DECISION MAKING UNDER
(Availability of some history enables estimation
1. Probabilities are used to measure the likelihood that an event
or state of nature will occur
2. A probability distribution lists all possible outcomes for a
Which one of a choice of decision
alternatives should I take now when
the outcomes are dependent upon
events outside of my control
DECISION MAKING UNDER
(No past history, no probabilities)
DECISION MAKING UNDER UNCERTAINTY
Traditional and activity-based
costing for overheads
Contrasting activity-based costing and traditional overhead cost allocation
Types of cost systems
Direct costing systems:
1 .Indirect costs are not assigned to cost objects so that only
Activity-based profitability analysis
Applies ABC hierarchical activity classification to profitability analysis.
Used for attention directing claimed provides more accurate information.
Hierarchical approach can be applied to different cost objects (e
ABC, ABM, ABB
ABC is better than Absorption costing because it
allocates indirect costs on the basis of their usage of
So, using ABC gives a more accurate price (with cost
plus pricing), or a more accurate product profit if
A measure of how sensitive net income is to
percentage changes in sales.
With high leverage, a small percentage increase
in sales can produce a much larger percentage
increase in net income.
THE USE OF ABSORPTION COSTING
Each product will have a specified number of either
direct labour hours or direct machine hours in each
production department. Using the OARs above, it is
possible to calculate how much overhead should be
added to the direct
It is assumed that costs are matched to income, i.e.
there is no increase or decrease in stock levels over
It is not very useful for multi-product businesses as
different breakeven points are produced for
The percentage relationship of revenue
load carried to capacity available
Break-even load factor
The load factor required to equate total
traffic revenue with operating costs.
Break-even and load factors in the airline
In absorption costing,
all production costs are absorbed into products
and the unsold stock is valued at total cost of production.
In marginal costing,
only variable costs of production are allocated to products
Assumptions of CVP Analysis
Selling price is constant throughout
the entire relevant range.
Costs are linear throughout the entire
In multi-product companies, the sales
mix is constant.
In manufacturing companies,
inventories do not ch
APPLICATIONS OF CVP
Consider the following basic data:
Per unit Percent
Less: Variable cost 150
Fixed costs total
APPLICATIONS OF CVP
Current sales are 100,000. Sales manager feels
Target Profit Analysis
Suppose Falcon Cycles Ltd. wants to know how many bikes must
be sold to earn a profit of 100,000.
We can use our CVP formula to determine the sales volume
needed to achieve a target net profit figure.
500Q = 300Q +
Calculating overhead cost
Rate [data for illustration]
Indirect costs incurred by the business
Information about each
Information about each department
Step 1 Apportion costs over
Apportioning (sharing) c
CVP Relationships in Graphic Form
Viewing CVP relationships in a graph gives managers a
perspective that can be obtained in no other way.
Consider the following information for Falcon Cycles Ltd.:
The break-even point (BEP)
The point where total sales revenue
equals total expenses (variable and
The point where total contribution
margin equals total fixed expenses.
Break-even analysis can be approached
in two ways:
The Basics of Cost-Volume-Profit
CM is used
Contribution Margin (CM) is the amount remaining from
sales revenue after variable expenses have been
Points to remember: Falcon Cycles Ltd.
After covering fi
Data for use in illustration
Budgeted fixed production overhead
cost = 30,000 per month.
Budgeted production volume =10,000 units per month.
Budgeted sales = budgeted production volumes.
January to June
Production and sales were 10,000 per month as bud
Arguments for absorption costing
Since all costs are incurred with a view to create a product for
sale, all costs should attach to products until sold.
In the longer term, fixed overhead costs must be recovered
through sales if the business is to survive.
Contribution Margin Ratio
The contribution margin ratio is:
CM Ratio =
Contribution X 100
For Falcon Cycles Ltd. the ratio is:
200 X 100
At Falcon Cycles Ltd., each 1.00 increase
in sales revenue results in a total
contribution margin in
Table Statement of cost of a production item
Examples: In a manufacturing business:
Repair of machinery.
Rent of factory buildings.
Examples: In a service business:
Cost of transport to jobs.
Classification of Costs
Costs are frequently organised into groups
accumulation, analysis and control purposes.
Direct costs can be directly attributed to a cost object,
whilst indirect costs cannot. Example: direct material and
Output (number of
Total cost s)
Fixed cost of 2,000
plus variable cost of 10 per unit of output
and level of activity
Total cost in s
Alternative Cost Analyses
Behaviour of Cost (within the relevant range)
Total variable cost changes
as activity level changes.
Variable cost per unit remains
the same over wide ranges
Total Variable Cost
Your total telephone bill is based on how many minutes
Variable Cost Per Unit
The cost per minute talked is constant. For example,
30 pence per minute.
Management Accounting Why?
Stay in business - avoid insolvency
legal requirement - criminal offence to trade whilst
To plan for the future
marshal resources - make best use of assets i.e. invest
or expand with spare cash
indicator of good m
Cost Terms, Concepts, and
Cost: What is it?
The amount of resources, usually
measured in monetary terms,
sacrificed to achieve a particular
Is it Management Accounting?
Consider the following financial accounting profit and
What is Management Accounting
Management accounting provides information for
managers of an organization who direct and
control its operations.
Functions of MA:
Directing and Motivating
New Tools of Management Accounting
New tools for
The just-in-time approach (JIT)
Just-in-time manufacturing a methodical approach to reducing
machine set-up times,
- accepting only perfect incoming r
Definition of accounting
The process of
communicating financial information about
informed judgements and
decisions by users of the information.