6 CHPT 7&amp 8

Slide 7.
Chapter 7 Cost–volume–profit analysis
LEARNING OUTCOMES
You should be able to
distinguish between fixed costs and variable costs

and use this distinction to explain the relationship
between costs, volume and profit;
prepare a break-even chart and deduce the break-

even point for some activity;
discuss the weaknesses of break-even analysis;
demonstrate the way in which marginal analysis

can be used when making short-term decisions.
Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 6th Edition, © Pearson Education Limited 2008
Slide 7.2
The behaviour of costs
Costs may be broadly

classified as follows:
Those that stay fixed (the

same) when changes occur
Fixed to the volume of activity
Those that vary according

Variable to the volume of activity
Slide 7.3
Graph of fixed cost(s) against the volume of activity
Cost
(£)
0
Volume of activity (units of output)
Slide 7.4
Graph of rent cost against the volume of activity
Rent
cost
(£)
0 Volume of activity (units of output)
Slide 7.5
Graph of variable costs against the volume of activity
Cost
(£)
Slide 7.6
Graph of electricity cost against the volume of activity
Electricity The slope of this line

cost gives the variable cost
(£) per unit of activity
Fixed
cost
element
Slide 7.7
Graph of total cost against the volume of activity
Cost
(£) Total costs
Variable
costs
F
Fixed costs
0
Slide 7.8
Break-even chart
Total sales
Cost revenue
(£)
Break-even
point o f it
Pr
Total costs
Variable
costs
oss
L
F
Fixed costs
0
Slide 7.9
Calculating the break-even point
b= Fixed costs
Sales revenue per unit – Variable costs per unit
Slide 7.10
Break-even and load factors in the airline industry

Load
100% factor
%
Break-
80 83 85 even
73 76
60 63 64
40
20
0
Ryanair BA easyJet
Slide 7.11
Break-even chart for Cottage Industries’ basket-

making activities without the machine
it
r of
P
5
Cost Break-even
(£000) point Total
4
costs
2
Total
1 revenue
o ss
L Fixed costs
0
100 200 300 400 500
Volume of activity (number of baskets)
Slide 7.12
Break-even chart for Cottage Industries’ basket-making

activities with the machine
Cost it
o f
(£000) Pr
6 Total
costs
5
Break-even
4 point
3
s Fixed costs
s
2 Lo
Total
revenue
1
0
100 200 300 400 500 600
Volume of activity (number of baskets)
Slide 7.13
BA’s margin of safety and operating profit, 2003 to 2007

11.0 Margin of safety 1,100
Margin of safety (as a percentage of break-even point)
Operating profit
10.0 1,000
10.1
Operating profit (£ million)

9.0 900
8.0 8.4 8.3 800
7.0 700
694
6.0 6.3 600
602
5.0 540 500
4.0 400
4.2 405
3.0 300
295
2.0 200
1.0 100
0 0
2003 2004 2005 2006 2007
Slide 7.14
The effect of operating gearing
Volume of
output
Profit
Slide 7.15
Profit–volume chart
Profit
(£)
Break-even
point Profit
Volume of activity
0 (units of output)
Fixed Loss
costs
Loss
(£)
Slide 7.16
Weaknesses of break-even analysis
Three general problems
Non-linear
relationships
Stepped fixed costs
Multi-product
businesses
Slide 7.17
Marginal analysis
Can be used for the following

short-term decisions:
Accepting/rejecting special contracts
The most efficient use of scarce resources
Make-or-buy decisions
Closing or continuation decisions
Slide 7.18
Chapter 8 Full costing
LEARNING OUTCOMES
You should be able to
discuss the usefulness of deducing the full cost

of a unit of output for decision-making purposes;
deduce the full cost of a unit of output in both a

single-product and a multi-product environment
using the traditional full cost method;
discuss the problem of charging full costs to jobs

in a multi-product environment;
explain the role and nature of activity-based costing.
Slide 7.19
Uses of full costs by managers
Assessing
relative
efficiency
Pricing and Uses of Exercising

output control
decisions full costs
Assessing
performance
Slide 7.20
Direct and indirect costs
Categories
of costs:
Costs that can be identified with

specific cost units – the effect of
Direct costs the cost can be measured in
respect of each particular output
These are all other costs, that is,

Indirect costs those that cannot be directly
or measured in respect of each
particular unit of output
overheads
Slide 7.21
Direct and indirect costs in practice
A survey of 176 fairly large UK

businesses, conducted during 1999,
revealed that, on average, total costs of
businesses are in the following
proportions:
Direct costs 70 %
Indirect costs 30 %
Slide 7.22
The relationship between direct costs and

indirect costs
Fair share of
Direct costs
indirect costs
of the unit
(overheads)
Full cost of the unit
Slide 7.23
The relationship between fixed costs, variable

costs and total costs
Fixed Variable
costs costs
Total (or full) costs
Slide 7.24
The relationship between direct, indirect,

variable and fixed costs of a particular job
Fixed Variable
costs costs
Indirect costs
(overheads) Total (or full)
cost of a
particular job
Direct costs
Slide 7.25
How the full cost is derived for the sail made by

