C. Short-term commercial decision-making Flashcards
(109 cards)
1
Q
What are relevant costs/revenues?
A
costs/revenues that change as a direct result of a decision taken
2
Q
What is the CIMA definition of relevant costs/revenues?
A
‘costs and revenues appropriate to a specific management decision;
-they are represented by future cash flows whose magnitude will vary depending upon the outcome of the management decision made’
3
Q
What are the features of relevant costs?
A
1) FUTURE COSTS
2) incremental/differential e.g attributable/specific fixed costs
3) they are CASH FLOWSs: not depreciation or amortisation
4
Q
What are avoidable costs?
A
the specific costs of an activity or sector of a business which would be avoided if that activity or sector did not exist
- relevant
e. g saved due to shut down
5
Q
Should variable costs be assumed as relevant costs?
A
yes, unless told otherwise
6
Q
Are apportioned head office costs relevant?
A
no
- would not be saved if operation shuts down
- attributable/specific
7
Q
What are examples of non-relevant costs?
A
sunk costs: already incurred
committed costs: past decision, cant be changed
fixed costs:if absorbed/charged/allocated/apportioned/avoidable
depreciation:not cash flow
notional costs
8
Q
How are fixed costs split between relevant and non-relevant?
A
relevant: extra, incremental
non-relevant:absorbed, charged, allocated, apportioned, notional
9
Q
What is a non-relevant cost?
A
costs that have already been incurred or committed
10
Q
What is an opportunity cost?
A
the best alternative that is forgone in taking the decision
-effects of cash flows on whole organisation
11
Q
What is a notional cost?
A
- similar to opportunity cost
e. g occupying premises instead of renting it out, if someone was willing to pay rent then it is a opp cost
12
Q
What are differential/incremental costs?
A
difference in total cost between alternatives, calculated to assist decision making
-incremental is useful if accountant wishes to highlight the consequences of taking sequential steps in a decision
13
Q
If additional labour cannot be hired for a special project, how is the relevant cost calculated?
A
contribution forgone + direct labour cost
14
Q
What are the potential relevant costs of non-current assets?
A
replacements cost of machinery
if not replaced, higher of sales proceeds and net cash flow from use (NRV)
15
Q
What should be maximised if there is just one limiting factor?
A
maximise contribution per unit of scarce resource
-the allocate to the products in order of priority
16
Q
Why is contribution per unit used, not profit?
A
as fixed costs are unaffected by production, and are left out of contribution
17
Q
What technique should be used if there is more than one limiting factor?
A
linear programming
18
Q
In a make or buy decision, how should products be selected?
A
ranked highest based on savings made per usage of the scarce resource
i.e buy-in cost less incremental cost of internal production
19
Q
If product is bought-in, what is the purchase cost classified as?
A
wholly marginal ie direct
20
Q
If manufactured, what costs should be compared during buy in vs make decision?
A
direct materials, labour and variable factory overhead
21
Q
When should a one-off order be accepted?
A
if selling price> relevant costs the order should be accepted
OR
compare contribution per scare resource
22
Q
What is a shutdown decision?
A
deleting a segment of the business
-likely absorption costing will be used
23
Q
When should a business be shutdown?
A
difference between forgone revenue < incremental cost savings from closure
24
Q
When is the minimum pricing decision used?
A
when there is:
- a lot of competition
- surplus productive capacity
- clearance of old inventories
- getting special order
- improving market shares
25
What is the minimum price that should be shared?
set at incremental costs of manufacturing, plus opportunity costs
26
How are the incremental and joint process costs treated in relevant costing?
incremental are relevant
| joint process are non-relevant as they are already sunk
27
What information is needed to determine whether or not joint products should be further processed?
- total cost of each of the additional processes
- unit selling price of each product
- unit selling price of each product before further processing
- % normal loss of each further process
- actual units of output of each product from the common process
28
What qualitative factors can affect decision making?
- state of the economy/inflation
- availability of cash
- effect of a decision on employee morale, schedules
- effect of a decision on long-term profitibility
- effect of a decision on a company's public image and reaction of customers
- likely reaction of competitors
29
Why are decision making processes more concerned with the impact on cash flow rather than the impact on profits?
cash flow is more objective and harder to manipulate than profits
-decisions made may have different impact on one than other which might affect stakeholders
30
Why are cash and profits different in the short term?
- some cash transactions don't affect profits e.g capital
- profits are calculated after deducting dep and NCAs. Depreciation is notional and doesn't affect cash flow
- cash flow is affected by the need to invest in working operational working capital i.e capital needed to complete day to day
31
Why do cash accounting and accrual accounting produce different profit figures on an income statement?
based on different assumptions about how revenues and costs are recorded in the income statement
32
Why is cash accounting generally not accepted as good accounting?
as businesses enter into transactions that are legally enforceable prior to the exchange of cash but use of cash accounting does not reflect any transactions which have taken place but are not yet paid for
-don't reflect non cash transactions
33
What happens to cash impact and profit impact in the long term?
they should become equal
34
Why might there be a conflict between decision making and performance management?
decision making:only consider relevant costs
| performance: based on total controllable costs, whether relevant or not
35
What is ethical decision making?
making decisions that go beyond purely financial /legal considerations and instead considers a much wider scope of stakeholder perspectives
36
What are some ethical issues a firm should consider when decision making?
