Management Accounting, Breakeven Analysis - Assignment Example

Management Accounting Prepared By Submitted to Word Count 2775 words Contents 1. Introduction 3 2. Breakeven Analysis 3 2.1 Breakeven Chart 3 2.2 Breakeven level output 5 2.3 Margin safety 5 2.4 Breakeven analysis as a tool in decision making 5 3. Explanation of Terms and Costs 6 3.1 Product cost Centre 6 3.1 Contribution pricing basis 7 3.2 Allocated Overheads 7 3.3 Effectiveness of Contribution pricing for Centrex 8 4. Cash Budget 8 Cash Budget for the coming year 8 Budget for Derailler Gears Ltd 10 Master Budget 11 References 13 1. Introduction The managerial accounting can present a detailed plan for the future regarding cost, expenses, budgets and profits. It takes into account the constraints, controls and the process of the controls in planning the accounting and budgeting. The decentralization of the processes and decision-making will make this effective. The directions and motivations are the part of the managerial accounting. The financial and operational feedbacks are necessary and they should be continuously monitored. This ensures the finished products to come out in time. This can be termed as the phase of accounting concerned with the providing information to managers to use in planning and controlling the processes and operations. This will take into account the non value added activities, organizational charts, performance reports, plan do check act cycle, planning, control cycle, process and reengineering, raw materials, segments, setup, staff, through put time and TQM are taken into consideration. (Mc Graw Hill Companies, 2007) 1 Task 1 1. Breakeven Analysis 1.1 Breakeven Chart: The breakeven point is important for preparing chart. The fixed costs and variable costs for the centrex product are as follows: The variable cost per unit is 10 GBP. The fixed cost is 25,000GBP. The variable cost of 10,000 units as mentioned will be 10x10,000 = 1,00,000GBP. The following graph shows number of units in X axis and cost in lacs of pounds on Y – axis. The fixed cost is shown as 25,000 GBP. (Mc Graw Hill, 2007) 2 After this the total revenue line has to be plotted. This requires the multiplication of sales price by number of units and termed as output. As the sales price is 14 GBP the total revenue can be calculated as 14x10,000= 140000. The4 total revenue line is in orange colour and the variable cost line is in green color. The intersection of them will give the break even point as 1,25,000 GBP. The profit will be 1,40,000-1,25,000 = 15,000GBP on the centrex product. (bbc.co.uk, 2007) 3  2.2 Breakeven Level of Output: Fixed costs are put at 25,000GBP. The variable cost will be maximum at 1,00,000. This makes the total cost of the product at 1,25,000 and the profit at 15,000 GBP. When the total revenue is 1,25,000 the product marketing and sales reaches the breakeven point. After that every pound of revenue obtained can be termed as profit. To get a profit of 15,000 GBP in the first year the company should sell 10,000 units of Cetnrex. The top portion between two lines gives the profit and the below portion inserted between the lines gives us the possible loss. Here the possible loss is more than the possible profit but the probability of gaining is more. 2.3 Margin Safety: The margin safety can be termed as the amount that is obtained by subtracting the breakeven sales from the budgeted sales or forecasted sales of the company. Here the forecasted sales can be put at 9,000 units and that amounts to 126000GBP. The breakeven sales is put at 1,25,000GBP. The difference is 1,000 GBP. This should be divided by budgeted sales and multiplied by 100 to get percent. This puts the margin safety percentage at .793. The sales of the company have to change more than 70 percent to show a net loss. This keeps the company at a secure position regarding after reaching the breakeven point. (cliffsnotes.com, 2007)4 2.4 Breakeven analysis as a tool in decision-making: The decision making in any business depends on the profit making and minimizing the probability of loss. In case of breakeven analysis, the calculation of budgeted sales, total revenue, breakeven revenue, maximum profit, minimum profit and the margin safety percentage can be done. This gives a manager the scope to estimate the chances of profit or loss in the course of production marketing. The decisions can be taken keeping them in view and relevant marketing or sales techniques can be adopted by estimating and calculating the minimum and maximum profit and loss. The probability of occurring loss will help in decisions of marketing and sales strategies. The breakeven analysis will help the manager to set the targets of sales and time to reach the breakeven and to gain profits. The manager can set time limits for both breakeven and budgeted or forecasted sales. This can help the management to take different decisions before the breakeven period and after that. Task 2 3. Explanation of Terms and Costs 3.1 Product cost Centre: Before explaining about product cost centre, the meaning of the cost centre need to be understood. The cost centers are the divisions that add cost to the company. The centers that add cost to the company due to production or by the product can be termed as product cost centers. By differentiating the cost centers from the others the areas the costs incur can be identified and this helps in good organization and decision making regarding strategies. These cost centers when maintained well can add profits indirectly to the company. These centers include the Research and development and marketing along with customer service. These centers only spend but give no direct income to the company. The activities of those centers will help in increasing sales, revenues and profits of the company. All these except customer service can be termed as product cost centers as they effect the production cost of the product before coming out of the company. In general and in the ordinary view, the cost centers have negative impact on the profit of a company. This will