F2:Management Accounting

Designed to give you knowledge and application of: Section F: Short–term decision–making techniques F1. Cost –Volume-Profit (CVP) Analysis F2. Relevant Costing F3. Limiting Factors

Learning outcomes  Calculate and interpret a break-even point and a margin of safety. [2]  Demonstrate an understanding of, and use, the concepts of a target profit or revenue and a contribution to sales ratio. [2]  Identify the elements in traditional and contribution break-even charts and profit / volume charts. [1]  Apply CVP analysis to single-product situations. (Multi-product break-even charts and profit / volume charts executed). [2] FI : Cost –Volume- Profit (CVP) Analysis

The gap between the fixed cost line and the total cost line increases suggesting that variable cost rises as the volume of activity increases As soon as the sales cross the BEP the organisation starts making profits and until then makes losses y-axis = Revenue, costs & profit (loss) x-axis = Production & sales Fundamental concepts of cost-volume-profit analysis Cost–volume–profit (CVP) analysis is the study of the effects on future profit of changes in fixed cost, variable cost, sales price, quantity and mix. CIMA Official Terminology, 2005

Contribution contributes towards Fixed costs Profit Assumptions of CVP analysis Marginal cost equations Contribution  Selling price per unit is constant  Costs can be categorised into fixed & variable elements  Semi-variable costs can be split into fixed & variable elements  Fixed costs remain constant & variable costs vary proportionately  Costs & revenues behave in a linear fashion  Inventory is valued at marginal cost  Production / sales volume can only affect costs & revenues

Marginal cost equation By combining these two equations: This equation can also be rearranged in the following ways: Sales - Contribution = Variable Cost - Contribution Fixed Cost Profit = Understand & use the concepts of a target profit or revenue & a contribution to sales ratio Sales – Variable cost = Fixed cost + Profit Sales - Fixed cost - Profit = Variable cost Sales – (Variable cost + Fixed cost) = Profit Refer to Example on page F1.4

(Fixed cost + Target profit) Target sales volume = Contribution per unit Target revenue = Target sales volume x Expected selling price Target profit or revenue Contribution to sales (C/S) ratio C/S ratio or profit volume ratio (P/V ratio) Expressed as a percentage Remains constant if selling price & variable cost remain constant A measure of profitability

Total contribution Contribution to sales ratio = Sales value (Sales – Variable costs) = Sales value x 100 High C/S ratio Indicates high profitability Signifies that contribution grows more quickly compared to increase in sales level

Break-even point Contribution = Fixed cost Total fixed costs Break-even point sales in units = Contribution per unit Break-even point in terms of sales value = Fixed costs/C/S ratio or Break-even point in terms of sales value = Break-even point in units x Selling price per unit C / S ratio is used to calculate the variable cost to sales ratio and hence, the variable cost. Variable cost to sales ratio = 1 - Contribution to sales ratio Variable cost = ‘variable cost to sales ratio x total sales revenue’. Calculating and interpreting a break-even point Refer to Summary on page F1.10

Margin of safety (MOS) Budgeted sales Less Break -even sales Margin of safety (MOS) = Budgeted / Expected sales – Sales at break-even point = {(Budgeted / Expected sales – Sales at break-even point)/Sales} x 100 Margin of safety % Calculate and interpret a margin of safety (MOS)  MOS BEP is much below the sales level Signifies  MOS High fixed costs and a high C/S ratio Signifies

Traditional break-even chart

This is done in order to overcome the major problem with the traditional break-even chart since it is not possible to read contribution directly from the chart Contribution break-even chart Refer to Example on page F1.12

Profit/volume chart

The following represents a profit/volume graph for an organisation At the specific levels of activity indicated, what do the lines depicted as ‘T’ and ‘V’ represent?Line ‘T’ Line ‘V’ A. Loss Profit B. Loss Contribution C. Total fixed costs Profit D. Total fixed costs Contribution Answer B.loss and contribution 14 Test yourself

RECAP  Calculate and interpret a break-even point and a margin of safety?  Demonstrate an understanding of, and use, the concepts of a target profit or revenue and a contribution to sales ratio?  Identify the elements in traditional and contribution break-even charts and profit / volume charts?  Apply CVP analysis to single-product situations. (Multi-product break-even charts and profit / volume charts executed)?