6 chpt 7&8

Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 6th Edition, © Pearson Education Limited 2008

Slide 7.1

Chapter 7 Cost–volume–profit analysis

LEARNING OUTCOMES

You should be able to

prepare a break-even chart and deduce the break-even point for some activity;

distinguish between fixed costs and variable costs and use this distinction to explain the relationship

between costs, volume and profit;

demonstrate the way in which marginal analysis can be used when making short-term decisions.

discuss the weaknesses of break-even analysis;


Slide 7.2

The behaviour of costs

Those that stay fixed (the same) when changes occur

to the volume of activity

Those that vary according to the volume of activity

Costs may be broadly classified as follows:

Fixed

Variable


Slide 7.3

Graph of fixed cost(s) against the volume of activity

Cost (£)

Volume of activity (units of output)

F

0


Slide 7.4

Graph of rent cost against the volume of activity

Rent cost (£)

Volume of activity (units of output)

R

0


Slide 7.5

Cost (£)

Volume of activity (units of output)0

Graph of variable costs against the volume of activity


Slide 7.6

Graph of electricity cost against the volume of activity

Electricity cost (£)


The slope of this line gives the variable cost

per unit of activity

Fixed cost

element


Slide 7.7

Cost (£)


F

Total costs

Fixed costs

Variable costs

Graph of total cost against the volume of activity


Slide 7.8

Break-even chart

Cost (£)


F

Total costs

Fixed costs

Variable costs

Break-even point

Total sales revenue

Profit

Loss


Slide 7.9

Calculating the break-even point

Fixed costsSales revenue per unit – Variable costs per unit

b =


Slide 7.10

Break-even and load factors in the airline industry

Load factor

Break-even

%

60

40

20

80

0easyJet

63

83

Ryanair BA

100

76

85

6473

%


Slide 7.11

Break-even chart for Cottage Industries’ basket- making activities without the machine

Fixed costs

Cost (£000)

Volume of activity (number of baskets)

0

1

5

4

3

2

Totalrevenue

100 400300200 500

Totalcosts

Break-evenpoint

Profit

Loss


Slide 7.12

Break-even chart for Cottage Industries’ basket-making activities with the machine

Cost (£000)

1

Fixed costs

5

4

3

2

Volume of activity (number of baskets)

0100 400300200 500

6 Totalcosts

Break-evenpoint

Totalrevenue

Loss

Profit

600


Slide 7.13

BA’s margin of safety and operating profit, 2003 to 2007

6.0

7.0

5.0

4.0

3.0

1.0

2.0

8.0

0

Mar

gin

of

saf

ety

(as

a p

erc

enta

ge

of

bre

ak-e

ven

po

int)

9.0

10.0

11.0

1,000

1,100

600

700

500

400

300

100

200

800

0

900

Op

erating

pro

fit (£ millio

n)

Margin of safety

Operating profit

2003 2004 20062005 2007

4.2

295

6.3

405

8.4

540

10.1

694

8.3

602


Slide 7.14

The effect of operating gearing

Volume of output

Profit


Slide 7.15

Profit–volume chart

Profit (£)

Volume of activity(units of output)0

Loss

Profit

Break-even point

Loss (£)

Fixed costs


Slide 7.16

Weaknesses of break-even analysis

Three general problems

Non-linearrelationships

Stepped fixed costs

Multi-product businesses


Slide 7.17

Marginal analysis

The most efficient use of scarce resources

Make-or-buy decisions

Accepting/rejecting special contracts

Closing or continuation decisions

Can be used for the following short-term decisions:


Slide 7.18

Chapter 8 Full costing

LEARNING OUTCOMES

You should be able to

deduce the full cost of a unit of output in both a single-product and a multi-product environment

using the traditional full cost method;

discuss the usefulness of deducing the full cost of a unit of output for decision-making purposes;

explain the role and nature of activity-based costing.

discuss the problem of charging full costs to jobs in a multi-product environment;


Slide 7.19

Uses of full costs by managers

Uses of full costs

Pricing and output

decisions

Exercising control

Assessing relative

efficiency

Assessing performance


Slide 7.20

Direct and indirect costs

These are all other costs, that is, those that cannot be directly measured in respect of each

particular unit of output

Categories of costs:

Direct costs

Indirect costs or

overheads

Costs that can be identified with specific cost units – the effect of

the cost can be measured in respect of each particular output


Slide 7.21

Direct and indirect costs in practice

Indirect costs

Direct costs 70 %

30 %

A survey of 176 fairly large UK businesses, conducted during 1999,

revealed that, on average, total costs of businesses are in the following

proportions:


Slide 7.22

The relationship between direct costs and indirect costs

Full cost of the unit

Direct costs of the unit

Fair share of indirect costs (overheads)


Slide 7.23

The relationship between fixed costs, variable costs and total costs

Total (or full) costs

Fixed costs

Variable costs


Slide 7.24

The relationship between direct, indirect, variable and fixed costs of a particular job

Total (or full) cost of a

particular job

Fixed costs

Indirect costs (overheads)

Direct costs

Variable costs


Slide 7.25

A particular sail (job)

Ascertain the total

overheads for Marine

Suppliers Ltd for the period

Derive a suitable overhead

absorption rate for the business

as a whole

Apply the overhead

absorption rate (based on the

specifics of the job, for example

direct labour hours)

Overheads

Direct labourCost of direct labour

for the sail

Direct materials Cost of direct materials

to make the sail

Direct costs

How the full cost is derived for the sail made by Marine Suppliers Ltd in Activity 8.5


Slide 7.26

Dealing with overheads on a departmental basis

Each department can have its own accounting records that enable its performance to be

assessed

Each department normally has its own area of specialism and is managed by a specialist

Many businesses are too large and complex to be managed as a single unit

Reasons for dividing a business into departments:


Slide 7.27

A cost unit (Job A) passing through the production process

Preparation department

CustomersFinishing department

Paintshop department

Job A

* Direct materials * Direct labour * A share of the preparation department’s overheads

Full cost of the

job+ + =

Co

sts

accu

mu

late

d

* Any further direct costs* A share of the paintshop department’s overheads

* Any further direct costs * A share of the finishing department’s overheads


Slide 7.28

Analysis of the number of cost centres within a business

30

20

10

40

0 More than 20 cost centres

14

Less than 6 cost

centres

6–10cost

centres

29

21

UK

bu

sin

ess

es (

%)

11–20cost

centres

36


Slide 7.29

The full cost of the batch, delivered on

a ‘job-costing’ basis

The number of cost units (products) in

the batch

The full cost of one cost unit (product)

divided by

equals

Deriving the cost of one cost unit where production is in batches


Slide 7.30

The current full costing environment

Highly competitive international market

A high level of overheads relative to direct cost

Capital-intensive and machine-based production


Slide 7.31

Traditional versus activity-based costing

Overheads are first assigned to product cost centres

Overheads are then allocated to cost units using an overhead recovery rate

Total overheads

Product cost centre 1



Overheads are first assigned to cost pools

Overheads are then assigned to cost units using cost driver rates

Activity cost pool 1

Total overheads




Activity cost driver rate 1 Products

A B C DActivity cost driver rate 2

Activity cost driver rate 3

Activity cost driver rate 4

Products

A B C D

Cost centre overhead recovery rate 3



ABC approach

Traditional approach


Slide 7.32

Analysis of businesses (by size) using or considering ABC

TOTAL(528)

Under $100M (213)

$100M–$1B(168)

Over $1B(125)

10%

20%

60%

50%

40%

30%

90%

80%

70% 32%44%

29%

16%

20% 19%22%18%

34%

24%

36%52%

Pilot ConsideringActive


Slide 7.33

Analysis of businesses (by industry) using or considering ABC

Pilot ConsideringActive

Total(528)

Financial services (213)

Communications(43)

Manufacturing(126)

10%

20%

60%

50%

40%

30%

90%

80%

70% 32%

22% 16%

41%

20% 24%12%

22%

34%

46%58%

24%

29% 36%

17%23%

29%32%

Public sector (78)

Other industries (188)

6 chpt 7&8

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