
Cost of goods sold (COGS)
200 000
120 000
Sales revenue
Variable costs
200 000
100 000
Gross margin
Sales costs
Administrative costs
80 000
15 000
25 000
Contribution margin
Fixed costs
100 000
60 000
Income from sales
Unit production cost
Total unit cost
40 000
60
80
Income from sales
Unit variable cost
Unit contribution margin
40 000
50
50
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Sensitivity analysis with unchanged fixed Sensitivity analysis with unchanged fixed costs. Contribution margin ratiocosts. Contribution margin ratioSensitivity analysis with unchanged fixed Sensitivity analysis with unchanged fixed costs. Contribution margin ratiocosts. Contribution margin ratio
Sensitivity analysis– Analysing the impact of changes in variables on the decision
taken
Sensitivity analysis with unchanged fixed costs– Impact of changes in sales volume on income from sales
and the cover margin with unchanged fixed costs
Contribution margin ratio
Example:
Contribution margin ratio Contribution margin x 100%
Sales revenue=
Contribution margin ratio 100 000 x 100%
200 000= = 50 %
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Break-even pointBreak-even pointBreak-even pointBreak-even point
Break-even point (pl. punkt krytyczny) – Amount of sales at which sales revenues equal total operating
costs, that is income from sales equals zero
Calculating break-even point: – The graphic form– The equation method – The unit contribution method
Symbols used to signify variables:K – total costs kz – unit variable costk – unit cost S – sales revenue
Ks – fixed total cost p – price per unit
ks – unit fixed cost V – production volume
Kz – variable total cost Z – income
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Graphical representation of break-even pointGraphical representation of break-even pointGraphical representation of break-even pointGraphical representation of break-even point
Sales revenue
Total costs
Variable costs
Fixed costs
unit
zł
1 2000
60 000
120 000
Break-even pointBreak-even point
Income areIncome are
Loss areaLoss area
Cover margin
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Equation method for calculating break-even Equation method for calculating break-even pointpointEquation method for calculating break-even Equation method for calculating break-even pointpoint
Income from sales = Sales revenue – Total costs
Assumptions:– Income from sales at break-even point = 0 – Sales revenue = price per unit x unknown sales volume Vo
– Total costs = fixed total cost + unit variable cost x unknown sales volume Vo
Equation:
0 = p x Vo – Ks – kz x Vo
p x Vo = Ks + kz x Vo
Z = S - K
S = p x Vo
Z = 0
K = Ks + kz x Vo
Vo = Ks
p - kz
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Unit contribution margin methodUnit contribution margin methodUnit contribution margin methodUnit contribution margin method
Unit cover margin– Share of one sold unit to the total cover margin
Unit cover margin method– How many unit cover margins must we have to cover fixed total
costs?
Quantitative break-even point Fixed costs
Unit contribution margin=
Break-even point (amount) Fixed costs
Contribution margin ratio=
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The margin of safety (M/S)The margin of safety (M/S)The margin of safety (M/S)The margin of safety (M/S)
Safety margin– Defines, by how much can sales go down for the enterprise
to find itself at the break-even point
Quantitative M/S (MBszt.) (estimated) Sales volume= - Sales volume at
break-even point
M/S (amount) (MBzł) (estimated) Sales revenue= - Sales revenue at
break-even point
M/S (amount) x 100%
(estimated) Sales revenue=Percentage M/S (MB%)
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Estimated income from salesEstimated income from salesEstimated income from salesEstimated income from sales
Sales volume at which estimated income from sales, Z, will be achieved:
Vo = Ks + a
p - kz
Vo = Ks + a
JMNP
How many contribution margins we must achieve in order to cover the estimated fixed costs and ensure required income from sales?
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Estimated income from sales after taxEstimated income from sales after taxEstimated income from sales after taxEstimated income from sales after tax
What is the required sales volume in order to achieve the required income from sales after income taxes?
Income from sales after tax
Sales revenue= - Variable
costs -Fixed costs -
Income tax deducted from income from sales
where:
Income tax = income from sales x tax rate r
Sales volume =(Estimated income from sales after tax)/ (1-r) + Ks
JMNP
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Sensitivity analysis with changes in fixed Sensitivity analysis with changes in fixed costs. costs. Sensitivity analysis with changes in fixed Sensitivity analysis with changes in fixed costs. costs.
Cost structure as an element of risk – Question: Is it better to operate on markets with high fixed
costs required or on markets with low fixed costs but relatively high variable costs?
The higher the share of fixed costs in the total cost structure, the greater the operating risk of the enterprise
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ExampleExample – – operating leverageoperating leverage (1) (1)ExampleExample – – operating leverageoperating leverage (1) (1)
Assumption: the structure of variable and fixed costs in changing due to changes in production employees compensation from wages to salaries (2 000 units produced – fixed salary of 20 000 zł).
Up-to-now cost structure
%Changed cost
structure%
Sales revenue
-Variable costs
Contribution margin
-Fixed costs
Income from sales
200 000
100 000
100 000
60 000
40 000
62,5%
37,5%
200 000
80 000
120 000
80 000
40 000
50%
50%
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ExampleExample – – operating leverageoperating leverage(2)(2)ExampleExample – – operating leverageoperating leverage(2)(2)
Assumptions: production and sales will decrease by 10% in relation to an earlier assumption of 2 000 units. Prepare the new P/L Statements?
Up-to-now cost structure
-10%Changed cost
structure-10%
Sales revenue
-Variable costs
Contribution margin
-Fixed costs
Income from sales
200 000
100 000
100 000
60 000
40 000
180 000
90 000
90 000
60 000
30 000
200 000
80 000
120 000
80 000
40 000
180 000
72 000
108 000
80 000
28 000
%-change in income from sales
- 25% - 30%
Result: The change in cost structure resulted in varying changes in income from sales given the same decrease in sales revenue. The company is more sensitive to changes in sales volume.
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Operating leverageOperating leverageOperating leverageOperating leverage
Operating leverage (pl. Dźwignia operacyjna)– Measure of the extent to which fixed costs are being used in an
organization
– The strength of operating leverage is higher in enterprises with greater share of fixed costs in comparison to variable costs – income is then more sensitive to changes in sales revenue
Degree of operating leverage– Measure of strength of operating leverage
– By how much % will the income from sales change, at a given sales volume, if the sales revenue changes by 1%
Degree of operating leverage =Income from sales
Contribution margin
% change in income from sales= % change in sales revenue x SDO
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ExampleExample – – degree of operating leveragedegree of operating leverageExampleExample – – degree of operating leveragedegree of operating leverage
What is the degree of operating leverage in "SIGMA” enterprise in these two different alternatives:
Up-to-now cost structure
Changed cost structure
Contribution margin
Income from sales
100 000
40 000
120 000
40 000
Degree of operating leverage
2,5 3,0
Results: In "SIGMA” enterprise a 10% decrease in sales resulted in a decline of income from sales by 25% and 30%, respectively
Operating leverage is a measure which management to quickly assess the impact of changes in sales volume on income from sales
Impact of operating leverage on income from sales in the highest near the break-even point