EXCEL PROFESSIONAL INSTITUTE LECTURE 5 Holy
Q1. a) Investment Appraisal Lecture 10 &11 i. Types of Investment and Capital Expenditure ii. Objectives of Investment appraisal iii. Investment Appraisal Techniques iv. Capital Rationing v. Adjusting for Risk, Inflation and Taxation in Investment Appraisal vi. Specific Investment Decision (Lease or Buy, Asset Replacement) (10 marks) b) Performance Measurement Systems, Measurements & Control i. Performance Management Information Systems ii. Sources of management information and management reporting Lecture 1 iii. Scope of performance management & divisional performance appraisal. Lecture 12 iv. Transfer pricing Lecture 12 v. Performance analysis in not-for-profit organisations and public sector. Lecture 12 Vi External considerations & Behavioural aspects. Lecture 12 (15 marks)
Question 2 a) Nature, Purpose & Sources of Management Information i. Accounting for management Lecture 1 ii. Sources of data, cost classification and presentation of information. Lecture 1 (5marks) b) Budgeting & Budgetary Control Lecture 7 i. The concept of budgeting, objectives, types, administration and stages of budgeting process. ii. Preparation and analysis of Cash, Functional and Master Budgets. iii. Behavioural aspects of Budget. (15 marks) QUESTION 3 (25 marks) Cost accounting Techniques i. Accounting for material, labour & Overheads Lecture 2 ii. Absorption & Marginal costing, Job costing, Batch costing, Service costing, and Contract and Process costing. Lecture 2, & 3 (15 marks) b) Specialized cost & Management Accounting Techniques- Lecture 4 Activity Based Costing Target Costing Life cycles costing Throughput accounting (10 marks)
QUESTION FOUR (15 marks) a) Decision making techniques i. Relevant Costs Lecture 6 ii. Cost Volume Analysis Lecture 5 iii. Limiting factors Lecture 5 iv. Pricing Decisions Lecture 5 v. Make or buy decision, outsourcing, split or further processing, special order acceptance decisions. Lecture 6 vi. Dealing with risk and uncertainty in decision making (Profitability & Expected Values) Lecture 6 QUESTION FIVE (15 marks) a) Standard Costing & Variance Analysis Lecture 8 & 9 i. Nature, scope & objectives of standard costing, behavioural aspects of standard costing. ii. iii. iv. Types of standards and standard setting process. Basic variances, mix and yield variances, causes and analysis of variance. Operating Statements (Reconciliation of budgeted results with actual results using variances. v. Productivity, efficiency and capacity ratios.
Process costing and Equivalent Units Refer to Assignments Joint Cost-Refer to Lecture 4 slides
SHORT TERM DECISION MAKING TECHNIQUES Cost Volume Profit Analysis Limiting factor analysis Pricing decisions
Break-even analysis examines the short term relationship between changes in volume of output, sales revenue, and net profit. In other words, break even analysis helps to understand how cost, volume of output and profit relate to each other. The strength of break-even-analysis lies in its ability to provide solution and decision points for several scenarios. Progressive firms usually develop break even financial models with Microsoft office excel to provide decision points for multiple scenarios. Break even analysis can be used for sensitivity analysis.
The behaviour of total revenue is linear. The behaviour of total cost is linear over the relevant range. Embedded in this assumption is that every cost can be classified as either fixed or variable. Fixed cost is constant over the relevant range and variable cost varies in direct proportion to output. Efficiency of production process and workers remain constant. In a multi-product organisation, the sales mix remains constant over a relevant range. In manufacturing firms, all units produced are sold
The limitations of break-even analysis are derived from the assumptions. In situations where the assumptions do not hold, break even analysis could be of a limited benefit. For instance, where the entity has semi-fixed costs, break even analysis could be of limited use. Similarly, where the firm enjoys significant efficiency both in production process and labour, it will be difficult to perform break even analysis. For emphasis, absence of the assumptions is the limitations of breakeven analysis.
