Managerial Accounting: Cost-Volume-Profit Analysis and Applications

This document provides a comprehensive solution to a managerial accounting assignment, addressing various key concepts and practical applications. The solution covers topics such as cost analysis, relevant costing, cost-volume-profit (CVP) analysis, and decision-making. It includes detailed calculations and explanations for problems related to profit maximization, break-even point analysis, and the evaluation of different costing methods. The assignment also explores the importance of distinguishing between direct and indirect costs, variable and fixed costs, and the application of techniques like activity-based costing (ABC) and benchmarking. Furthermore, it delves into the principles of total life cycle costing and Kaizen costing, providing a thorough understanding of managerial accounting principles and their impact on business decisions.

RUNNING HEAD: MANAGERIAL ACCOUNTING
Management Accounting

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Question 1
1.1
i. The action of reducing the staff salaries in order to cut the cost for resolving the
purpose of maximizing the owner’s wealth cannot achieve the purpose fully. Reason
being, cutting down the salaries of employees may lead to maximizing of wealth and
saving of cost but the management will not be able to retain its employees anymore.
Instead of this, management must focus on increasing its capital investments as this is
directly related to wealth maximization (Lumby & Jones, 2003).
ii. A general conclusion can be made about the goals of the business and its stakeholders
that the business’s objective must be increasing the wealth of its shareholders and
working in their best interest. Value creation should be the goal for business as well as
for the shareholders.
1.2
The managers are part of the management and are responsible for the smooth functioning of
the organization. They are held responsible for taking important decisions and making
successful strategies. Also managers are there for planning in advance the future course of
actions for the business. In order to fulfil all such duties and perform all such functions,
managers required complete information about the accounts and financial performance of the
company. They have the power to access the confidential financial data in order to perform
their duties. This is the reason they are treated well than the other groups.
Question 2
2.1

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Under historical cost concept, the price of the asset is based on its original value and the
method does not takes into account the current market value of the asset. For taking decisions
about the future of an asset, considering its historic cost is wrong because it does not show
the true value of the company. Moreover, the concept lead to the insufficient provision for
depreciation as the amount of the provision may not be sufficient enough for replacing the
cost. There are other demerits also and because of such disadvantages, it will be better not to
consider historic cost of the asset while taking decisions about its future (Maheshwari, 2012).
2.2
Opportunity cost: It is basically a benefit or a form of profit that is forgone by an investor,
individual or a business for choosing one alternative over the other. Generally, it is not shown
in the financial reports but businesses use this concept to make appropriate decisions related
to relevant costs (Holtzman, 2013).
Sunk cost: It is a cost incurred by a company which cannot be recovered any longer in
future. These are not considered while taking investment decision because such costs cannot
be recovered. In place of these costs, relevant costs are considered. For example, cost on
research and development, market research cost and many more.
Committed cost: It is similar to sunk cost to some extent and is referred as the investment
made by the company which cannot be recover by any means even if the company got
dissolved. For example, cost incurred on acquiring a machine and the contract of its repairs
and maintenance (Kinney, Raiborn & Poznanski, 2011).
Question 3
3.1

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A variable cost changes in total as and when the production level changes but per unit
variable cost remains the same. Reason being, it is directly proportional to the volume of
production and increases in the same ratio as the production increases. While on the other
hand, the fixed cost in total remains constant at all the levels of productivity but per unit cost
changes. This is due to the inverse relationship between the fixed cost and volume of
production. As and when the units increases, fixed cost gets spread among them and thus the
per unit cost changes.
3.2
XYZ Ltd produces three types of products for which the sales, estimated cost and production
data is given below:
Fixed cost of the company are £250,000 and the limiting factor is raw material, the supply of
which is limited to 50,000 kg in the period.
Product Chair Table Stools
Units 7000 6500 4500
Per unit data (£)
Selling Price 100 150 110
Variable Cost
Direct Material (£5 per
kg) 20 45 35
Direct Labour (£3 per
hour) 10 20 15
Other variable overheads 10 15 10
Total Variable cost (£) 40 80 60

