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CMA Revision Decision Types and Rules
CMA Revision Decision Types and Rules
Sales as a
constraint,
choose
product with
highest C/S
Ratio, CMR,
p/v
Classification of costs
Classification by nature: Material, Labour and Overhead
Classification by traceability: Direct and Indirect cost. Cost driver is the cost object.
Classification by behaviour: Variable, fixed and mixed cost. Cost driver is
volume/activity level.
Classification by function: Administrative cost, selling cost, distribution cost etc
FOUR types of costs for MANAGEMENT DECISION MAKING
1) Fixed Costs: Fixed cost is a cost where the Total remains constant
irrespective of volume change as long as it is within relevant range but its cost
per unit reduces asymptotically as volume increases.
2) Variable Costs: Variable cost is a cost where the Total changes in direct
proportion with volume change but its cost per unit remains constant.
3) Direct costs: are costs that are incurred specifically in order to make a
product such as costs directly related to purchasing them. Can be traced to
cost object.
4) Indirect Costs: are incurred generically in order to make it possible for the
company to sell the products, or simply to exist, such as management, sales
and finance expenses. Generally, they are not identifiable with the task of
obtaining the product. Can’t be traced to a cost object.
Sunk costs
Sunk costs are historical costs that have already been incurred and will not
make any difference in the current decisions by management. Sunk costs
are those costs that a company has committed to and are unavoidable
or unrecoverable costs. Sunk costs are excluded from future business
decisions.
BREAKEVEN
List FIVE ASSUMPTIONS of Breakeven analysis
(i) The total costs may be classified into fixed and variable costs. It ignores semi-
variable cost.
(ii) The cost and revenue functions remain linear.
(iii) The price of the product is assumed to be constant
(iv) Costs and sales revenue are affected only by the sales volume.
(v) The unit variable cost remains constant since the change in total variable cost is
considered to be proportionate to the output level.
(vi) The other factors such as efficiency, production and technology do not change
1) FC remains constant
2) Volume of sales and production are equal
3) Constant increase in total variable cost
BEP in units = TFC/SP – UVC
BE in sales ($) = BEP in units x SP
BE in sales ($) = FC/CM %age
CM %age can also be Revenue – VC/Revenue x 100
If you are to calculate BE in sales and you don’t have SP, VC or CM %age but have
VC %age, remember CM = SP – VC. SP in this case will be 100%
BEP = TF/(C/S)
c/s ratio is a complement of v/s ratio. Therefore c/s + v/s = 1
c/s = 1 – v/s
Cost driver in the breakeven point formula?
TFC/CM/U U = units is the cost driver
Breakeven is the point at which TC = TR
When TC>TR = Loss Zone
When TC<TR = Profit Zone
Cost Object
That which we wish to evaluate its performance. Any item for which costs are being
assigned and separately evaluated eg product, service, department, project etc.
Responsibility Centres
Are functional entities within a business that has its own goals and objectives,
dedicated staff, policies and procedures, and financial reports. A subset of a
business.
Types
Revenue Centre e.g. sales department. Metric for measurement – growth in turn
over, industry average
Cost centre e.g. procurement dpt. Metrics for measurement – cashflow budget,
actual cost compared to budget (Efficiency).
Profit centre – metrics for measurement include profit compared with budget,
contribution margin (CMR), absolute dollar of profit
Investment centre - is the highest level of responsibility. Measurement metric is
Return on asset, ROI
What type of function do accountants use to represent revenue?
Linear function.
Function
Revenue = SP x Quantity
R=pxX
Nature of Total revenue
The nature of Total revenue is an increasing function. While the nature of price is a
flat function.
What is revenue/unit?
Total Revenue/No of units sold
Types of costing methods
1) Full costing/Total costing method (3-line model) – useful in CFA
Revenue – Top line
Expenses (VC and FC) – Middle line
Profit/Loss – Bottom line
2) Marginal Costing method/Contribution Analysis Method (5-line model) –
useful in CMA
Revenue
Less TVC
Total contribution – increases with volume
Less TFC
P/L
Total Cost
TC = TFC + TVC
TC (y) = a + bx
a = TFC, b = variable cost/unit, x = no of units, bx = TVC
Profit
Profit = TR - TC
When is the use of Marginal Contribution appropriate?
1) When working under capacity
2) When there is stiff competition in the market
3) When a product is in the early stage of a product life cycle and there is still
demand for the product, therefore marketing efforts can be improved to raise
awareness of the product
4) When a company wants to decide whether or not to accept a special order
Conditions costs must satisfy to be relevant in making a decision
1) Must be a future cost/revenue
2) Must make a difference among alternatives i.e. if cost will still be incurred if a
decision is made or not so it doesn’t make any difference then it is not
relevant.
3) Must generate future cash flows
Contribution Margin
Total contribution = (TR)Sales – TVC
CM/U = SP – UVC
CM Ratio = CMU/SP/U
When volume increases, sales increase, VC increase and contribution increases
Margin of safety %= (target sales – bep sales)/target sales x 100
MOS in sales = Target sales – BEP Sales
MOS in units = Target units – BEP units
High and Low Level Method
Level Takes precedence
Level – x axis (Independent)
Amount – y axis (Dependent)
Change in cost/Change in level
Used to separate TFC from UVC.
TC = TVC + TFC
TFC = TC – TVC