- impact on staff: redundancies, retraining
- knock on effect on morale:other areas motivation
- customers:no service, image of product/business
- local community:housing, govt investment
- reputation of firm:signalling, inconsiderate
37
How does acting 'morally correct' help a business?
- lower business risk
- make organisation attractive to customers, collabs, partners
- more attractive to employees
- less time and cost spent on regulation
- less spent on fines and damages
38
What are the issues involved with acting ethically?
- strategy can be copied by rivals thereby taking away advantage of differentiation
- acting ethically typically adds costs to activities
- success often relies on trial and error
- international businesses may have to adopt different ethical approached in different markets lacking consistency
39
What does break even mean?
cover all costs without making profit
40
What is Cost-Volume-Profit analysis?
study of the effects on future profit of changes in fixed cost, variable cost, sales price, quantity and mix
-what -if? analysis
41
CVP analysis makes use of the contribution concept to assess what measures for a single product?
- C/S ratio
- breakeven point
- margin of safety
42
What is another term for a variable cost?
marginal cost
43
Why is contribution named so?
'contributes' towards fixed costs and profits as it covers them and any extra is profit
44
why is contribution more useful than profit?
contribution per unit does not change with volume
| profit per unit can change significantly as volume changes
45
How is the the C/S ratio calculated ?
contribution per unit/ sales per unit
OR
total contribution/total sales revenue
46
What is another name for the C/S ratio?
the Profit/Volume ratio (P/V)
47
What is the C/S ratio of a product?
the proportion of the selling price that contributed to fixed overheads and profits
48
After breakeven point, does profit accumulate more quickly for higher C/S or lower C/S products?
for higher
| -higher ratio means contribution grows more quickly with sales levels increase
49
What is the breakeven point?
total sales revenue = total cost
or
total contribution=fixed costs
50
How is the break even point calculated in units sold?
fixed costs/contribution per unit
51
How is the break even point calculated? (in sales revenue)
fixed costs/ C/S ratio
52
What is the margin of safety?
buffer between anticipated sales and budget before loss is made
53
How is the margin of safety, in units, calculated?
budgeted sales - breakeven point of sales
54
How is the margin of safety, in % of budgeted sales, calculated?
(budgeted sales - breakeven sales) x100%
| / budgeted sales
55
How is the expected profit calculated?
margin of safety (in units) x contribution p.u
56
What information can be gathered from a break even chart?
- TFC
- TC:TFC+VC
- TR
- break even units
- break even total revenue
- profit & loss
- margin of safety:budgeted- breakeven
57
What information is it difficult to obtain from the break even chart?
- contribution
| - exactly how much profit and loss made at each activity
58
How is a contribution break even chart different to a normal one?
VC line plotted instead of FC
| -can then read contribution at budgeted units (revenue - VC)
59
What is the profit-volume chart?
another form of break even bur profit/loss on y-axis instead of revenue
60
What information does the PV chart provide?
- breakeven point:x intercept
- fixed cost:y-intercept
- profit and loss:at given unit
- slope:C/S ratio
61
What does a steeper profit line on the PV graph indicate?
higher contribution per unit
| -as volume increases, profit increases faster
62
What changes can affect the break even point?
changing operational gearing
computerisation
mechanisation
63
What is operational gearing?
proportion of costs which are fixed
| -high FC:TC ratio means high gearing
64
How do you change operational gearing?
convert FC to VC
- e.g convert from salary to day rate
- reduces negative impact from fall in sales
65
How does operational gearing affect break even point of a firms with high and low gearings?
high gearing=
- high break even point
- more contribution will have to be earned to cover cost
- high C/S ratio:change in revenue has large impace on profit
low gearing=
- low breaking point
- perform better as sales fall e.g supermarket in recession
66
How does operational gearing affect the profit volume chart of high/low operational gearing firms?
high gearing:
- steeper line
- potential to make higher sales and profits
- would suffer huge losses as sales fall
low gearing:
- flatter line
- not much profit as units rise
- smaller loss if sales fall
67
When is a weighted average C/S used?
when an organisation produces and sells more than one product
68
How is the weighted average C/S ratio calculated?
total contribution/ total revenue
69
How is the break even point calculated from weighted average C/S ratio?
fixed costs/weighted average C/S ratio
70
What does CVP analysis assume when there are multiple products to be sold?
pre-determined sales mix will remain constant for all volumes of activity
71
How is revenue required to generate target profit caluclated?
(fixed costs + required profit)/weighted average C/S ratio
72
What do the two lines in a multi-product PV graph assume?
straight line:assumes constant mix
| bow shaped:company sells its most profitable product first, then next and so on
73
What is on the axis of a multi product PV graph?
cumulative profit (y) and cumulative revenue (x)
74
Where are the 2 break even points on the multi product PV graph?
