Business 2 Strategic Planning CostVolumeProfit Analysis Page 2

Business 2 Strategic Planning

Cost-Volume-Profit Analysis (Page 2 -3) Cost Behavior Variable Cost Constant per unit Change in total Fixed Cost Constant in total Change per unit Mixed Cost or Variable Cost + Fixed Cost Semi-variable cost

Absorption versus Variable Costing (Pages 2 -6 and 2 -7) Absorption Costing (GAAP) Direct Material + Direct Labor + Manufacturing Overhead Variable or Direct Costing Direct Material + Direct Labor + Variable Manufacturing Overhead Example on page 2 -7

Contribution versus Absorption Approach (Pages 2 -3 to 2 -6) Contribution Approach Absorption Approach Revenue Less: Variable Costs Contribution Margin Less: Fixed Costs Net Income Revenue Less: Cost of Goods Sold Gross Margin Less: Operating Expenses Net Income

Contribution Margin (Page 2 -4) Contribution Margin per Unit Selling Price per Unit Less: Variable Cost per Unit Contribution Margin Ratio CM per Unit / Selling Price per Unit= CM Ratio

Breakeven (Pages 2 -8 to 2 -9) Sales = Costs Sales = Variable Costs + Fixed Costs Breakeven in Units = Total Fixed Costs CM per Unit Breakeven in Dollars = Total Fixed Costs CM Ratio

Cost-Volume-Profit (CVP) Analysis (Page 2 -9) Required volume for target profit Total Fixed Costs + Profit before tax Contribution Margin per Unit or Ratio

Cost-Volume-Profit (CVP) Analysis Example on page 2 -9 Breakeven in Dollars =Total Fixed Costs = $150, 000 = $250, 000 CM Ratio. 60 Breakeven in Unit =Total Fixed Costs = $150, 000 = 2, 000 units CM per Unit 75 Selling Price - Variable costs CM per Unit (60% X 125) $125 75

Cost-Volume-Profit (CVP) Analysis Example on page 2 -10 Required volume for target profit Total Fixed Costs + Profit Contribution Margin per Unit $150, 000 + (50, 000 X 1. 20) = 2, 800 units 75

Cost-Volume-Profit (CVP) Analysis Margin of Safety (page 2 -11) Total Sales in dollars - Breakeven Sales in dollars Breakeven Charts (pages 2 -12 to 2 -13)

Target Costing (Page 2 -13) TARGET COSTING Target costing is a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume. Target Cost = Market Price - Required Profit Target Cost will occur when the firm faces stiff competition and the product differentiation is the key to maintain market share.

Operational Decision Analysis (Pages 2 -14 to 2 -16) Marginal analysis focuses on the future relevant revenues and future relevant costs. � Special Orders and Pricing Consideration of most direct and variable costs as well as incremental costs. Presumed excess capacity ▪ If the selling price per unit is greater than the variable cost per unit, the CM will increase and the special order should be accepted. Example on page 2 -16 Presumed full capacity ▪ The opportunity cost of producing the special order should be included in the analysis. Example on page 2 -16 ▪ Acceptance of the special order requires consideration of other factors such as effect on regular-priced sales, possibility of future sales to this customer, etc. �

Operational Decision Analysis (Page 2 -17) Marginal analysis focuses on the future relevant revenues and future relevant costs. � Make or Buy Decision The decisions are made by comparing the costs of making the product internally (insourcing) with the cost of buying the product externally (outsourcing). Managers should select the lowest-cost alternative. Capacity consideration ▪ Excess capacity ▪ No Excess capacity ▪ Include the opportunity cost associated with the decision Example on page 2 -17 �

Operational Decision Analysis (Page 2 -18) � Marginal analysis focuses on the future relevant revenues and future relevant costs. � Sell or Process Further Decision The decision regarding additional processing is made based on profitability. Joint costs are sunk costs that are not relevant to decisions whether to sell or to process further. Separable costs are costs incurred after the split-off point and are relevant to decisions of whether sell or to process further. If the incremental revenue exceeds the incremental cost after the split-off point, the organization should process further.

Operational Decision Analysis (Page 2 -18) � Marginal analysis focuses on the future relevant revenues and future relevant costs. � Keep or Drop a Segment The fixed costs associated with the segment must be identified as either avoidable (relevant) or unavoidable, even if the segment is discontinued. The firm should keep the segment if the lost contribution margin exceeds the avoided fixed costs. Examples on page 2 -19

Forecasting Analysis Regression Analysis (pages 2 -20 to 2 -21) Y= A + Bx A= Total fixed costs B= Variable cost per unit x= Cost driver Coefficient of Correlation (r) Coefficient of Determination (R 2) High-Low Method (page 2 -22) Variable Cost per unit = Change in cost driver Total Fixed Cost = Total Cost - Total Variable Cost Example on page 2 -23

Budgeting (Pages 2 -24 to 2 -40) MASTER BUDGET (page 2 -27) Sales Budget (page 2 -29) Production Budget (page 2 -31) Direct Materials Budgets (page 2 -33) Direct Labor Budget (page 2 -33) Factory Overhead Budget (page 2 -33) Cost of Goods Sold Budget (page 2 -34) Selling and Administrative Expense Budget (page 2 -35) Pro Forma Income Statement (page 2 -37) Pro Forma Balance Sheet (page 2 -37) Cash Budget (page 2 -36) FLEXIBLE BUDGET (Page 2 -38 / example 2 -40)

Direct Materials Variances (Page 2 -42) Direct Material Price Variance (Actual price - Standard price) X Actual Quantity purchased Direct Material Quantity Variance (Actual Q used - Standard Q allowed) X Standard Price

