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HEC: MCA > 1. Contribution Margin Analysis > Flashcards

1. Contribution Margin Analysis Flashcards

1
Q

What are the three broad purposes of accounting?

A
  1. Internal reporting to managers - for use in planning and controlling routine decisions (focus of this course)
  2. Internal reporting to managers - for use in making non-routine decisions and in formulating major plans and policies (part of this course)
  3. External reporting to - shareholders, government and other outside parties, for use in investor decisions, tax collections, employee needs - meeting external legal and regulatory requirements (not part of this course)
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2
Q

Management accounting and Financial accounting differ in terms of:

A
  • Type of information
  • Frequency of information
  • Content of information
  • Verification of information
  • Regulation of information
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3
Q

What is the general uses of management and financial accounting?

A

Management → Planning, controlling, decision-making
Financial → Reporting

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4
Q

What are the characteristics of management accounting?

A
  • Future oriented
  • Financial and non-financial
  • Decision-making, control and planning
  • Time horizons are flexible: hourly, daily, weekly, monthly, etc
  • Not so standardised or regulated
  • Internal parties
  • Prepared to meet specific needs (strategy)
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5
Q

What are characteristics of financial accounting?

A
  • Reports on past performance
  • Annual (regular) financial statements
  • Highly aggregated
  • Highly regulated: company law, IFRS, GAAP, professional standards, audit
  • External parties’ evaluation of company
  • Prepared to meet regulatory standards
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6
Q

What is cost accounting?

A

Focus on cost accumulation and assignment, the undercurrent of any system.

  • Provides information for both management and financial accounting
  • Measures and reports financial and non-financial data that relates to the cost of acquiring or consuming resources by an organization
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7
Q

Why is management and cost accounting important?

A
  • Measures organizational performance
  • Needed to value inventory (product costing)
  • Helps implement relevant cost controls
  • Provides basis for profitability analysis
  • Assists managers in decision making in present
  • Aids in planning and budgeting for future activities
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8
Q

How can we define costs?

A

Cost is a resource sacrificed or forgone to achieve a specific objective.

  • Usually measured as the monetary amount that must be paid to acquire goods and services
  • Term is rarely used without an add-on: “cost of materials”, “cost of production”, “cost of goods sold” - labor, materials, machinery
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9
Q

What are some ways of classifying costs?

A

Behavior, traceability, timing of charge to income (depends on decision)

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10
Q

What does it mean to classify costs according to their behavior?

A

Classifying based on how they behave when activity (volume or output) changes (–> Fixed/variable)

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11
Q

What are fixed costs?

A

Fixed costs remain constant over a wide range of activity and are not affected by a change in activity levels

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12
Q

What are variable costs?

A

Variable costs change in direct proportion to the level of activity

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13
Q

What is the cost driver when we classify costs based on behavior?

A

Volume of activity

Total costs = Fixed costs + Variable cost per unit * Volume of activity

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14
Q

What is CVP analysis used for?

A

To know at what level of activity the company will not lose money from operations (BEP)

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15
Q

In what ways can the BEP be expressed?

A
  • Number of units sold
  • Sales euros
  • Etc
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16
Q

What is the profit equation in CVP analysis?

A

Contribution margin per unit * Quantity - Fixed costs

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17
Q

What is the equation for the BEP?

A

Fixed costs / contribution margin per unit

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18
Q

What is the equation for CVP with a target profit?

A

(Fixed costs + target profit) / Contribution margin per unit

19
Q

What does the contribution margin per unit show?

A

Indicator of how much money per unit the company is generating to cover fixed costs.

20
Q

If we want to lower the BEP (more quickly reach a profit-making point), we can:

A
  • Increase the selling price
  • Lower the fixed costs
  • Lower the variable cost per unit
21
Q

What are some possible limiting factors?

A
  • Demand
  • Skilled labor
  • Raw materials
  • Machine time
22
Q

What are the two decisions a company must make in the short term?

A
  • What is the best way to use the resources available?
  • How to maximize contribution when resources are scarce/constrained?
23
Q

What are the non-routine decisions (short-term) brought up in this class?

A
  • Product mix decisions
  • Special order/pricing decisions
  • Outsourcing (make-or-buy) decisions
  • Discontinuation decisions
24
Q

What does it mean to use contribution margin as a decision making criteria?

A

Choose the product that yields the highest contribution margin per unit

25
Q

What do we do in CVP for multiple products?

A

Construct a composite-product that assumes a stable product mix and uses weighted averages to calculate a unique BEP.

