CERTIFICATE LEVEL

Subject Fundamentals of Management Accounting (BA2)

K.Sivagar
Lecturer B.Sc (Hons), ACMA, CGMA

Module Tute 09 – Short-term Decision Making

Code BA2/KS/09
 Short-term Decision Making
Cost-Volume-Profit Analysis (Breakeven Analysis)
Marginal costing and short-term decision making
Marginal costs are variable costs which are considered relevant in decision making and obtaining
business information.

Contribution
The difference between the sales value and variable cost is known as “contribution” which is an
important factor in decision making.
Contribution = Sales value – Variable cost

Breakeven point
Breakeven point is the point at which business has neither profit nor loss (zero profit).
Fixed costs
Breakeven points in units =
Contribution per unit

Fixed costs
Breakeven points sales value =
Contribution to sales (C/S) ratio

Contribution
Contribution to sales (C/S) ratio =
Sales

The margin of safety

The margin of safety is the difference between the expected level of sales and the breakeven point.

Margin of safety in units = Projected sales – Breakeven sales

Projected sales – Breakeven sales

Margin of safety % =
Projected sales

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 Practice Question – 01
A company manufactures and sells a single product which has the following cost and selling price
structure.
$/Unit $/Unit
Selling price 120
Direct material 22
Direct labour 36
Variable overhead 14
Fixed overhead 12
84
Profit per unit 36

The fixed overhead absorption rate is based on the normal capacity of 2,000 units per month. Assume
that the same amount is spent each month on fixed overheads.
Budgeted sales for next month are 2,200 units.
Calculate the following:
i. The breakeven point, in sales units per month
ii. The margin of safety for next month
iii. The budgeted profit for next month
iv. The sales units required to achieve a profit of $96,000 in a month

Breakeven Charts
There are three charts which could be used for breakeven analysis purpose.
1. Traditional/conventional breakeven chart
2. Contribution breakeven chart
3. Profit volume chart (PV chart)

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Traditional/conventional breakeven chart
For example;
Selling price - £50 per unit
Variable cost - £30 per unit
Fixed costs - £20,000 per month
Forecasted sales - 1,700 units per month

• Sales revenue at 1,700 units = £50 X 1,700 = £85,000

• Total cost for 1,700 units = (£30 X 1,700) + 20,000 = £71,000
• Breakeven point in units = £20,000/(£50 - £30) = 1,000 units

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The contribution breakeven chart

• Total variable cost for an output of 1,700 units = £30 X 1,700 = £51,000

Profit-volume chart

The limitations of breakeven (or CVP) analysis

• Costs are assumed to behave in a linear fashion.
✓ Unit variable costs are assumed to remain constant.
✓ Fixed costs are assumed to be unaffected by changes in activity levels.
• Sales revenue are assumed to be constant for each unit sold.
• It is assumed that activity is the only factor affecting costs, and factors such as inflation are ignored.
• The charts can only be applied to a single product or service.

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The economist’s breakeven chart
From economist’s point of view the assumptions made by the accountant are not realistic. Therefore,
the economist’s breakeven chart may have more than one breakeven point.

Limiting Factor Analysis

A limiting factor is any factor which is in scarce supply and which limits the organisation’s activities.
Example: material, labour, machinery, sales volume etc.

When the business does not have adequate resources to fulfill the quantity demanded the decision of
what to produce (optimal production plan) will be made by comparing the “contribution per unit of
limiting factor” earned by the products.

Following steps should be followed to establish the optimal production plan which is the profit
maximizing production mix.
1. Identify the limiting factor
2. Calculate the contribution per unit for each product
Selling price per unit – Variable cost per unit
3. Calculate the contribution per unit of limiting factor for each product
Contribution per unit
Amount of limiting factor required per unit

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4. Rank the products according to their contribution per unit of limiting factor
5. Allocate the limiting factor to the highest-ranking product
6. Once the demand for the highest-ranking product is satisfied, move on to the next highest-ranking
product and so on until the (limiting factor) scarce resource is used up

Practice Question – 02
Following is the budget of Y plc for the quarter ending 30/09/2020

A B C D
Products
Demand (units) 5000 8000 10000 2000
Selling price ($) 100 80 40 120
Per unit ($)
Direct Mat X ($5/kg) 20 15 10 25
Direct labour 20 10 13 15
Variable overhead 10 15 2 25

Fixed overheads $415,000

The purchasing manager has confirmed the availability of material X is limited to 58,000 kg.

Requirement:
Identify the optimal production plan.