CVP analysis is an important tool for short-term planning and decision making. Example of these decisions include 1. choice of sales mix optimum sales mix 2. derivation of optimum pricing policy, given cost structure and volume of sales 3. determination of volume to be sold to breakeven 4. determination of how many units to be sold to achieve a target profit 1. decision point for whether a special order be accepted or rejected 2. Modelling for will profits if a new product or service is introduced.
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Key formulas to know: Break-Even Quantity = Fixed Cost/Contribution per unit Break-even value = Fixed cost/cmr Margin of Safety = Budgeted Volume of Sales - Breakeven quantity Unit to sell in achieve a target profit Fixed Cost +Target Profit Contribution per unit
Illustration: Tango Ltd Tango Ltd produces and sell a packaged fruit Juice; Quench. The following cost information has been provided Selling Price Prime cost per unit GHC8.00 GHC3.00 Variable non production cost per unit GHC2.00 Fixed cost per Annum GHC30, 000 Budgeted Annual sales volume 12,000 units Required: By how many units can Tango Ltd reduce their sales volume without falling into a loss making zone? Will Tango Ltd be able to make an annual after tax profit of at least GHC18,000 with their current budgeted annual production and sales level? (Assume tax rate of 25%) Tango Ltd can procure a technology that will reduce prime cost by 20%. This technology will mean the organization incurs an extra GHC5,000 in fixed cost. Should this technology be adopted?
Break even analysis is essentially a decision making model. Decision makers will want to know how much a firms bottom line (profit) will change when there is a change in either variable cost or revenue. Degree of operating leverage (DOL) provides a solution. DOL is computed as =Contribution/Net Profit DOL is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. We illustrate the importance of DOL with an example: Jean Ltd produces and sell ceramic tiles. Cost build up for a square metre of their product is analysed as follows: Budgeted annual volume Annual fixed cost Variable cost GHC50,000 Selling price per square metre GHC120,000 20,000 units GHC15 Required: If variable cost per unit increase by 20% by how much will profit change?
Break even analysis can be applied for firms that deal in multiple products. The caveat is that the sales mix should be constant over the given period. The following procedures may be useful in determining the break-even point for an organization with a multiple product: Determine the sales mix ratio/percentage for each product. A ratio might be given else compute as sales quantity for the product divided by total sales volume of the company. Find the unit contribution for each of the products Compute the weighted average unit contribution for each product by multiplying the contribution by the product s respective sales mix ratio. Add up to derive the weighted average unit contribution of the company. Break-even quantity of the company is derived as: Fixed Cost/Weighted Average unit contribution To make more sense, split the break-even point for each unit by multiplying the total break eve- point in (4) with the respective sales mix ratios.
Illustration Samfafa Ltd Samfafa Limited manufactures and sells Motor King to customers dividend into High Quality, Medium Quality and Low Quality motor Kings and categories below: It is on record that sale quantities of Low Quality Motor King are twice compared to Medium. Medium has same quantity as High Quality Motor Kings. Annual fixed cost of GHC313,200 is expected to be incurred. Sales Price Involved cost GHC GHC GHC High quality 3,400 1,200 80 Medium quality 2,300 1,080 60 Low quality 1,700 690 40 commission on sales You are required to: i. Compute the sales mix. ii. Compute the unit contribution margin for each brand of Motor King. iii. Compute the weighted average unit contribution. iv. Compute break even sales in volume and in sales. v. How many motor kings should be sold to earn target profit of GHC208,800
LIMITING FACTOR DECISIONS
A limiting factor is described as resources that are in scarce supply and places ceiling on the organisation s volume of activity. An organisation might have more than one limiting factor other than sales demand or two or more resources (labour, materials, machine capacity). The most pressing limiting factor is called a binding constraint. Linear programming is used for solving scenarios that involve more than one limiting factor. For the purposes of our discussion, we will assume only one limiting factor, aside sales demand. Other assumptions are as follows: Management will decide to use its scarce resources in such a way that will maximize total contribution Fixed cost are the same whatever the selected sales mix Variable costs are the only relevant cost In establishing the contribution maximum product mix with a single limiting factor, product must be ranked in order of contribution they earned
For exams purposes, candidates are expected to draw up optimum production plans subject to a constraint. The following steps are helpful: 1. Determine the binding constraint by comparing requirement of each resource available with resource requirement to meet effective sales demand. 2. Determine the contribution per unit for each of the products 3. Ascertain contribution per limiting factor by dividing contribution per unit by limiting factor per unit of each product 4. Rank the output from step 3 in descending order. 5. Draw up the production plan by utilizing the limiting factor in the order of rankings (take note if there are reserved minimum production units for each/any of the products. In such case, the reserved units will be prioritized first before using the rankings to ration). 6 Based on the question requirement, you may want to prepare profit statement using the optimum production plan arrived at.
