Module 4 - Background
Break-Even Analysis and Planning
Cost-Volume-Profit Analysis Equations
Profit Equation
Profit = SP (x) – VC (x) - FC
Where: SP = unit sales price
VC = unit variable cost
FC = fixed cost
x = units sold
Break–Even Point (BEP)
BEP is the point where total sales equals total costs.
Using the profit equation to calculate BEP:
0 = SP (x) – VC (x) – FC
Margin of Safety
The difference between actual or budgeted sales and BEP sales.
Contribution Margin (CM)
The difference between sales (in total or per unit) and variable costs (in total or per unit).
No. of units = Before Tax Profits
Unit CM
BEP in units =
FC
Unit CM
Contribution Margin Ratio (CMR)
The ratio of contribution margin (in total or per unit) and sales (in total or per unit).
Sales dollars = Before Tax Profits
Unit CM
BEP in dollars = FC
Unit CM
Required Background Material
Tsorakidis, N. (2009). Break-Even Analysis. Retrieved from
Walther, l. (2010). Chapter Eighteen. Cost-Volume-Profit and Business Scalability. Retrieved (including video lecture) from
Optional Resources
n.a. (2010, September 20). Breakeven Analysis - Starting a Coffee Shop - [Video file] Retrieved from
Martin, J. R. (n.d.) Management Accounting: Concepts, Techniques, and Controversial Issues - Chapter 9: Introduction. Management And Accounting Web Home Page. Retrieved from
Module 4 - Case
Break-Even Analysis and Planning
Assignment Overview
Pringly Division
A meeting of senior managers at the Pringly Division has been called to discuss the pricing strategy for a new product. Part of the discussion will focus on estimating sales for the new product. Over the past years, a number of new products have failed to meet their sales targets. It appears that the company’s profit for the year will be lower than budget and the main reason for this is the disappointing sales of new products.
This time a range of possible sales targets - rather than only one goal - will be established and evaluated.
The first strategy is to set a selling price of $170 with annual fixed costs at $20,000,000. A number of managers are in favor of this strategy, as they believe it is important to reduce costs.
The second strategy is to increase spending on advertising and promotions and set a selling price of $220. With the higher selling price the annual fixed costs would increase to $25,000,000. The marketing department is adamant that increased emphasis on advertising and promotions is essential.
The table below shows three probable levels of customer demands. The likelihood of reaching a certain level is indicated by the estimated probability. Note that it is not necessary to create a complex model based on probabilities. However, the probability distribution provides some guidance for the managers. Don't forget that the company has certain minimum expectations of a new product.
Estimated demand (units)
Estimated probability (units)*
150,000
0.25
180,000
0.5
200,000
0.25
*Estimated probabilities are given to assist in making a final recommendation. These probabilities don't have to be incorporated into a model, just considered in the final recommendation.
Additional information:
•The estimate of variable cost per unit is $35.
•The probability of the new product achieving break-even is very important. A profit greater than $4,000,000 is expected.
Case Assignment
Required:
•Compute break-even at each level.
•Is the company likely to achieve its desired target profit of $4,000,000 or more? Support your discussion with financial analysis.
•Compute the margin of safety and explain the meaning of the number derived.
•Should the company go ahead with the new product?
•Would this type of analysis be useful to a large company with a wide range of products?
•ROI (return on investment) and residual income are two other methods that can be helpful for this type of decision. Could they be applied in this situation? Support your answer with financial analysis.
HINT: Don't forget to use the variable costing approach for your analysis.
Assignment Expectations
It is important to answer the questions as posed. The discussion should be 4 to 6 pages and written in a clear and concise manner. Support your discussion with references in APA format. You are encouraged to use Excel or other compatible spreadsheet when computations are involved.
Module 4 - SLP
Break-Even Analysis and Planning
Budgeting is an important internal activity. Preparing budgets involves forecasting sales and estimating costs. For this SLP, you will prepare a flexible budget for next year for the company of your choice. The budget needs to be realistic and based on corporate and economic trends.
Companies prepare budgets based on absorption and/or variable costing. Due to lack of information, we're limiting our budgeting to the absorption approach. Don't forget that the presentation of the information is important.
Set up the flexible budget showing three different growth rates. Use the financial statements and do research on the company of your choice to determine growth trends. Explain your estimates and prepare a flexible budget showing the low, the average, and the high revenues and adjust all other line items in the income statement to reflect the revised revenue assumptions.
•What is the growth rate in sales for the past three years?
•Are revenues and expenses growing at the same rate? What was the experience in the past few years?
•What is the current growth rate in the economy?
•How are the competitiors doing?
•Current interest rates and tax burdens.
Discuss the implications of the information after you have completed the flexible budget.
•How does the flexible budget differ from a static budget?
•Budgets are used for planning and control. Discuss how you can use the information derived for these two purposes?
•Comment on using this information for performance evaluations.
SLP Assignment Expectations
Always include the name of the organization(s), time period covered, and source of information. It is important to answer the questions as posed. The document should be 2 to 4 pages and written in a clear and concise manner. Don't forget to include tables as required. Support your discussion or tables with references in APA format. You are encouraged to use Excel or other compatible spreadsheet when computations are involved. You can turn in the spreadsheet instead of the Word document. The content should be equivalent to the page length suggested for a word processing document.
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Management accounting is about using financial data in the decision-making process. Much of the analysis will relate to revenues and expenses. The income statement is often the main focus, but the format mandated by current accounting standards may not be optimal for many types of analysis. Organizations may worry about quality, environmental issues, and modern manufacturing techniques, but there are no categories for quality cost, environmental cost, lean manufacturing costs, etc. on the income statement.
Decision makers may need information categorized in a different manner than the traditional income statement. We are learning about creating an income statement where costs are categorized by behavior (i.e., fixed or variable). This approach is useful in many situations but may not be what we need in other instances.
New management initiatives also need to be tracked to measure whether or not they are successful. Data and reports must then conform to and support these initiatives. Consequently, it is crucial that we understand the relationship between management approaches and accounting.
References:
Accounting for Management. (n.d.) Total Quality Management (TQM) System. Retrieved from
ICMS, Inc. (n.d.). What is ABM/ABC? Retrieved from
Lean Enterprise Institute. (n.d.). What is Lean? Retrieved from
United Nations. (n.d.). Environmental Economic Accounts. Retrieved from
The World Conversation Union. (n.d.). Environmental Accounting: What Is It All About? Retrieved from
Required:
In this module, we’ll discuss some modern management techniques and their relationship with or effect on accounting. Some ideas for discussion are: lean manufacturing, TQM, activity-based management (costing), and environmental management (accounting).
Above, find resources for some of these topics that you can use as a starting point. The links are not meant to provide any particular viewpoint but are a mix of resources viewed both from an accounting and a business perspective.
Choose one or two topics for further investigation and share your knowledge with the class. Provide factual information (not merely opinions) backed up by current news, examples, or other interesting details. Your comments should be in your own words and include references in APA format, if applicable.
Presence during both weeks of the module and a minimum of three postings are required, one original posting and two responses to colleagues. Minimum required participation does not guarantee a perfect score.