26
Q

How can a firm relax constraints/limiting factors?

A

A firm may be able to relax a constraint by, for example:

  • Paying overtime to labor per hour (if labor hours are the constraint)
  • Paying for additional machine hours (if that’s the constraint)

These are opportunity costs: the maximum a firm is prepared to pay to go beyond their current scenario

27
Q

What are opportunity costs?

A

These are opportunity costs: the maximum a firm is prepared to pay to go beyond their current scenario

28
Q

What can be said about product mix in the long term?

A

In the long-term, product mix decisions are crucial strategic issues where many factors play a role:

  • Economies of scope (synergies)
  • Costs of heterogeneity and complexity
  • Value to the customer/retention
  • Overall brand value and position
29
Q

What is the key concept for relevant costs for decision making?

A

“For decision making, only expected future cash flows that will differ under some or all of the alternatives available should be considered”

30
Q

What are the relevant costs for decision making?

A

Focus on the things that change between decisions, or that haven’t already happened:

  • Costs that differ - differential costs: RELEVANT
  • Costs that adjust - incremental costs: RELEVANT
  • Costs avoidable in some alternatives: RELEVANT
31
Q

What are irrelevant costs for decision making?

A

Don’t focus on things that will not change in the future, or that have already happened:

  • Costs that must be paid regardless are committed: IRRELEVANT
  • Costs that have been incurred already are sunk: IRRELEVANT
  • Fixed costs are commonly treated as irrelevant, but some may be avoidable
  • Historical costs are irrelevant but may be used to predict future costs
32
Q

What are special order/pricing decisions about?

A

One-off orders, from customers outside the firm’s main market, often at a price less than prevailing market price

33
Q

What are examples of variable manufacturing overhead?

A

sales, commissions, fuel or energy, production supplies, hourly wages for receiving/handling

34
Q

What are examples of fixed manufacturing overhead?

A

salaries of production managers, rent, utilities, insurance, depreciation of plant and equipment used in production

35
Q

What are some qualitative/strategic aspects of special orders?

A
  • Are last minute orders from usual customers likely?
  • How do special orders affect the prevailing market price and customer relationships?
  • Are there no preferable alternative uses of the spare capacity?
  • Is the excess capacity going to become permanent?
36
Q

What are some aspects of long-term thinking about special orders?

A

Decisions that appear good in the short term may prove sub-optimal in the long term:

  • Increasing range of products via special orders increases complexity, and thus, in the longer term, costs
  • Accepting/rejecting repeat or multiple special orders should not be treated as a series of independent short-term decisions, but as a combined long-term one
37
Q

What is the basic question behind outsourcing decisions?

A

Should a firm source goods or services from external suppliers vs. producing them internally?

Maximize value chain of business functions to produce:

  • Better customer value for equivalent cost
  • Equivalent customer value for a lower cost

Tradeoff between price, time, quality

38
Q

What are examples of non-manufacturing overheads?

A

SG&A for marketing, legal, distribution, HR, IT, finance/accounting

39
Q

What are the qualitative/strategic aspects of Make in outsourcing?

A

Good:

  • Control over processes and products
  • Independence

Bad:

  • Rigid structure
  • Possible inefficiencies
  • Quality issues
40
Q

What are the qualitative/strategic aspects of Buy in outsourcing?

A

Good:

  • Focus on key competences
  • Leaner structure
  • Improved value

Bad:

  • Performance risk
  • Relational risk
  • Other costs of uncertainty and coordination
41
Q

What are discontinuation decisions about?

A

Adding or deleting product lines or segments

42
Q

What are some problems with cost behaviours?

A

Volume as a cost driver

  • Assumption that costs vary mainly in relation to volume… But there are many other cost drivers

Time as a crucial variable

  • Depending on the time horizon, what counts as fixed and what counts as variable changes

Shifting cost structures

  • Cost structures move towards the ends of a continuum between entirely fixed or variable costs
  • Complex organizational environments make it difficult to detach fixed from variable costs
43
Q

What are other factors to have in mind before making a recommendation about short-term decisions?

A
  • Beware simple/single person model decisions
  • Aligning decisions with overall firm strategy (market growth, cost leader, etc)
  • Changing the risk profile of the company
  • How will customers be affected
  • Loss of goodwill; product interdependencies
  • Employee motivation, company culture
  • Environmental impact
44
Q

What is the BEP?

A

Where the activity (units produced and sold) generates enough contribution to cover all fixed costs

HEC: MCA (4 decks)

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