Illustration: Unity Company Ltd is preparing for next seasons operations. The company has provided the following information relating to its three products. Product TO GE DA Selling Price 18.50 16.20 12.6 Material Cost (@ GH 1.75 8.75 10.5 3.5 per kg) Labour cost (@ GH 2.2 per 7.7 4.4 7.7 labour hr) Annual Demand (Units) 2,150 3,235 1556 The company can only make available a total of 18,560 hours in the short run. Required: a. Provide the optimal production plan for Unity Ltd for the ensuing period. b. What is the total incremental benefit of producing DA instead of GE, assuming available resources can only meet demand of DA? Source: (CA, May 2016)
Shadow prices refer to the maximum amount an organisation should rationally pay for an additional unit of a limiting factor. Shadow price is usually computed as the additional contribution that will result from having an additional unit of a limiting factor. For instance, in our previous example, demand for product DA was not fully met due to scarcity of labour hours. If the entity procure an additional 1hour of labour, it can produce an extra 0.2857 units (1/3.5) and earn an extra GHC0.40 (1.4 contribution per unit x 0.2857 extra units). This GHC0.40 represents the shadow price, maximum amount to pay for an extra unit of a limiting factor. Slack on the other hand refer to unused limiting factor, even in a situation of a constraint. In a situation of a single limiting factor, slack result when a remaining limiting factor is incapable of producing a full unit of a product. In context of multiple limiting condition, slack results when other limiting factors are unused as a result of unavailability of a binding limiting factor.
Taking the decision to price a particular product or services is often the most important to make. Theoretically, price of products are premised on cost information. In recent times, a myriad of factors, other than cost information affect pricing decisions and strategies. Factors that influence pricing decisions Aside cost, the following factors influence pricing decisions: Quality of the product, relative to competitive product offering Economic conditions such as inflation, exchange rate and interest rates Stage of the product: The various stages; introductory, growth, maturity and decline; influence pricing decisions Level of competition in the market place price perception of customers: this includes price sensitivity of customers Bargaining power of suppliers Demand for a product/service: very key factor when making price decisions.
There are a number of pricing strategies which are discussed as follows; Cost-plus pricing strategy: thus adding a percentage mark-up for profit to the full cost of the product. Marginal cost-plus pricing: thus adding a profit margin to the variable cost of the product Market skimming pricing: This strategy usually apply to new products. It involves charging high prices when products are launched in order to maximize short-term profitability Market penetration: pricing is a policy of low prices when product is first launched in order to obtain strong demand. Complementary product pricing: It is a pricing policy for complementary goods (thus goods which are used together). A company can decide to sell the complementary product at high prices or low prices or at a loss leader (thus charging one lower to influence higher demand that will affect the other products demand). Product line pricing: It is a pricing policy for a group of product which are closely related to one another. Price discrimination strategy: A strategy that involves selling at different prices across varying customer groups.
Cost-volume-profit analysis feature prominently in almost every exams diet. Examiners test both computation skills and decision making capability of students. Candidates were largely caught unprepared when the examiners feature break-even analysis for multiple product in an exam diet. Candidates should also master the assumptions and limitations of break-even analysis. On decision making front, candidates should be conversant with scenario planning and assessment of production plans when cost components are varied. Questions on limiting factor in past exams decision have been straight forward. Candidates should however be mindful when the examiner present a question that looks like a multiple limiting factor problem; while in actual fact, it has only one binding constraint For pricing, questions so far requested for pricing strategies and qualitative factors that shape pricing decisions Undoubtedly, this topic is a must-know for any candidate who intend passing the management accounting paper.
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