- lower line at x:BE point if products are sold in the standard product mix
- upper line at x:BE point if products are sold in order of C/S ratio ranking
i.e when profit=0
75
How to draw multi product PV graph?
1. calculate C/S ratio of each product and rank
2. in rank, determine CUMULATIVE REVENUE and P/L as each product is sold
3. draw graph
4. start from fixed cost point and plot points for cumulative values
5. connect in bow shape
6. draw straight line from FC to end of bow shaped
76
Why does the bow shaped line get flatter?
as C/S ratio decreases for each product, gradient gets flatter
77
When is a higher break even point achieved between ranking products and a constant mix?
when products sold in a constant product mix
| -line crosses revenue axis later
78
What are the advantages of CVP?
- provides a target volume
| - helps understanding of costs and revenues and the relationship between them
79
What are the disadvantages of CVP analysis?
- profits can be affected by other factors besides volume
| - a small change in the assumptions could have a large change in the outcome
80
What are the assumptions that the CVP analysis is based on?
- linear relationship between TC and TR
- costs can be divided into fixed and variable elements
- TFC remains constant
- TVC is directly proportional to volume
- selling prices constant
- prices of the factors of production are to be unchanged e.g wages, materials, price
- efficiency and productivity are to be unchanged
- analysis either covers a single product or assumes mix will be maintained
- revenue and costs are being compared on a single activity basis
- volume is only relevant factor affecting cost
- volume of production equals the volume of sales, or changes in beginning and ending inventory levels are insignificant in amount
- multiple break even points can be confusing/misleading
81
What is sensitivity analysis?
effects of various types of changes on CVP model
- changing some of the constraints
- made easy with software, Excel
82
When do we use linear programming?
when there are two or more limiting factors (constraints)
83
What is linear programming?
technique that solves scarcity issue by maximising and minimising quantities
-model represents decision problem
84
Why are simultaneous equations used to solve linear programming?
each equation is a straight line
| -solving is same as finding intersection
85
How should each unit be valued in linear programming?
contribution per unit
86
What is the feasible region?
all the possible production combinations that the company may undertake
-area within all the constraints
87
What is the solution if the feasible region does not exist?
model has no solution
88
What is the profit line?
determines the outer most point of the feasible region i.e where the optimal point of production is
89
How is the profit line calculated?
- using simultaneous equations at vertex of feasible region then calculate contribution
- using iso-contribution line
90
What is another name for the profit line?
iso-contribution line
91
Applications of linear programming in airline industry?
products:
- what rates for different seats to charge
- different prices bring different contribution]
- find optimal breakdown of tickets at what price
constraints:
- routes, schedules, layovers:planning
- pilot sleep and schedule:pilot hours
- pilot fee
92
What is the aim of a minimisation problem?
finding the TC line touching the feasible region as close to origin as possible
93
What is slack?
remaining resources once scarce resources have been used up
| -under-utilised resources at optimum level
94
What is a scarce resource?
a constraint that has slack of zero
95
What is a surplus?
utilisation of a resource over and above a minimum
96
When do surpluses usually arise?
in minimisation problems
97
What are the binding constraint?
intersection of optimal points
| -no slack in the constraint lines
98
What are non-binding constraints?
lines that have slack
99
What is the shadow price?
maximum premium on price that the organisation would pay for the extra scarce resource
100
How is shadow price calculated?
extra contribution if one more unit of that scarce resource became available
101
Do non-binding constraints have a shadow price?
No as they are not scarce
102
What are the limitations of linear programming?
- linear relationships must exist
- needs one clearly defined objective function
- if many variables, becomes too complex to solve manually
- assumed that the variables are completely divisible
- single value estimated are used for the uncertain variables
- assumed that the situation remains static in all other respects
- only two products even though multiple scarce resources
103
How can Excel be used for linear programming?
- solver tool for LP
- 'What if' analysis for decision making and budgeting
- graphs and visualisations
104
What advantages can technology bring to decision makers?
- more complex scenarios with more data can be worked with
- quicker and more efficient
- using visualisations can make problems and solutions easier for decision makers to understand
- formulae and look up tables can be used so that if any figure is amended, all the figures recalculate (sensitivity analysis)
- results can be printed out or distributed to other users electronically quickly and easily
105
What are some issues with software?
- simple, off-the-shelf programmes may not have problem solving capabilities
- output will only be as good as the input i.e errors in data
- visualisations and graphs can give a simpler and quickly understood picture of information but it can hide much of the detail and subtleties in the raw data. Decision makers should not make decisions based on such simple sources
106
What type of qualitative data can be relevant to choosing the optimal product mix?
- customer value placed on a product
- competitor plans
- length of time that a particular resource will be scarce
- opportunities to use alternative resources through product redesign
- expected demand for a product
- ethical impacts of removing a product
107
What are the steps to LP graphical method?
1. Define variables
2. State objective function
3. State the constraints
4. Draw the graph
5. Find the optimum solution
108
How to calculate shadow price of contribution?
- difference in contribution
| - premium over price of scarce resource
109
How can the sales volume variance be broken down?
sales mix variance + sales quantity variance
