1. RM Accounts Ed
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lesson notes on
SHORT TERM DECISION MAKING

2. CONTENTS
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3.
4.
5.
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RM Accounts Ed
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COST VOLUME ANALYSIS
BREAK-EVEN ANALYSIS
MARGIN OF SAFETY
OPERATING LEVERAGE
INCREMENTAL (DIFFERENTIAL)
ANALYSIS
ASSORTED DECISIONS
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3. RM Accounts Ed
COST VOLUME ANALYSIS (CVP)
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CAPE UNIT 2 MODULE 3

4. RM Accounts Ed
CVP EXAMINES…
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Changes in cost and volume ; and
their effect on profit (net income) over
the short term.
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5. CVP STUDIES…
The interrelationships among
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•
price of the product
•
volume of sales
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• mix of product sold
•
•
variable costs per unit
total fixed cost
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6. CVP IS …
Useful in short-term decision making and
planning, especially as it relates to
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Choice of product or product lines
Pricing of products or services
Marketing strategies
Utilization of productive facilities

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7. RM Accounts Ed
COST VOLUME PROFIT ANALYSIS
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8. CVP IS BASED ON…
The Variable Costing Income Method
RM Accounts Ed
S(X) – VC(X) – FC = P
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SALES (REVENUE)
Less VARIABLE COSTS
=
TOTAL CONTRIBUTION
Less FIXED COSTS
=
NET PROFIT
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9. RM Accounts Ed
REVENUE
Changes in direct proportion to the level of activity
or volume.
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REVENUE PER UNIT
Tends to remain constant within the relevant range.
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VARIABLE COST PER UNIT
Tends to remain constant within the relevant range.
RM Accounts Ed
VARIABLE COST
Changes in direct proportion to the level of activity
or volume.
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FIXED COST PER UNIT
Changes in inverse proportion to the level of activity
or volume.
RM Accounts Ed
FIXED COST
Tends to remain constant within the relevant range
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SHORT TERM
generally a period of twelve (12) months or less.
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RELEVANT RANGE
expected output of the firm with the short term
based on its past events/analysis.
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13. CONTRIBUTION IS…
an important element of CVP analysis.
RM Accounts Ed
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It is the amount available to make
payments on fixed costs; aid profits.
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14. CONTRIBUTION
Contribution margin per unit
= selling price per unit less variable cost per unit
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Contribution margin ratio (percentage [x 100])
=
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Contribution
= Selling price less variable cost
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15. CVP
ASSUMPTIONS
Changes in revenue or costs arise only due to a change in the volume
of products produced or sold.

Total costs can be easily divided into to fixed and variable
components in the measure of the level of output.

Total cost and total revenue are linear relationships to output within
the relevant range.

The unit selling price, unit variable cost, and unit fixed cost are known
and constant.
RM Accounts Ed

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16. RM Accounts Ed
CAPE UNIT 2 MODULE 3
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BREAK EVEN ANALYSIS

17. BREAK EVEN ANALYSIS ….
Seeks to find the point, over the short term, at
which the costs of operating the business are the
same as the revenues earned by the business.

Break Even Point
=> total revenue = total cost
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
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
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18. BREAK EVEN POINT
is derived using the same variable costing income
method:

But re-written as
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S(X) – VC(X) – FC = 0

RM Accounts Ed
P = S(X) – VC(X) – FC
Thus
X=
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19. BREAK EVEN POINT
Recall that
Therefore (number of units required)
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X=
RM Accounts Ed
S – VC => CMu
(that is contribution margin per unit)
And (volume of sales required)
X=
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20. BREAK EVEN ANALYIS
can help forecast….
=
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(2) Sales to reach target profit
RM Accounts Ed
Requirements to reach a target profit (or production)
(1) Units to reach target profit
=
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21. BREAK EVEN ANALYSIS
(PRESENTED GRAPHICALLY)….
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http://www.bing.com/images/search?q=BREAK+EVEN+ANALYSIS&FORM=HDRSC2#a

22. RM Accounts Ed
CAPE UNIT 2 MODULE 3
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MARGIN OF SAFETY

23. MARGIN OF SAFETY
The excess of the budgeted (or actual) sales of the
firm over the break-even point.
The extent to which the firm’s activity (amount of
sales) can decline before it incurs a loss (reaches
BEP).

The indicator to management that the firm’s
operations are reaching a dangerous level.

Can be useful as an risk indicator.
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
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
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24. MARGIN OF SAFETY
Measured in units
=> actual units – break even units

Measured in dollars
=> actual sales $ - break-even sales $

Measured as a percentage
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=>
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
and/or
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25. RM Accounts Ed
CAPE UNIT 2 MODULE 3
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OPERATING LEVERAGE

26. OPERATING LEVERAGE
The proportionate relationship between the firm’s
variable costs and its fixed cost.
A measure of the extent to which fixed costs are
being used in the firm.

An indicator of how a percentage change in sales
(from existing levels) will affect the firm’s profits.

The calculation
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
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27. OPERATING LEVERAGE INDICATORS

Firms with high variable costs and low fixed costs
(e.g. very labour intensive company)
Firms with low variable costs and high fixed costs
(e.g. a capital intensive company)
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
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Tend to have a low OP and a low BEP
 A wide swing in volume may still show a profit.

Tend to have a high OP and a high BEP
 A small change in volume may still show a profit

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28. RM Accounts Ed
CAPE UNIT 2 MODULE 3
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INCREMENTAL ANALYSIS

29. INCREMENTAL ANALYSIS

The difference between costs and revenues
generated over an alternative choice of actions.
Recall that new actions are impacted by relevant costs
(which differ according the action taken)
The Profit/Loss will be affected by any factor that
alters the Break-Even Point.
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

It is important to include variable selling expenses [use
the Marginal cost of Sales] when referencing the
pricing policy.
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30. INCREMENTAL ANALYSIS

The Break-Even Point will increase if there is
An increase in total fixed costs
 A decrease in contribution margin per unit

The Break-Even Point will decrease if there is
A decrease in total fixed costs
 An increase in contribution margin per unit
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

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
The Contribution Margin will decrease if there is


A reduction the selling price
An increase in variable cost per unit
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31. RM Accounts Ed
CAPE UNIT 2 MODULE 3
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DECISIONS

32. DECISIONS (QUESTIONS)
Should the firm accept orders below normal selling
price?
 Should the firm make or buy the product?
 How can the firm make profitable use of its limited
resources?
 Should the firm continue with or drop a product or a
department?
 Should the firm sell joint products at a split off
point?
 Should the firm scrap or rework a product?

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33. DECISIONS (OTHER CONSIDERATIONS)

Various qualitative and quantitative factors impact
on the decision-making process:




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The alternative use of the resources
The spare productive capacity available
The environmental concerns
The firm’s obligation to its employees
The effect on customer relations
The image of the firm itself
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
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34. SOURCES (REFERENCES)
Thank to

CAPE self-study guide –D Carrington
CAPE Accounting – Randall, Stephens-James
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http://www.bing.com/images/search?q=BREAK+EVEN+ANALYSI
S&FORM=HDRSC2#a
RM Accounts Ed

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