REVIEW

• Managerial Accounting referred to as internal accounting.

• It provides information to managers whose decisions and actions
determine the success or failure of an organization.
- Cost-volume-profit (CVP) analysis is a method for analyzing the
relationships among cost, volume, and profits.
- managers use these relationships to plan, budget and make decisions.
 Profit Planning
Companies must earn profits to stay in business. Managers
want to increase profitability and therefore need to predict
how their actions will affect profits.
Cost-volume-profit (CVP) analysis
- is a method for analyzing the relationships among cost,
volume, and profits.
- managers use these relationships to plan, budget and make
decisions.
- first step, classifying costs according to behavior
Cost Behavior
A cost is classified as either fixed or variable, according to
whether the total amount of the cost changes as activity changes.
Activity - general term denoting anything that the company does
include units of product sold or produced, hours worked, invoices
prepared, and parts inspected.
Volume - common measure of activity.
Contribution Margin
• contribution margin is the difference between selling price per unit
and variable cost per unit
• the term often is used to denote total contribution margin, the
difference between total sales and total variable costs
• contribution margin percentage is per-unit contribution margin
divided by selling price, or total contribution margin divided by total
sales
Unit Costs
• fixed cost remain the same at different levels of activity
• average fixed cost per unit changes whenever volume
changes
• additional profit at the higher level of activity is simply
the result of spreading the fixed cost over a larger
number of units.
 Cost Behavior
• Previous illustration shows an increase in profit because only its variable
costs increase and its fixed cost remain constant.
• Failing to recognize that average total per-unit cost changes as activity
changes creates a problem for managers who - unwisely - use averages to
predict future costs. Managers should not use the average total per-unit
cost for one level of activity to predict total cost at another level. What
appears to be additional profit per unit at the higher level of activity is
simply the result of spreading the fixed costs over a larger number of units
 Cost Behavior
• Supposed that a manager uses the P885.71 average total cost per unit (at
7,000 units) that is 2,000,000 / 7,000 = P285.71 + P600 (VC) = P885.71 to
predict costs at a volume of 8,000 units. The predicted cost is P7,085,714.3.
Cost Behavior
• previous illustration shows that costs has not
changed at all; variable costs remain at 60% of sales
and fixed costs remain at P2,000,000. Using average
total cost per unit to predict total costs works only if
all costs are variable.
Relevant Range
• range of volume over which it can reasonably expect
selling price per unit, variable cost and total fixed
cost to be constant.
Operating Leverage
• leverage - smaller object used to move a larger
object
• Operating leverage = contribution margin/profit
Operating Leverage
• Operating leverage is a cost-accounting formula that
measures the degree to which a firm or project can
increase operating income by increasing revenue. A
business that generates sales with a high gross margin
and low variable costs has high operating leverage.
Target Return on Sales
• Managers might also state a profit target as an ROS
( profit divided by sales).
• Example if company X wishes to earn a 15% ROS. If variable cost is
60% of sales. Therefore, it wants 75% of its sales to cover variable
costs and profit, leaving 25% to cover fixed cost.
• Sales, in peso, to achieve target ROS
• = Fixed Cost / Contribution Margin % - target ROS %
Changing Plans
• The concept of contribution margin and target profit are useful when
managers are contemplating changes in plans in hope of increasing
profits.
• Example:
• An increase in advertising, with the expectation of increasing sales.
Changing Plans

• Sample Illustration: Company X's marketing manager has

proposed an advertising campaign that will cost P500,000 and
is expected to increase sales by 2,000 units. How many
additional units they must sell to make the additional
advertising pay off? Note: CM = P400
Changing Plans

• Sample Illustration: Company X's marketing manager has

proposed an advertising campaign that will cost P500,000 and
is expected to increase sales by 2,000 units. How many
additional units they must sell to make the additional
advertising pay off? Note: CM = P400
• Solution:
• Additional sales required = P500,000 / P400 = 1,250 units
Target Costing
• is a planning technique used to help decide whether to enter new
market or bring out a new product
• the essence of target costing is to determine how much the company
can spend to manufacture and market a product, given a target profit
• the price and volume are estimated first, then that cost
• Example if target profit is P15,000,000 and the unit volume of
100,000 is achievable at P1,000 price, how much is the allowable
cost?
Solution

• Revenue (100,000 x P1,000) P100,000,000

• Target profit (15,000,000)
• Total allowable cost P 85,000,000
Activity: Compute for Target Selling Price
• Company X's target is P500,000 per month and it expects to sell 6,000
backpacks per month. Remember that Company X's variable costs are
P500 to purchase a backpack, P50 for packing and shipping and a 5%
sales commission. Thus, per-unit variable cost is P550 plus 5% of
selling price. Note: Fixed cost = P2,000,000
TFC + Target profit
Price = + unit variable cost
unit volume