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 Relevant Costing
Organisations face many decisions, and they usually must choose between two or more alternatives.
Decisions will generally be based on taking the decision that maximizes shareholder value, so all decisions
will be taken using relevant costs and revenues.

Relevant costs and revenues are those costs and revenues that change as a direct result of a decision
taken. Relevant costs and revenues have the following features.
• They are future costs and revenues
• They are incremental
• They are cash flows

Relevant costs
1. Opportunity cost-This is the amount foregone as a result of selecting the best alternative against
the next best alternative.
2. Avoidable cost-These are specific costs of an activity, which could be avoided if that activity is
discontinued.
3. Differential/Incremental cost-This is the additional cost incurred as a result of selecting an
alternative.
4. Material, labour, overheads etc.

Non-relevant costs
1. Sunk cost-A cost that is already spent and will have no change as a result of the decision to be
made.
2. Committed cost-This is a future cash flow that would be incurred irrespective of whatever the
decision is. Normally the committed cost may exist as a result of a legal contract already agreed
into.
3. Notional cost-This is a cost used in accounting or performance evaluation to represent the cost
using resources which may not have an actual cash flow.
4. Non-cash flow costs or items such as depreciation.
5. Common costs-These are the costs that would anyway be incurred, whether or not the decision
is made to accept the project.
E.g: General fixed cost

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Relevant cost of materials
If a material used for a new product, we should identify whether this material is already in stock or not
following sequence of questions can be used to identify the relevant cost.

Are materials already in

inventory?
No

Cost of purchase
Yes
Will they be replaced? No

Will they be used for other

Yes purposes?

Replacement cost

Yes No

Contribution from Net Realisable value

alternative use

Practice Question - 03
Z Ltd has 50 kg of material P in inventory that was bought five years ago for $70. It is no longer used but
could be sold for $3/kg.
Z Ltd is currently pricing a job that could use 40 kg of material P.
The relevant cost of material P that should be included in the contract is $ …………………..

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Relevant cost of labour
When making a decision on a new project we should identify whether the labour requirement is already
available in the company or not. Following sequence of questions would apply.

Does spare capacity exist?

Yes
Nil cost unless overtime
No worked or extra labour
hired, when cash outlay
Can extra employees be No
hired?
Yes
Contribution from
alternative products which
Cost of hiring
must be abandoned to
create spare capacity

Practice Question - 04
(a) 100 hours of unskilled labour are needed for a contract. The company has no surplus capacity at
the moment, but additional temporary staff could be hired at $4.50 per hour.
What is the relevant cost of the unskilled labour on the contract?

(b) 100 hours of semi-skilled labour are needed for a contract. There is at the moment 300 hours
worth of spare capacity. There is a union agreement that there are no lay-offs. The workers are
paid $6.50 per hour.
What is the relevant cost of the semi-skilled labour on the contract?

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Relevant cost of overheads
1. Variable overheads-This is relevant cost since it is incremental as well as avoidable.
2. Fixed overheads,
i. Specific fixed overheads-These are relevant since they are incremental cost.
ii. General fixed overheads-Not relevant since this cost would continue to exist whether or
not the project is undertaken.
iii. Absorbed fixed overheads-Not relevant since it arrives as a result of internal cost
allocations.

Practice Question - 05
JB Ltd absorbs overheads on a machine hour rate, currently $20/hour, of which $7 is for variable
overheads and $13 for fixed overheads. The company is deciding whether to undertake a contract in the
coming year. If the contract is undertaken, it is estimated that fixed cost will increase for the duration of
the contract by $3,200.
Identify the relevant costs of the fixed and variable overheads for the contract.

Relevant cost of non-current assets

The relevant cost associated with non-current assets, such as plant and machinery, are determined in a
similar way to the relevant cost of materials.
• If plant and machinery is to be replaced at the end of its useful life, then the relevant cost is the
current replacement cost.
• If plant and machinery is not to be replaced, then the relevant cost is the higher of the sale
proceeds (if sold) and the net cash inflows arising from the use of the asset (if not sold)

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Practice Question - 06
A machine which cost $10,000 four years ago has a written down value of $6,000 and the depreciation
to be charged this year is $1,000. It has no alternative use, but it could be sold now for $3,000. In one
year’s time it will have no resale value.
Relevant cost of the machine = $

Make or Buy Decisions

Businesses may be faced with the decision about whether to make components or products themselves
(in-house) or to obtain these from outside suppliers.

Relevant costing principles are applicable when making the make or buy decisions.

