COST VOLUME PROFIT ANALYSIS

The break-even point

 The break-even point is the point in the volume of activity where the organization’s revenues and
expenses are equal.

Contribution Margin Approach

Formula for break-even volume:

Formula for break-even point in sales dollars rather than units by using contribution-margin ratio

BUDGETARY PLANNING

Budget

 A formal written statement of management’s plans for a specified future time period, expressed in
financial terms
 Primary way to communicate agreed-upon objectives to all parts of the company
 Promotes efficiency
 Control device- important basis for performance evaluation once adopted

Role of Accounting

 Historical accounting data on revenues, costs, and expenses helps in formulating future budgets
 Accountants normally responsible for presenting management’s budgeting goals in financial terms
 The budget and administration are however, entirely management’s responsibility

Benefits of Budgeting

1. Budget provide a means of communicating management’s plans throughout the organization

2. Budgets force managers to think and plan for the future. In the absence of the necessity to prepare a
budget, too many managers would spend all of their time dealing with daily emergencies
3. The budgeting process provides a means of allocating resources to those parts of the organization where
they can be used most effectively
4. The budgeting process can uncover potential bottlenecks before they occur. In short it serves as an early
warning device
5. Budgets coordinate the activities of the entire organization by integrating the plans of the various parts
6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent
performance

*A BUDGET IS AN AID TO MANAGEMENT NOT A SUBSTITUTE FOR MANAGEMENT

Essentials of Effective Budgeting

 Depends on sound organizational structure with authority and responsibility for all phases of operations
clearly defined
 Based on research and analysis with realistic goals
 Accepted by all levels of management

Length of Budget Period

  May be prepared for any period of time
Most common – 1 year
Supplement with monthly and quarterly budgets
Different budgets may cover different time periods

 Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations
 Continuous twelve-month budget
Drop the month just ended and add a future month
Keeps management planning a full year ahead

Budgeting Process

 Based budget goals on past performance

Collect data from organizational units
Begins several months before end of current year
 Develop budget within the framework of a sales forecast
Shows potential industry sales
Show’s company’s expected share

Factors considered in Sales Forecasting:

1. General economic conditions

2. Industry trends
3. Market research studies
4. Anticipated advertising and promotion
5. Previous market share
6. Price changes
7. Technological developments
 Usually informal in small companies
 Assigned to a budget committee in larger companies
Include the president, treasurer, chief, accountant (controller), and management personnel from
each major area of company
Review board where managers defend budget goals and requests

Budgeting and Human Behavior

 May inspire higher levels of performance or discourage additional effort

 Depends on how budget developed and administered
 Invite each level of management to participate

This “botoom-to-top” approach is called Participative Budgeting

Participative Budgeting

 Advantages:
1. More accurate budget estimates because lower level managers have more detailed knowledge of
their area
2. Tendency to perceive process as fair due to involvement of lower level management
 Overall goal – produce budget considered fair and achievable by managers while still meeting corporate
goals
 Risk of unrealiable budgets greater when they are “top-down”
  Disadvantages:
1. Can be time consuming and costly
2. Can foster budgetary “gaming” through budgetary slack
situation where managers intentionally underestimate budgeted revenues or
overestimate budgeted expenses so that budget goals are easier to meet

Flow of budget data from lower management to top levels

President
Vice President Production

Manager Plant A Manager Plant B

Department Department Department Department

Manager Manager Manager Manager

Budgeting and Long Range Planning

3 Basic Difference between the Two

1. Time period involved

 Budgeting – short term usually 1 year
 Long-range Planning – usually at least 5 year
2. Emphasis
 Budgeting – short term goals
 Long-range Planning – long term goals, select strategies to achieve goals
3. Detail presented
 Budgeting – very detailed
 Long-range Planning – contain less detailed

The Master Budget

 A set of interrelated budgets that constitutes a plan of action for a specified time period
 Contains two classes of budgets:
1. Operating Budgets – individual budgets that result in the preparation of the budgeted income
statement - establish goals for sales and production personnel.
2. Financial Budgets – the capital expenditure budget, the cash budget, and the budgeted balance sheet -
focus primarily on cash needs to fund operations and capital expenditures

The Master Budget – Components

Sales Budget  Production Budget Operating Budget

Direct Materials Direct Labor Manufacturing

Budget Budget OH Budget
Selling and
Administrative Expense Budget  Budgeted Income Statement

Capt. Expenditure Cash Budgeted

Financial Budget
Budget Budget Balance Sheet
NOTE: Cash Budget should be prepared first to compute budgeted income statement, to estimate the interest
expense to be included.