Limitations of Accounting

Description

Description: This course will equip students with an understanding of key costs and managerial accounting techniques used in costs control, costs management and planning; and limits to accounting and planning for crises.

Background: Cost-volume-profit analysis is a powerful tool for managerial decision making. Managers need to estimate future revenues, costs, and profits to help them plan and monitor operations. They use cost-volume-profit (CVP) analysis to identify the levels of operating activity needed to avoid losses, achieve targeted profits, plan future operations, and monitor organizational performance. Managers also analyse operational risk as they choose an appropriate cost structure.

Cost-volume-profit (CVP) analysis is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to plan future levels of operating activity and provide information about:

• Which products or services to emphasize
• The volume of sales needed to achieve a targeted level of profit
• The amount of revenue required to avoid losses
• Whether to increase fixed costs
• How much to budget for discretionary expenditures
• Whether fixed costs expose the organization to an unacceptable level of risk

Profit Equation and Contribution Margin

CVP analysis begins with the basic profit equation.

Profit = Total revenue - Total costs

Separating costs into variable and fixed categories, we express profit as:

Profit = Total revenue - Total variable costs - Total fixed costs
The contribution margin is total revenue minus total variable costs. Similarly, the contribution margin per unit is the selling price per unit minus the variable cost per unit. Both contribution margin and contribution margin per unit are valuable tools when considering the effects of volume on profit. Contribution margin per unit tells us how much revenue from each unit sold can be applied toward fixed costs. Once enough units have been sold to cover all fixed costs, then the contribution margin per unit from all remaining sales becomes profit. If we assume that the selling price and variable cost per unit are constant, then total revenue is equal to price times quantity, and total variable cost is variable cost per unit times quantity. We then rewrite the profit equation in terms of the contribution margin per unit.

Profit = this equation:

P×Q-V×Q-F=(P-V)×Q-F
Where:
P = Selling price per unit
V = Variable cost per unit
(P _ V) = Contribution margin per unit
Q = Quantity of product sold (units of goods or services)
F =Total fixed costs

Author

Sentinel | 9

90 Courses