• If spare capacity exists:

The relevant cost of making the product in-house = the variable cost of internal manufacture plus
any fixed costs directly related to that product

• If no spare capacity exists:

The relevant cost of making the product in-house = the variable cost of internal manufacture plus
any fixed costs directly related to that product plus the opportunity cost of internal manufacture
(e.g. lost contribution from another product).

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Practice Question – 07
XYZ manufactures three components (A, B and C) All the components are manufactured using the same
general-purpose machinery. The following production cost data are available, together with the
purchase prices from an outside supplier.
Production cost: A B C
$ $ $
Direct material 14 20 10
Direct labour 24 13 12
Variable overhead 8 7 8
Allocated fixed overhead 9 6 4
Total 55 46 34
Purchase price from outside supplier 54 50 28
Identify which components should be manufactured in-house and which components should be
purchased from the outside supplier.

Practice Question – 08
Same information as practice question – 07, further details of A, B and C are now available:
A B C
Machine hours per unit 2 5 4
The external price of C has risen to $42. Manufacturing requirements show a need for 1,500 units of
each component per week. The maximum number of general-purpose machinery hours available per
week is 15,000.
Which components should be purchased from the outside supplier?

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 Objective Test Questions
1. A company makes a single product which it sells for $10 per unit. Fixed costs are $48,000 per month
and the product has a contribution to sales ratio of 40%. In a month when actual sales were
$140,000, A Co’s margin of safety, in units, was:
A. 2,000
B. 12,000
C. 14,000
D. 20,000

2.

Profit/loss
($)

0 C
Level of Activity
L
B
D

In the above profit volume chart, the contribution at level of activity L can be read as:
A. Distance A
B. Distance B
C. Distance C
D. Distance D

3. Data concerning K Co’s single product is as follows.

$ per unit
Selling price 6.00
Variable production cost 1.20
Variable selling cost 0.40

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 Fixed production cost 4.00
Fixed selling cost 0.80

Budgeted production and sales for the year are 10,000 units.
It is now expected that the variable production cost per unit and the selling price per unit will each
increase by 10%, and fixed production costs will rise by 25%.

What will the new breakeven point be, to the nearest whole unit?
A. 8,788 units
B. 11,600 units
C. 11,886 units
D. 12,397 units

4. Crasher Co budgets to make and sell 4,000 units of product. The selling price of the product is $7.
This price was calculated using the following unit cost information.
Variable cost $2.60
Fixed cost $1.10
Total $3.70
Calculate the margin of safety ratio of Crasher’s Co’s sales (as a percentage of budgeted sales). The
margin of safety ratio is ……………….% of budget.

5. S Co manufactures a single product V. Data for the product are as follows.

$ per unit
Selling price 40
Direct material cost 8
Direct labour cost 6
Variable production overhead cost 4
Variable selling overhead cost 2
Fixed overhead cost 10
Profit per unit 10
The profit/volume ratio for product V is:
………………………….%

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6. F Scuttle Co has fixed cost of $50,000 per annum. The company sells a single product for $25 per
unit. The contribution to sales ratio is 40%.
What is the breakeven point in revenue?
$..............................

7. Product N generates a contribution to sales ratio of 20%. Annual fixed costs are $80,000. The selling
price per unit is $50. The break even point, in terms of units sold per annum is:
A. 96,000
B. 400,000
C. 480,000
D. 8,000

8. Which THREE of the following statements concerning cost-volume-profit (CVP) analysis are true?
A. Changes in inventory levels are ignored
B. Only one product at a time can be analysed on a breakeven chart
C. A change in the estimate of fixed costs will alter the slope of the line on a profit-volume (PV)
chart
D. A change in the selling price per unit will alter the slope of the line on a P/V chart
E. An assumption is made that variable costs per unit are the same at all levels of output

9. Marker Co makes a single product, the Whizzo. This product sells for $10, and makes a contribution
of $5 per unit. Total fixed costs per annum are $12,518.
If Marker Co wishes to make an annual profit of $8,982, how many Whizzos do they need to sell?
………………………… units
10. A single product company has a contribution to sales ratio of 40%. Fixed costs amount to $90,000
per annum. The selling price per unit is $25.
The number of units required to break even is:
A. 9,000
B. 36,000
C. 150,000
D. 225,000

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11. B Co manufactures and sells a single product, with the following estimated costs for next year.
Unit cost
100,000 units of output 150,000 units of output
$ $
Direct materials 20.00 20.00
Direct labour 5.00 5.00
Production overheads 10.00 7.50
Marketing costs 7.50 5.00
Administration costs 5.00 4.00
47.50 41.50
Fixed costs are unaffected by the volume of output.
B Co’s management think they can sell 150,000 units per annum if the sales price is $49.50.
The breakeven point, in units, at this price is:
A. 36,364
B. 90,000
C. 101,020
D. 225,000
12.