Direct Materials Variances (Example on page 2 -43) Direct Material Price Variance (Actual price - Standard price) X Actual Q purchased ($8 - $10) X 200 = $400 Favorable Direct Material Quantity Variance (Actual Q used - Standard Q allowed) X Standard Price (110 – 100) X $10 = $100 Unfavorable

Direct Labor Variances (Page 2 -42) Direct Labor Rate Variance (Actual rate - Standard rate)X Actual Hours Worked Direct Labor Efficiency Variance (Actual hours - Standard hours allowed) X Standard Rate

Direct Labor Variances (Example on page 2 -43) Direct Labor Rate Variance (Actual rate - Standard rate) X Actual Hours Worked ($20 - $15) X 450 = $2, 250 Unfavorable Direct Labor Efficiency Variance (Actual hours - Standard hours allowed) X Standard Rate (450 – 500) X $15 = $750 Favorable

Manufacturing Overhead Variances (Page 2 -44) Spending Manufacturing Overhead Variance (Actual MOH Flexible Budget MOH) Standard Variable MOH Rate X Actual cost driver Total Variable + Budgeted Total Fixed MOH Total Flexible Budget MOH

Manufacturing Overhead Variances (Page 2 -44) Efficiency Manufacturing Overhead Variance Standard Variable MOH Rate (Actual hours - Standard hours allowed) Volume Manufacturing Overhead Variance Standard Fixed MOH Rate (Standard hours allowed - Capacity)

Manufacturing Overhead Variances (Page 2 -44) Controllable Manufacturing Overhead Variance Spending Variance + Efficiency Variance

Manufacturing Overhead Variances (Example on page 2 -47) Spending Manufacturing Overhead Variance (Actual MOH $16, 800 - Flexible Budget MOH) = $17, 850 $1, 050 F Standard Variable MOH Rate $ 1. 50 X Actual cost driver X 3, 900 Total Variable $ 5, 850 + Budgeted Total Fixed MOH 12, 000 Total Flexible Budget MOH $17, 850

Manufacturing Overhead Variances (Example on page 2 -47) Efficiency Manufacturing Overhead Variance Standard Variable MOH Rate (Actual Hours - Standard hours allowed) $1. 50 ( 3, 900 – 3, 800) = $150 Unfavorable Volume Manufacturing Overhead Variance Standard Fixed MOH Rate (Standard hours allowed - Capacity) $3. 00 ( 3, 800 – 4, 000) = $600 Unfavorable

Manufacturing Overhead Variances (Example on page 2 -47) Controllable Manufacturing Overhead Variance Spending Variance + Efficiency Variance $1, 050 F + $150 U = $900 F

Sales Variance Analysis (Pages 2 -48 to 2 -50) Selling Price Variance (Page 2 -49) (actual selling - budgeted selling) price per unit X Actual units sold

Sales Variance Analysis (Pages 2 -48 to 2 -50) Sales Volume Variance (Page 2 -49) (actual units sold - budgeted sales in units) X Standard CM per unit

Sales Variance Analysis (Pages 2 -48 to 2 -50) Sales Mix Variance (Page 2 -49) (actual product sales mix ratio - budgeted X Actual units X Standard product sales sold CM per unit mix ratio) of that product

Sales Variance Analysis (Pages 2 -48 to 2 -50) Sales Quantity Variance (Page 2 -49) (actual - budgeted X Standard units sold sales in units) product sales CM per unit of product mix ratio of that product

Sales Variance Analysis (Pages 2 -48 to 2 -50) Market Size Variance (Page 2 -50) It measures the effect the size of the entire market for the product has on the CM for the firm. (actual - expected market size in units) X Budgeted market share % X Standard weighted average CM per unit

Sales Variance Analysis (Pages 2 -48 to 2 -50) Market Share Variance (Page 2 -50) It measures the effect of the firm's market share on the firm’s CM. (actual market share % - budgeted market share %) X Actual industry units X Standard weighted average CM per unit

Analysis of Business Performance (Pages 2 -50 to 2 -54) � Responsibility Accounting is dependent upon proper delegation and authority given to managers. Financial Scorecards – Variance reports and overall analysis of business performance Types of Responsibility Centers or Strategic Business Units (SBU) ▪ Cost ▪ Revenue ▪ Profit ▪ Investment Specific Accountability – the performance and effectiveness of each strategy can be analyzed by ▪ Product lines ▪ Geographic areas ▪ Customer

Analysis of Business Performance (Pages 2 -50 to 2 -54) � Responsibility Accounting is dependent upon proper delegation and authority given to managers. Contribution Reporting – The degree to which the profit has covered variable and controllable costs. (example on page 2 -53) ▪ Contribution Margin ▪ Controllable Margin

Analysis of Business Performance (Pages 2 -50 to 2 -54) Responsibility Accounting is dependent upon proper delegation and authority given to managers. � Balanced scorecard Fully integrates financial and non financial measures. Balanced scorecard describes the classification of critical success factors, the strategic goals, the tactics and the related measures. Links vision and strategy from four perspectives ▪ Financial (measuring financial results) ▪ Internal business processes (measuring efficiency and effectiveness of business process) ▪ Customer (measuring the effort that adds to customer satisfaction) ▪ Learning and growth (leveraging human resources capabilities) �

Analysis of Business Performance (Pages 2 -50 to 2 -54) � Responsibility Accounting is dependent upon proper delegation and authority given to managers. Non-Financial Scorecards – formal reporting of qualitative and nonfinancial quantitative dimensions of the business. ▪ Qualitative ▪ Selected aspects of operations ▪ Generally not numerical ▪ Example: employee morale, customer satisfaction, etc. ▪ Quantitative ▪ Selected aspects of operations that may be reduced to numerical measurements. ▪ Example: reduction in travel time, hours or miles, etc.