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Contribution per unit (£) 60 70 50
Material used per unit 4 9 7
Contribution per kg (£) 15 7.78 7.14
Production Ranking 1st 2nd 3rd
Selecting the product on the basis of highest contribution per unit will not consider the
contribution of the various products in relation to their usage of limiting resource. As a result
of which, this approach fails to maximize the profits.
3.3
Usually, the labour cost per unit remains constant but it changes due to the following factors:
 The change in unit labour cost is highly generated from the efficiency of the workers.
An organization may pay higher to the most efficient worker according to its
efficiency to work as compare to the amount paid to the less efficient worker. So,
efficiency is one of the factor which for the per unit labour cost to change.
 Another factor is the pay received by the workers for their overtime. Bonus and
incentive given by the organization also fluctuates the total labour cost per unit.
Question 4
4.1
As the business provide only one standard service, it is very important to distinguish between
the direct and indirect cost as it will help the business to evaluate its inventory properly.
Moreover, a proper accounting control of the company can be established and the prices of
goods can be defined accurately (Drury, 2005).

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4.2
The statement is not true as there are some direct cost which are fixed and some indirect cost
which are variable. For example, salary paid to a supervisor for producing X item is a fixed
direct cost as the cost object is identifiable. Similarly, power cost at the factor which
produces X item and Y item can be a variable indirect cost because as and when the
production increases, the cost also increase but cannot be traceable (Drury, 2005).
4.3
Direct labour hour basis is generally used in the labour intensive cost centre where most of
the overhead is covered of labour related cost. However, most of the production methods
used machines also, which makes this method inappropriate and illogical. It is a logical basis
only for the companies which are labour intensive (Lal, 2009).
Question 5
5.1
Following are the reasons for the non-popularity of ABC in UK:
 Absence of relevance for the firm’s business.
 Lack of support from management.
 Shortage of resources and expertise required for ABC (Al-Sayed, Abdel-Kader &
Kholeif, 2008).
5.2
Principles that underpin total life cycle costing approach are:
 The basic premise of the approach is to trace the cost and revenues on the product
over several years.

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 Accumulating the cost and the revenue through the entire life cycle of the product.
 Principle is to focus on development cost that are incurred to individual products.
5.3
Kaizen is a Japanese term which means continuous improvement. Kaizen costing is important
for the business for following reasons:
 Discover the problems at initial stage and solve them instantly.
 Reduces the wastage.
 Better utilization of employees and production capacity.
 Modification of existing procedures.
 Focusing on continuous improvements (Bragg, 2010).
5.4
Benchmarking means comparing the performance of an organization with the ones that are
considered as the industry leaders. It is very beneficial for the business as it tells the
management about the weak and strong point of the organization and help them in taking the
correct actions for improving the performance.
Principles of benchmarking include principle of use, collaboration, reciprocity,
confidentiality, preparation, leadership, communication and transparency (Rolstadås, 2012).
Question 6
Part 1
Relevant cost for the new
project
New Project
X 20*£9 (Rep. cost) £ 180.00

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Y (200*£10) + (30*£12) £ 2,360.00
Total Cost £ 2,540.00
Part 2
Peeping Tom Contract
Component A (30*1800) + 5% £ 56,700.00
Component B 6*2200 £ 13,200.00
Component C 20*1600 32000
Less: (40*1600)*10% 6400
£ 25,600.00
Additional Materials £ 2,800.00
Labour 100*35
(£50-£15) £ 3,500.00
Inspection Labour Hours 50*7.99
(£6*133.33%) £ 399.50
Minimum price £ 102,199.50
Working notes:
Note 1: Component A is widely used and use on this contract required to be replaced.
Therefore the original cost of the contract is irrelevant and business will be worse off if used
by replacement cost on the contract.
Note 2: The disposal cost of the component B is irrelevant because if the contract is not
undertaken then existing inventories must be disposed off. Whereas, if it is taken then there
will be surplus component which also requires to be disposed off.
Note 3: The relevant cost for Component C will be the addition cost incurred by undertaking
the contract. Thus, the relevant cost will be cost incurred on components if contract is taken
less the cost incurred on same if the contract is not taken.