$
A C
D
B

X Units

In the above breakeven chart, the contribution at level of activity X can be read as:
A. Distance A
B. Distance B

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 C. Distance C
D. Distance D

The following information relates to questions 13, 14 and 15.

Fast fandango Co manufactures a single product, the FF, which sells for $10. At 75% capacity, which is
the normal level of activity for the factory, sales are $600,000 per period.
The cost of these sales are as follows.
Direct cost per unit $3
Production overhead $156,000 (including variable costs of $30,000)
Sales costs $80,000
Distribution costs $60,000 (including variable costs of $15,000)
Administration overhead $40,000 (including variable costs of $9,000)
The sales costs are fixed with the exception of sales commission, which is 5% of sales value.

13. The contribution per unit of product FF is:

$.................

14. The fixed cost per period is:

$.................

15. The breakeven volume of sales per period is ………………. Units.

16. Lime Co makes a single product and incurs fixed production costs of $90,000 per month and fixed
selling costs of $240,000 per year. Budgeted sales revenue for June is $200,000 and budgeted
contribution for June is $80,000.
What is the breakeven sales revenue for June?
$........................

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17. A company manufactures three products, details of which are as follows.
Product J Product K Product L
$per unit $per unit $per unit
Selling price 140 122 134
Direct materials ($2/kg) 22 14 26
Other variable cost 84 72 51
Fixed cost 20 26 40
In a period when direct material is restricted in supply, the ranking of the products in terms of the
most profitable use of the material is:
First product ………………………
Second product ………………………
Third product ………………………

18. SIM Co manufactures three products, the selling price and cost details of which are given below.
Product A Product B Product C
$ $ $
Selling price per unit 375 475 475
Costs per unit
Direct materials ($5/kg) 50 25 75
Direct labour ($4/hour) 80 120 100
Variable overhead 40 60 50
Fixed overhead 120 180 150
In a period when direct materials are restricted in supply, the most and least profitable uses of
direct materials are:
Most profitable Least profitable
A. B C
B. C A
C. B A
D. C B

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19. A company makes a single product for which standard cost details are as follows.
$ per unit
Direct material ($8 per litre) 72
Direct labour ($7 per hour) 49
Production overhead 56
Total production cost 177
The product is perishable and no inventories are held.
Demand for next period will be 2,000 units but only 16,000 litres of material and 15,000 hours of
labour will be available. The limiting factor(s) next period will be:
A. Material only
B. Labour only
C. Material and labour
D. Neither material nor labour

20. TTT Co makes three products. All three use the same machine, which is available for 125,000 hours
per period.
The standard costs of the products per unit are as follows.
Product T1 Product T2 Product T3
$ $ $
Direct labour:
Machinists ($11 per hour) 55 33 66
Maximum demand (units) 9,000 8,000 11,000
The deficiency in machine hours for the next period is………………..hours.

21. FEEB manufactures two products, the FE and EB, using the same material for each.
Annual demand for the FE is 10,000 units, while demand for the EB is 7,000 units.
The variable production cost per unit of FE is $15, while that of the EB is $21. The FE requires 1.5 kg
of raw material per unit, and the EB requires 2 kg of raw material per unit. Supply of raw material
will be limited of 25,000 kg during the year.

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 A subcontractor has quoted prices of $24 per unit for the FE and $27 per unit for the EB to supply
the product. How many units of each product should FEEB manufacture in order to maximise
profits?
FE: ……………….units
EB: ……………….units

22. J Co manufactures three products, details of which are as follows.

Product K Product L Product M
$ per unit $ per unit $ per unit
Selling price 105 133 133
Direct materials ($3/litre) 15 6 21
Direct labour ($8/hour) 24 32 24
Variable overhead 9 12 9
Fixed overhead 23 50 42
In a period when direct labour is restricted in supply, the most and least profitable use of labour are:
Most profitable Least profitable
A. K M
B. L K
C. M K
D. M L

23. A company makes three products, to which the following budget information relates.
B A T
Selling price 100 120 145
Labour at $20 per hour 40 40 60
Materials at $10 per kg 10 20 30
Fixed overheads 30 40 20
Profit 20 20 35
The marketing department stays that maximum annual sales are 1,000 units of product B, 1,200
units of product A and 1,500 units of product T. The factory has budgeted to make that number of
units. It has just been discovered that next year materials will be limited to 5,000 kg and labour to
10,000 hours.

