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18.4 Malaka Oyster Company has increased its variable costs per kilogram of
oysters harvested. However, its fixed costs decreased as a result of these
changes. Why might this happen and how will these changes affect the firms
break-even sales volume?
An increase in variable costs per unit can result in decreased fixed costs if the
behaviour of a cost has changed such that it requires a change in classification.
An example is the increasing opportunity to hire equipment as and when
required rather than purchase the equipment and record fixed depreciation
costs. This means that the variable cost per unit has increased but the fixed
costs have decreased. At Malaka Oyster Company it is possible that crew
members were previously rewarded on the basis of a fixed payment per trip but
this has changed to the size of the catch. The unit contribution margin, which is
the denominator of the break-even (sales volume) equation, decreases when
the unit variable cost increases. This increases the break-even point. However,
the fixed cost (the numerator) has decreased, and this will decrease the breakeven point. So, the firms break-even sales volume increases with the decrease
in unit contribution margin but would decrease when there is a decrease in fixed
costs. Whether the final break-even sales volume has increased or decreased
will depend on the relationship between the decreases in (a) the numerator and
(b) the denominator. If both increase by the same percentage the break-even
sales volume will remain the same. If the fixed costs decrease by a greater
percentage than the unit contribution margin the break-even volume will
reduce, and vice versa.
18.7 Explain why safety margin means. How can managers use this
information to manage the profitability of a business?
The safety margin is the amount by which budgeted sales revenue exceeds break-even
sales revenue. It is the amount by which actual sales can fall below budgeted sales
before losses are incurred. Managers may use this information to highlight how close a
project or enterprise is to the break-even point and hence focus on maintaining
activities so that revenue does not fall below the break-even point. In this way managers
can focus on keeping operations profitable, which adds to shareholder value.
18.10 Refer to the Real Life on page 815. How could cost volume profit
analysis be used in budgeting and making decisions about pricing coffee and
cakes in a caf?
Cost-volume-profit analysis can be used in budgeting by projecting the profit that will be
achieved at the budgeted sales volume. Budgeting in a cafe business begins with a
sales forecast of number of coffees and cake to be sold. A CVP analysis also shows how
pricing would contribute to the profitability, as changes in coffee and cake prices would
change the contribution margin and affect the break-even sales volume. However, it is
important to understand that CVP analysis ignores the effect that sales price has on
sales volume because it is not designed to predict sales.