create a ground to set targets. These include layoffs and rollbacks when the budgets are cut. The decisions regarding the operations will affect the expenditure in the product cost centers and they are capable of effecting profitability either negatively or positively according to the nature and quality of the decision. When the costs are incurred in the product cost centers due to installation of new equipment or recruitment of new staff, the decisions should be taken to improve the revenues with the help of new installations and recruiting. This makes the product cost centers to help indirectly to increase the profitability of the company. When the revenues are increased more than the percentage of the increase of cost in cost centers, then the decision of increasing the cost can be justified. This compels to take into consideration the bottom line figures in the production costs. The decisions and metrics in the business can quantify the benefits of any product cost center. This is done by relating the costs and benefits to the organization as a whole. The metrics like average handle time, service level and cost per call can be used to quantify the benefits of a cost centre. (D.J.Power, 2000) 5 3.1 Contribution pricing basis: The contributions of the company assets in the manufacturing or production of a product will incur a cost in making. The pricing of the product should include the contributions of the assets of the company. This will increase the capability of assets in generating revenues or profits when the sales has been done up to the mark. When the contribution price is below the original cost price of the product the capital can be reduced for the difference. This results in decrease of investment on the immovable assets by the company. The contributions of assets of the company like cash and stock can be permitted to contribute to the pricing of the product. This can pose problem when the contributions of the assets are overvalued and it is more than the cost price of the product. This makes the contributions of the assets to result in undesirable happenings. To avoid the negative effect due to the contribution pricing basis, the fair market value of assets should be allowed to decide the contribution price for the product. This should not be higher than the company’s tax basis in the property. This enables the company to make the recognizable taxable gain. When the basis is less the tax deduction cannot be allowed. 3.2 Allocated Overheads: Adding value by the allocated overheads to the business depends on the nature of allocation. The allocation should result in actions that fit the function of the production. When an activity or service can change the information content that customer is willing to pay, the allocation can be done on that activity. This is due to the fact that the allocation can indirectly increase the revenues due to sales and service. This studies the difference between the product costing and allocated overhead. While the product’s cost equals the direct labor hours and material cost, the allocated overhead relate to all products and can be considered as an average cost. The average cost will take into consideration the overall cost and is capable of deciding the overall cost or gain in the future course. The overhead allocation will give good results when it is capable of resulting in customer profitability. The companies may need to incur special costs to achieve the product profitability. This is possible by allocating the overheads prudentially. This may mislead the overall picture if one out of the number of products is incurring loss and there is profit as on overall calculation. The avoiding of expensive activity based costing system will result in good results in allocating overheads. (Michael Bremer, 2004) 6 3.3 Effectiveness of Contribution pricing for Centrex: The contribution pricing basis will be effective for the cetnrex product as long as the remaining products of the company are also incurring profits. As the company is having 3 other products than Centrex, the overall profit with any of the product incurring loss may result in wrong calculation of profitability or gains. As long as the management is following the contribution pricing, the monitoring of the profitability of every product is a compulsion. This makes the contribution pricing effective and enables the management to take decisions that can enhance profitability and cost effectiveness. Task 4 4. Cash Budget 4.1 Preparation and purposes: The preparation of the cash budget will give us the flow of cash in business due to different activities. This can be used for planning for short term credit as it depends on cash flows. The preparation of cash budget is necessary for today’s financial institutions to be transparent with their cash inflows as they all are not owned by company. This determines the capacity of repaying the debt in the future. This can clear debt in the future and shows the surplus cash if any due to overflowing revenues. This will avoid credit as the cash inflows are organized and spent in a planned manner. The day to day borrowings can be avoided to make the activities more profitable and cost effective. In this context the yearly cash budget can be prepared as some payments are done on quarterly basis. Cash Budget for the coming year Beginning cash balance 10,000 GBP Estimated collections on accounts receivable Estimated Cash Sales 5, 09,000 GBP Estimated payments on accounts payable 8700 GBP Estimated cash expenses 86,300GBP Half yearly dividends 20,000GBP Total inflows 5,19,000 GBP Total out flows 1,15,000GBP 1,15,000 GBP Balance 4,04,000 GBP Cost of goods sold 3,63,000 GBP 3,63,000 GBP Gross profit before interest and tax at the end of the year 41,000 GBP The sales in first quarter 159062.5 The expenses at the end of the first quarter 119500.0 119500.0 Cash balance at the end of first quarter 39562.5 GBP The sales in 2nd quarter 159062.5 GBP The expenses at the end of the 2nd quarter 119500.0 119500.0 Balance at the end of the 2nd quarter 397250 Sales in the 