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Note 4: The actual wages are not relevant because the workers will be employed for the same
number of hours if the contract is undertaken. Therefore, there will be a loss of revenue from
other activities. Also total R&D cost is not relevant.
Question 7
Given information
April May
Sales units 500 620
Sales Revenue (£) 25000 31000
Cost (£) 15000 16200
Operating profit (£) 10000 14800
Part A
Sales price per
unit
April 25000/500 £ 50.00
May 31000/620 £ 50.00
Part B
Increase in cost 16200-15000 1200
Increase in sales units 620-500 120
Variable cost per unit 1200/120 £ 10.00
Part B
Increase in cost 16200-15000 1200
Increase in sales units 620-500 120
Variable cost per unit 1200/120 £ 10.00
The only reason for increase in cost is the rise in variable cost caused by higher volume
Fixed Cost Total cost -Variable cost
April [£15000 - (£10*500)] £ 10,000.00
May [£16200 - (£10*620)] £ 10,000.00
Total fixed cost £ 20,000.00

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Per month £ 10,000.00
Part C
Break Even point Fixed cost / Contribution
Fixed cost (per month) £ 10,000.00
Contribution £ 40.00
BEP (units per
month) 250
Part D
Breakeven point help the company to know about the link between the fixed cost, variable
cost and sales revenue so that proper assessment and planning can be done. It also helps in
assessing the risk on time as it tells about the minimum number of units to be produced and
sold at which the company will be having no profit and no loss. If the company sells below
BEP, then there will be a loss and if it sells above BEP then there will be a profit. This is why
knowledge about BEP is very much necessary for the business.
Part E
Contribution margin ratio
Sales per unit £ 50.00
Variable cost per unit £ 10.00
Contribution per unit £ 40.00
Contribution margin ratio =
(Contribution/sales ) 80%
Contribution margin basically shows the amount of sales revenue covered by variable cost.
For Rennes Ltd, the contribution margin ratio is 80% which means a small fluctuation in the
sales will have a big impact on the profit and loss of the business.

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For example: If a company sold 500 units in May which are above BEP of 250 units then the
profit will be:
Sales (500*£50) 25000
Variable cost (500*£10) 5000
Contribution 20000
Fixed cost 10000
Profit 10000 (250*£40 contribution each)
Part F
Margin of Safety
April May
Sales units 500 620
BEP units 250 250
Margin of Safety 250 370
MOS (%) 50% 60%
Margin of Safety gives an indication of loss to the business which may occur due to change
in sales. For Rennes Ltd. in order to make loss, the company have to reduce its sales by 50%
in April and by 60% in May. As of now, the business is well reserved from the unexpected
fall in its sales forecast.
Question 8
Part 1: Smith Ltd.
Product A B C
Selling price per unit (£) 140 180 240
Variable cost per unit (£) 80 100 90
Contribution per unit (£) 60 80 150
Machine time per unit 5 10 15
Contribution per limiting factor (£) 12 8 10
Ranking 1st 3rd 2nd
Monthly demand (in units) 90 100 80
Machine Hours are limited to 850 hours per month

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Combination of products
Product Total Hours
A = 90*5hrs 450
C = 26*15hrs 390
B = 1*10hrs 10
Note: In order to maximize the profit the company must produce all the 90 units of Product A
and after that due to the limited machine hours, 26 units of product C and 1 unit of Product B
should be produced.
Part 2: Lorient PLC
The point where the contribution per limiting factor is equal, the products will be equally
profitable.
Contribution per unit of Product X
Selling price per unit £ 60.00
Variable cost per unit £ 30.00
Contribution per unit £ 30.00
Material per unit 9
Amount of limited resource per Product X (kg) 0.75
Contribution per kg £ 40.00
Product Y Z
Use of limited resource
(kg) £12/£12 = 1 £15/£12 = 1.25
Required Contribution 1 x 40 = £40.00 1.25 x 40 = £50.00
Required Price
40+15+6+12+12 =
£85.00 50+20+3+15+16 = £ 104.00
Question 9
Part A
Direct Materials 200000
Direct labour 700000