Impact of Cost Classification on Profitability: A Detailed Report

This report examines the critical role of cost classification in business profitability, emphasizing the distinction between fixed and variable costs. It highlights how accurate cost classification is essential for effective pricing strategies and financial decision-making, particularly within labor-intensive industries like distilleries. The report analyzes the cost-volume-profit (CVP) analysis, including break-even points and sensitivity analysis, demonstrating how businesses can use these tools to assess profitability, make informed decisions about sales volumes, and manage financial risks. It underscores the importance of understanding management accounting concepts to enhance business performance, supported by references to relevant academic research and industry publications. The report stresses the practical applications of cost classification in optimizing business operations and achieving financial goals.

2.1
All businesses, irrespective of the nature of business, incur both fixed as well as variable costs,
classification of each cost incurred by the business is essential, so as to be able to assess the
profitability of the products manufactured by it and also to decide the pricing for the products
(Kaplan, Robert S., 2015). From the given case study, it is understood that management accounting
concepts are not fully utilized by the businesses to take business decisions, it is primarily due to the
lack of understanding of the concepts. Manufacturing units of gins or wine are more often than not
labor intensive industries, relying mainly on labor for the production activities and hence, salaries
account for a major chunk of the expenses of a distillery.
In case the business classify the cost incorrectly, i.e. a fixed cost as variable or vice versa, it would
have significant effect on the pricing of the goods manufactured as the fixed cost being loaded on a
good would mean that the good is overpriced and similarly skipping the loading of a variable cost to
a good would imply that good is underpriced and the company would end up making loss due to
manufacturing of the good.
2.2
An organisation’s primary aim is to cover the fixed cost and ensure that the contribution generated
by the goods sold is sufficient enough to cover fixed cost and then generate profit for the entity.
Cost-volume profit is the analysis of contribution generated by per unit of good sold and also on an
overall volume that the business operates at.
Short term economic decision of a manager is based on the sales volume data for the firm and the
amount of contribution expected from each unit sold. Profit is a function of total revenue and total
cost, total cost includes fixed cost and variable cost. Variable cost varies proportionately to the
quantity manufactured and fixed cost, as the name suggests remain fixed (Cynthia E. Bolt-Lee, 2016).
Thus, Profit = (Selling price – Variable cost)*Quantity sold – Fixed cost. The contribution margin per
unit is equal to Selling price-Variable cost, the quantity of goods required to be sold is equal to (Fixed
cost + profit)/Unit contribution margin.
The sales volume considered in the budgeting for break-even analysis and for analysis of profit, is
budgeted number and the actual sales volume could vary significantly. The managers usually prepare
a sensitivity analysis wherein, they consider various probable sales levels and analyse the profit/loss
at each probable level of sales.

References:
Kaplan, Robert S. (2015), Advanced Management Accounting (Online). Retrieved on 16th April, 2020,
Available on http://182.160.97.198:8080/xmlui/handle/123456789/494.
Cynthia E. Bolt-Lee (2016), Highlights of management accounting research. Retrieved on 16th April,
2020. Available on https://www.journalofaccountancy.com/issues/2016/dec/management-
accounting-research.html.
Etges, Ana Paula & Calegari, Rafael & Dos Santos Rhoden, Marisa Ignez & Cortimiglia, Marcelo.
(2016). USING COST-VOLUME-PROFIT TO ANALYSE THE VIABILITY OF IMPLEMENTING A NEW
DISTRIBUTION CENTER. Retrieved on 16th April, 2020. Available at
https://www.researchgate.net/publication/299282530_USING_COST-VOLUME-
PROFIT_TO_ANALYSE_THE_VIABILITY_OF_IMPLEMENTING_A_NEW_DISTRIBUTION_CENTER/
citation/download.
Seung Hwan Kim(November, 2015). Cost-Volume-Profit Analysis for a Multi-Product Company: Micro
Approach. Retrieved on 16th April, 2020. Available at
http://www.macrothink.org/journal/index.php/ijafr/article/view/6832.
Sadiq Rabiu Abdullahi, Bello Abiodun Sulaimon, Ibrahim Salihu Mukhtar and Muhammed Hardy
Musa (Feb, 2017). Cost-Volume-Profit Analysis as a Management Tool for Decision Making In Small
Business Enterprise within Bayero University, Kano. Retrieved on 16th April, 2020. Available at
http://iosrjournals.org/iosr-jbm/papers/Vol19-issue2/Version-1/G1902014045.pdf.