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 If the company wishes to maximise profit, the priority in which the products should be made and
sold is:
A. B, A, T
B. A, B, T
C. T, A, B
D. T, B, A

24. A company makes three products and has produced the following standard cost cards.
X Y Z
$ per unit $ per unit $ per unit
Selling price 100 80 70
Variable costs
Material 20 30 5
Labour 30 10 5
Fixed overheads 40 10 40
Profit 10 30 20
The same labour is used to make all three products, but in different quantities.
In a month when expenditure on labour is restricted to $50,000, what is the maximum contribution
that can be earned?
Assume that the company can make and sell any combination of products.
$ ………………………

25. When using limiting factor analysis in order to calculate maximum profit, which THREE of the
following assumptions should be made?
A. Fixed costs per unit are not changed by changes in production
B. Fixed costs in total are not changed by changes in production
C. Variable costs per unit are not changes by changes in production
D. Variable costs in total are not changed by changes in production
E. Sales demand, prices and resources required for each product are known with certainty

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26. A company makes three products, to which the following budgeted information relates.
B A T
Selling price 100 120 145
Labour at $20 per hour 40 40 60
Materials at $10 per kg 10 20 30
Fixed overheads 30 40 20
Profit 20 20 35
The marketing department stays that maximum annual sales are 1,000 units of product B, 1,200
units of product A and 1,500 units of product T. Budgeted production levels for the year are the
same as maximum annual sales.
It has just been discovered that materials will be limited to 5,000 kg per year. The company does not
hold any finished inventory. The products have been correctly ranked by contribution per kg as
follows:
B A T
Contribution per unit ($) 50 60 55
Kg of material per unit 1 2 3
Contribution per kg of material ($) 50 30 18.3
Rank by contribution per kg of 1 2 3
material
Calculate the maximum profit for next year.
$......................

27. A company manufactures three products X, Y and Z.

Product X Product Y Product Z
$ per unit $ per unit $ per unit
Variable cost 5.00 16.00 10.00
Fixed cost 4.00 16.60 7.50
Total unit cost 9.00 32.60 17.50

The fixed costs are an allocation of general fixed overheads. A supplier has offered to supply the
components at the following prices:
Component X $8

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Component Y $14
Component Z $11
Which products should be purchased externally?
A. Components X and Y
B. Components Y only
C. None of the components
D. All of the components

28. V Co manufactures three products which have the following selling prices and costs per unit.
V1 V2 V3
$ $ $
Selling price 30.00 36.00 34.00
Costs per unit
Direct materials 8.00 10.00 20.00
Direct labour 4.00 8.00 3.60
Overhead
Variable 2.00 4.00 1.80
Fixed 9.00 6.00 2.70
23.00 28.00 28.10
Profit per unit 7.00 8.00 5.90
All three products use the same type of labour.
In a period in which labour is in short supply, the rank order of production is:
1st: V ……..
2nd: V ……..
3rd : V ……..

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The following information relates to questions 29, 30 and 31.
A company makes three products. All three sue the same machine, which is available for 50,000 hours
per period. The standard costs of the products per unit are as follows.
Product A Product B Product C
$ $ $
Direct materials 70 40 80
Direct labour:
Machinists ($8 per hour) 48 32 56
Assemblers ($6 per hour) 36 40 42
Total variable cost 154 112 178
Selling price per unit 200 158 224
Maximum demand (units) 3,000 2,500 5,000
Fixed costs are $300,000 per period.

29. The deficiency in machine hours for the next period is …………… hours.

30. In order to determine the priority ranking of the products, it is necessary to calculate the
contribution per machine hour (as machine hours are the limiting factor). State your answers to 2
decimal places.
Contribution per machine hour (Product A) = $ ……………………..
Contribution per machine hour (Product B) = $ ……………………..
Contribution per machine hour (Product C) = $ ……………………..

31. If the optimum production plan includes manufacturing 2,500 units of product B, this product will
generate a contribution of (to the nearest $):
$ …………………………..

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32. Jump Co currently makes and sells three products with costs per unit as follows.
Spring Ping Ting
$ $ $`
Direct material 6 9 7
Direct labour 15 12 15
Allocated fixed overheads 10 12 12
Directly attributable fixed 5 2 3
costs
Jump Co is considering whether it would be financially worthwhile to buy the products instead of
making them and a supplier has offered to make the products for the following prices:
Spring Ping Ting
Selling price ($) 27 24 23

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