1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 1 Chapter 8 Short-term decision making techniques

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 2 Objectives Explain the terms incremental costs and incremental benefits. Describe situations where incremental analysis may be used to assist management. Distinguish between relevant and irrelevant information used in decision making.

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 3 Objectives (continued) Apply incremental analysis to two (2) of the following situations: – make or buy a component – accept a special order – add a new product – close a department – process a product further, or sell the product as is.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 4 Objectives (continued) Explain how costs and profits respond to changes in sales volume. Use a cost-volume-profit analysis as a tool for management. Define contribution margin. Calculate the contribution margin per unit and the contribution margin as a ratio.

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 5 Objectives (continued) Calculate a break-even point by use of a formula and by use of a graph. Calculate the sales required to earn a desired level of profit (in dollars and units). Apply a cost-volume-profit analysis to practical situations.

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 6 Incremental benefits and incremental costs To assist decision makers by providing information?? Incremental benefits – the difference between revenues of different alternatives. Incremental costs – the difference between costs of the alternatives

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 7 Incremental benefits and incremental costs (continued) Managers will aim to choose the alternative which derives the greatest benefit. highest revenue lowest cost.

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 8 Incremental analysis – Making an informed decision when faced with alternatives. Examples: – to make or buy a component – to accept a special order – to add a new product line – to close a department – to process a product further, or sell the product as is.

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 9 Relevant and irrelevant information Management needs information to make decisions, the more information the better. The accountant needs to identify all relevant information to assist decision makers. Relevant data is data that will alter the result of the decision made.

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 10 Decision-making situations Making or buying a component – Wether to make or buy a component is a very common decision for management in a manufacturing business.

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 11 Decision-making situations (continued)

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 12 Decision-making situations (continued) Special orders – Management also needs to choose whether to accept a special order with prices lower than normal.

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 13 Decision-making situations (continued)

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 14 Decision-making situations (continued) Adding a new product – If a manufacturing firm had idle production time management may need to decide about adding a new product to reduce idle time.

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 15 Decision-making situations (continued) Closing a department – If a department is making a loss, management may need to choose whether to close the department or allow it to run at a loss.

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 16 Decision-making situations (continued)

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 17 Changes in sales volume Cost-volume-profit-analysis (CVP) shows the effects changes in the volume of production will have on cost and profits. Fixed costs remain fixed no matter what the level of production. Variable costs vary in direct proportion to production: as output increases the total variable costs will increase.

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 18 Cost-volume-profit analysis (CVP) CVP can be used in a number of situations; to determine the effect changes in volume of production will have on profits to calculate the break-even point (see slides 8:22 - 8:26 )

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 19 Contribution margin is the amount remaining after total variable costs have been deducted from sales revenue is required before management can use CVP analysis as a tool for decision making.

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 20 Contribution margin calculation The contribution margin can be calculated in two ways: Contribution margin per unit – by subtracting the unit variable cost from the unit selling price. Contribution margin ratio – by expressing the contribution margin as a percentage of sales.

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 21 Example 6

22. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 22 Break-even point Total revenue equals total costs. Allows managers to know how many units need to be sold to break even. Any sales over this will be profit. It can be calculated by the formula or graph method.

23. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 23 Break-even point: Formula method There are two formulae: Total fixed costs = Units required to break even contribution margin per unit Total fixed costs = Sales value to break even contribution margin ratio

24. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 24 Break-even point: Graph method Gives a visual presentation of the relationship between costs and revenues.

25. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 25 Example (continued)

26. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 26 Break-even point (continued)

27. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Accounting for Business – A non-accountant’s guide 2/e by Jopling, Lucas and Norton Slides prepared by Rick Nieuwenhoven 8- 27 Desired profit – certain level of profit – CVP analysis allows managers to determine the level of sales required to determine profit. Formula: Total fixed costs + Desired profit = Required units Contribution margin per unit