Marine Suppliers Ltd in Activity 8.5
Overheads
Apply the
Ascertain the Derive a suitable overhead
total overhead absorption rate
overheads for absorption rate (based on the
Marine for the business specifics of the
Suppliers Ltd as a whole job, for example
for the period direct labour
hours)
A particular
sail (job)
Direct costs
Direct labour Direct materials

Cost of direct labour Cost of direct materials
for the sail to make the sail
Slide 7.26
Dealing with overheads on a departmental basis
Reasons for dividing a business

into departments:
Many businesses are too large and

complex to be managed as a single unit
Each department normally has its own area of

specialism and is managed by a specialist
Each department can have its own accounting

records that enable its performance to be
assessed
Slide 7.27
A cost unit (Job A) passing through the production

process
Preparation Paintshop Finishing Customers

department department department
Job A
Costs accumulated
* Direct
* Any further * Any further
materials
direct costs direct costs
* Direct
* A share of * A share of Full cost
labour
* A share of
the
+ the
paintshop + the
finishing = of the
job
department’s department’s
preparation
overheads overheads
department’s
overheads
Slide 7.28
Analysis of the number of cost centres within a business
UK businesses (%)
40
36
30
29
20
21
14
10
0 6–10 11–20 More than

Less than 6
cost cost cost 20 cost
centres centres centres centres
Slide 7.29
Deriving the cost of one cost unit where production is

in batches
The full cost of the

batch, delivered on
a ‘job-costing’ basis
divided by
The number of cost

units (products) in
the batch
equals
The full cost of one

cost unit (product)
Slide 7.30
The current full costing environment
Capital-intensive and
machine-based production
A high level of overheads

relative to direct cost
Highly competitive
international market
Slide 7.31
Traditional versus activity-based costing

Traditional approach
Overheads are first assigned to Overheads are then allocated to cost
product cost centres units using an overhead recovery rate
Product cost Cost centre overhead Products

centre 1 recovery rate 1
Total AB C D
Product cost Cost centre overhead
overheads
Product cost Cost centre overhead

ABC approach
Overheads are first assigned to Overheads are then assigned to cost units
cost pools using cost driver rates
Activity cost pool 1 Activity cost driver rate 1 Products

Total Activity cost pool 2 Activity cost driver rate 2 A B C D
overheads
Activity cost pool 3 Activity cost driver rate 3
Activity cost pool 4 Activity cost driver rate 4

Slide 7.32
Analysis of businesses (by size) using or considering ABC

Pilot Active Considering
90%
80% 16%
70%
29%
32%
44%
60%
50%
52%
40% 36%
34%
30% 24%
20%
10% 20% 22% 19%

18%
TOTAL Under $100M $100M–$1B Over $1B

(528) (213) (168) (125)
Slide 7.33
Analysis of businesses (by industry) using or considering ABC

Pilot Active Considering
90%
80% 22% 16%

70% 32% 41% 29% 36%
60%
50%
46%
40% 58%
34% 24% 29%
32%
30%
20%
22% 24% 23%

10% 20% 17%
12%
Total Financial Communications Manufacturing Public Other
(528) services (213) (43) (126) sector (78) industries (188)

6 CHPT 7&amp 8

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6 CHPT 7&amp 8

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Slide 7.

Chapter 7 Cost–volume–profit analysis

distinguish between fixed costs and variable costs

prepare a break-even chart and deduce the break-

discuss the weaknesses of break-even analysis;

demonstrate the way in which marginal analysis

The behaviour of costs

Costs may be broadly

Those that stay fixed (the

Those that vary according

Graph of fixed cost(s) against the volume of activity

Graph of rent cost against the volume of activity

0 Volume of activity (units of output)

Graph of variable costs against the volume of activity

0 Volume of activity (units of output)

Graph of electricity cost against the volume of activity

Electricity The slope of this line

0 Volume of activity (units of output)

Graph of total cost against the volume of activity

Calculating the break-even point

Break-even and load factors in the airline industry

Break-even chart for Cottage Industries’ basket-

Break-even chart for Cottage Industries’ basket-making

BA’s margin of safety and operating profit, 2003 to 2007

Operating profit (£ million)

8.0 8.4 8.3 800

The effect of operating gearing

Weaknesses of break-even analysis

Three general problems

Stepped fixed costs

Can be used for the following

Accepting/rejecting special contracts

The most efficient use of scarce resources

Closing or continuation decisions

Chapter 8 Full costing

discuss the usefulness of deducing the full cost

deduce the full cost of a unit of output in both a

discuss the problem of charging full costs to jobs

explain the role and nature of activity-based costing.

Uses of full costs by managers

Pricing and Uses of Exercising

Direct and indirect costs

Costs that can be identified with

These are all other costs, that is,

Direct and indirect costs in practice

A survey of 176 fairly large UK

The relationship between direct costs and

Full cost of the unit

The relationship between fixed costs, variable

Total (or full) costs

The relationship between direct, indirect,

How the full cost is derived for the sail made by

Direct labour Direct materials

Dealing with overheads on a departmental basis

Reasons for dividing a business

Many businesses are too large and

Each department normally has its own area of

Each department can have its own accounting

A cost unit (Job A) passing through the production

Preparation Paintshop Finishing Customers

Analysis of the number of cost centres within a business

0 6–10 11–20 More than