Week 3 DQ 1 For what is cost-volume-profit (CVP) analysis used? What are some main
underlying assumptionsthat make CVP analysis useful for decision makers? Why
might decision makers use CVP analysis?
Cost volume profit analysis (CVP) is the tool to evaluate that how the operating profit will be
affected by changing the level of activity and change in the cost. It analysis helps to determine
the breakeven point i.e. how many unit to be sold by the company to have no profit no loss.
CVP analysis employs several assumptions in order to be applicable. Following are the
assumptions:
•All cost has to be classified either fixed or variable.
•Only one product is produced by the company or if more than one product is sold there
is constant sales mix.
•There is a linear function between cost and revenue.
•All units produced in the period are sold out. No concept of opening and ending
inventory.
•It applies to short term horizon.
The decision maker’s uses CVP analysis as it help to indentify the interrelationships
between cost, volume, per unit variable cost, total fixed cost, and profit. Once the
decision makers understand this relationship then they can easily make the decision for
the organization as to which product to be sold? What pricing and marketing strategies to
be adopted and which facilities to purchase or invest in.
Week 3 DQ 2 What are the differences between variable and absorption costing? Why is
variable costing not allowed for GAAP reporting? Which method is more usefulfor internal
decision making? Why? As a manager, which would you prefer? Why?
Marginal costing and Absorption costing are two different approaches to value the cost of
inventories in the company’s possession at year-end. They provide results which are effective
for decision making of the company as well. The core difference between the both approaches is
how the overheads are treated & offloaded in the cost of inventory or not.
In marginal costing, the concept is that management accumulated all the variable cost incurred
by the company to sell one unit of company’s product. Sales value less all variable cost
(including selling variable cost as well) provides us with the result of “Contribution Margin”.
Contribution margin primarily provides management a clear picture of the profitability of each
product. Since, all the company’s has to incur some fixed cost as well, to manufacture and sell
products, which is not accounted yet till contribution margin.
In marginal costing, all fixed cost are accumulated at end and deducted from contribution
margin to provide management with the result of how much profitable company was in the
current year. If the management divides the per unit contribution margin with the total fixed cost
incurred during the year, it provides management with the break-even units as well, i.e.
minimum units which a company must sell to cover its fixed expenses and end up at a no profit/
no loss situation. Thus, marginal costing is often used by the management accountants for
decision making purposes as well, while deciding, which product should be preferred to be
manufactured (higher CM) within the available capacity of company.
Absorption costing is more reflective towards the financial reporting of the company as well. In
this method, the management estimated fixed cost, which will be incurred in that period, and
then estimated the total number of units expected to be produced during the year. A per unit
fixed cost is determined on the basis of estimated production volume and estimated expenses.
This estimated fixed overhead are charged in the cost of per unit, while determining profitability
of the product. At the end of the period, when company has incurred the entire fixed overheads
as well, then management accounts for the over/under absorption of the fixed cost in the units
produced during the period. If the units produced are more than the expected units, then
company must have over absorbed the fixed cost, since, fixed cost does not increase
proportionately with the increase in the volume of production. These over/under absorption of
fixed cost is calculated and accounted for at the end of the accounting period.
I personally prefer absorption costing as it is more inclined towards the financial reporting of the
company and it provides a clear picture of the true profitability of each product.I think this
method is best suited for environments where production levels are relatively stable from month
to month to keep the analysis simpler.
Week 4 DQ 1 What are some advantages and disadvantages of standard costs? How do
managers determine what the standard cost should be? Describe the effect of inaccurate
standard costs
on financial reporting.
Following are the some advantages of standard costing:
•Standard costing act as a yard stick for the performance measurement.
•Standard costing assist in preparation of budgets, as it is difficult to have the exact
figure at the time of finalization of budget.
•Through standard costing the variances are identified and corrective actions can be
done for huge variances.
•Standard costing acts as an effective tool for business planning, budgeting,
marginal costing , inventory valuation etc
•Standard costing assist in price formulation of the
product. Following are the some disadvantages of standard
costing:
•Standard costing is time consuming and expensive to manage.
•It is in effective in those organizations where non standard products are manufactured.
•Due to number of variances reported, management might take some incorrect action
to have favorable variances.