3rd quarter 95437.5 Expenses at the end of 3rd quarter 119500.0 492687.5 119500.0 Cash at the end of 3rd quarter 373187.5 Sales at the end of 4th quarter 95437.5 Expenses at the end of 4th quarter 119500.0 Total cash inflow at the end of 4th quarter 468624.5 119500.0 Balance at the end of 4th quarter 349124.5 Cost of goods sold 308,124.5 Total profit at the end of the year 41,000 GBP 4.2. Budget for Derailler Gears Ltd Production of number of units in first month: 4750 Cost of number of units in the first month 44208.3 GBP Revenue incurred by sales of the units 66500 44208.3 Profit before interest and tax 22291.7 Sales at the end of the 2nd month 66500 Cost of the units 44208.3 88791.7 44208.3 Profit before interest and tax at the end of 2nd month 44583.7 Sales at the end of third month 66500 Cost of the units 44208.3 Expenses 875.0 45083.3 111083.7 45083.3 Profit before interest and tax 66000.4 Profit at the end of 6th month before interest and tax 132000.8 Sales in the second half of the year 9,500 units Revenue through sales in the 2nd half of the year 127250 GBP Total revenues at the end of the year 509000GBP Total expenses 458000 GBP Profit before tax and interest 51,000 GBP 4.3 Production budget by product: The Derailler Ltd Company is having 4 products along with the new product Centrex. The monthly production budget for Derailler Tourist Number of units per month 1000 Variable costs 7500 Allocated costs 2083.3 Total Cost of the units 9583.3GBP The monthly production budget for Derailler Professional Number units per month 500 Variable costs 6250 Allocated overhead 1041.6 Total Monthly Cost of the units 7291.6 GBP The monthly production budget for derailler mountain Number units per month 1334 Variable costs 10666.6 Allocated overheads 3333.3 Total monthly Cost of the units 14000 The monthly production budget for Centrex Number of units per month 584 Variable costs 5833.3 Allocated overhead 1458.3 Total Cost of the units 7291.6 GBP 4.4 Administration budget: The monthly administration budget depends on rents, leases, heat, lights, stationary, Salaries. The costs are as follows Rents and rates 166.6 Heat and lights 25 Salaries 6250 Stationary 83.3 Total monthly administrative budget 6524.93 GBP 4.4 Master Budget : The master budget makes the planning a compulsion for an organization. This can integrate and coordinates the activities of production, sales and marketing. The equipment, materials, labor supplies are made comprehensive and are placed in right time and context. It will help in insuring the manufacturing planning to produce the same mix of products and a marketing plan to sell. The products in the master budget are pulled through the system on the basis of the sales budget. The speculative production is not involved and this develops accuracy in the budget. The avoiding of the excess of inventory is also a part of the master budget. The unnecessary costs are eliminated. The emphasis in the master budget is placed on total organization instead of subsystems and functional areas. In preparing the Master Budget the following are considered 1.Sales Budget 2. Production budget 3. Direct Material Budget 4. Direct Labor Budget 5. Factory overhead Budget. Sales Budget involves budgeted sales, current period cash collections and prior period credit sales collected in current period. As the company is giving credit for 30 days and was getting credit from suppliers for 30 days, the business done was termed as cash. The budgeted sales for the total four products was put at 5,09,000 GBP. In the context of Deraillers Ltd these calculations are simple as the business was being done on cash and the monthly estimates are prepared for the production of the goods. The pricing of the goods was done at 40 percent of contribution price basis. As the cost of centrex is 10GBP, the selling price of that is put at 14 GBP. This makes 40 percent of the gross profit before interest and tax. The second step in the master budget is the production budget. The units should be produced in a month and in the year were calculated and the budgeted unit sales per month are prepared earlier in this paper. That will constitute a part of the master budget. The desired ending inventory is usually based on the next period of sales and this was done by making 25 percent of more sales in the first half of the year and the remaining in the second part of the year. The next step is direct material budget In this case the quantity of the material needed for the production will be equal to the units produced x quantity of material budgeted per nit. In the above case the direct material cost is put at 3,63,000 GBP for the four products of the Deraillers Ltd. 4. Direct Labor Budget This budget involves the direct labor hour needed for production. This will depend on units produced and DL hours budgeted per unit. They are put at 75, 000GBP per annum for all the four Deraillers Ltd’s products. References: 1. Mc Graw Hill Companies, 2007, Managerial accounting and business environment, Mc Graw Hill, ,electronic, 7—07-07, http://www.mhhe.com/business/accounting/garrison/Student/olc/garrison9emgracct_s/ch01s_kt.html#Managerial Accounting 2.Mc Graw Hill, 2007, Managerial accounting and business environment, Mc Graw Hill, ,electronic, 8-7-07, http://www.mhhe.com/business/accounting/garrison/Student/olc/garrison9emgracct_s/ch01s_cs.html 3. bbc.co.uk, 2007, breakeven analysis, bbc.co.uk, Business studies production, ,electronic, 8-7-07, http://www.bbc.co.uk/schools/gcsebitesize/business/production/breakevenanalysisrev3.shtml 4. cliffsnotes.com, 2007, Margin of safety, Cliffsnotes.com ,electronic, 8-7-07, http://www.cliffsnotes.com/WileyCDA/CliffsReviewTopic/Margin-of-Safety.topicArticleId-21248,articleId-21230.html 5. D.J.Power, 2000, supporting business decision making, Dss resources, ,electronic, 8-7-07, http://dssresources.com/dssbook/ch1sbdm.pdf 6. Michael Bremer , 2004, Overhead allocation - does it make sense? , imakenuews.com, ,electronic, 8-7-07, http://www.imakenews.com/rainmakers/e_article000057368.cfm?x=b11,0,w Read More