•Improper application of management by exception principles
The managers determine the standard cost on the basis of past few months’ record. An average of
the most recent data is taken. Many other factors also considered in setting the standard cost
such as life of equipment, labor efficiency, labor rate, learning effect, purchasing terms, etc
Standard costing mainly assist in product costing. Most of the cases, it only focuses on the
manufacturing overhead. Variances occur when there is a difference between actual cost and the
standards. The companies review budgets to have the expected cost of the product. Average past
cost is taken to have the current product cost. If the related variances are not adjusted in the
respective financial statements then it will have inaccurate effect.
Week 4 DQ 2 When should variances be investigated? Who should be responsible for
correcting a negative variance? Why? What are some factors that can lead to variances?
How can variances be corrected?
A standard cost is the cost the company’s expect based on the prior experience with incurring
such cost. Usually, there is difference in the actual and standard cost. These variances should be
investigated at the regular intervals to determine, what’s going wrong and what factor has let the
cost to be increased for the company.
Each cost variance determines what the reasons for the variance are, and whether they are
controllable by the company by making efforts within the company’s premises (factory) or in
negotiation with external parties (supplier).
For example, if the company produces a Product A, for which it required 5 units of product
“U2”. The per unit of U2 cost $15. So, the total standard material cost for Product A is (15*5
=$75). Now, when company compares the actual cost with the standard one, they find a
difference of $ 33. Upon investigation, it was observed that per unit cost of U2 has now increase
to $18 and company has used 6 units of U2 to make Product A.
So, it provides company with the result, that, actual cost of material exceeds standard cost by
$33. This is not wholly due to the inefficiency of workers or due to procurement department, but,
both these department have their contribution in this negative variance. The procurement
department has contributed {(18-15) * 5} = $15 negative impact in the standard cost of the
company. Due to the increase in prices of the product, company cost has increased by $15. To
higher extend, these variances are uncontrollable by the company as well.
On the contrary, the negative material usage variance amounting to {(6-5) * 18} = $18, indicates
the inefficiency at the worker’s part, since, they used 1 more unit of U2 to manufacture Product
A. These variances can be and need to be corrected by the management since, it related to
internal management and work of the company.
Week 5 DQ 1 What is a master budget?
What are some underlying budgets that form the master budget? What is the budgeting
process at your organization? Is it effective? Why or why not?
Master budget is aggregation of all lower level budgets needed for the operation of the
company. It includes budgeted income statement, balance sheet and cash flow of the company.
Budgets for the finance, production and sales are also the part of it.
Following are the underlying budgets that form up the master budget.
•Direct labor budget
•Direct materials budget
•Ending finished goods budget
•Manufacturing overhead budget
•Production budget
•Sales budget
•Selling and administrative expense budget
In my organization the management engages those who are responsible for making the budget
and implementing it. Finance committee and senior staff are employed for the preparation of the
budget. Deadline is made to have adequate time for the review, feedback and revision if required.
Firstly the monthly budgets are prepared then the annual budget is prepared on its basis. The
annual budgeting process also documents tasks, responsibility assignments and deadlines. It also
incorporates strategic planning initiatives and stipulates that income is budgeted before expenses.
Fixed cost is identified as that cannot be avoided by the company.
The above process is effective as the company goals are set to that the departments must have the
mission to accomplish during the period.
Week 5 DQ 2 What is the difference between external and internal pricing? What factors
must be considered whensetting internal transfer pricing between company divisions?
What are the different methods of setting internal transfer pricing? Which is the most
effective? Why?
The internal pricing is the price that is being charged within the company by producing
department to selling department to purchase the produced product. Whereas, external pricing is
the price that is charged by the company from the outside customers for the product being
produced.
Many factors influence the transfer pricing, including relevant cost of producing the product,
available capacity of the department, market price, performance measurement, capabilities of
accounting systems , import quotas , customs duties , VAT, taxes on profits , and (in many cases)
simple lack of attention to the pricing.
There are several different methods used for determining transfer prices. They are as follows:
•cost -based transfer pricing,
•cost-plus transfer pricing (full costs plus normal markup),
•negotiated transfer pricing and
•Market-based transfer pricing.
•Comparable profit method
The best method is cost based transfer pricing. As the transaction is made internally the selling
department saves the various costs such as marketing, delivery, handling etc., the same is being
avoided. If the purchasing department, finds the lower price outside the market, why it would be
purchasing internally. So the selling department should set the price that is below market so that
the same is being purchased internally.
Reference:
http://www.cpaireland.ie
http://accountlearning.blogspot.com
http://www.investorwords.com
http://www.referenceforbusiness.com
http://en.wikipedia.org
