Management Accounting Lecture Notes

Introduction

• Last class covered an introduction to management accounting and fundamental concepts of cost.
• Discussed cost-volume relationships and types of costs:
  • Fixed Costs
  • Variable Costs
  • Semi-variable Costs

Cost Behavior with Volume

• Total cost = Total fixed cost + Variable cost (dependent on volume).
• Cost volume graph constructed to visualize cost behavior.
• As volume increases, average fixed cost per unit decreases due to spreading of fixed costs.

Relevant Range

• Cost behavior is valid only within a relevant volume range (e.g., 100 to 200 units).
• Outside this range, fixed costs may change due to operational needs (e.g., needing more machinery).

Revenue Volume Relationship

• Important to also understand revenue behavior with volume:
  • Total revenue = Unit selling price × Number of units sold.
• Aim is to determine the minimum volume required for a viable business.

Break-even Analysis

• Break-even volume: where total revenue equals total cost.
• Formula for break-even volume:
  • Break-even volume = Total fixed cost / (Unit revenue - Unit variable cost)
• Graphically, the break-even point is where total cost line intersects with total revenue line.

Profit Per Unit and Operating Leverage

• Average profit per unit increases with volume due to fixed cost spreading.
• Operating leverage: indicates how sensitive profits are to changes in volume due to fixed cost structure.
• Example of leverage: 25% increase in volume leading to 125% increase in profit (leverage factor of 5).

Contribution Margin

• Contribution margin = Unit selling price - Unit variable cost.
• This margin remains constant irrespective of volume.
• Break-even volume can also be calculated using contribution margin:
  • Break-even volume = Total fixed cost / Contribution margin.

Factors Affecting Profit

• Four basic ways to increase profit:
  1. Increase selling price.
  2. Decrease unit variable cost.
  3. Decrease total fixed cost.
  4. Increase sales volume.
• Homework: Analyze effects of 10% changes in these factors on revenue and cost.

Multiple Products Consideration

• The cost-volume-profit relationship holds good for multiple products if:
  • Each product has the same contribution margin.
  • Product mix remains constant.
• Otherwise, each product must be treated as a separate entity.

Definition and Measurement of Cost

• Cost is a monetary measure of resources consumed for a specific purpose.
• Key aspects:
  1. Monetary measurement.
  2. Resources consumed.
  3. Specific purpose (e.g., production).

Cost Components

• Cost is made up of various components that must be accounted for, including:
  • Tangible resources (e.g., raw materials, labor).
  • Intangible resources.
• Understanding the difference between expected vs. actual costs is essential for control and management decisions.

Conclusion

• Next class will focus on basic components of total cost, standard costs vs. actual costs, and decision-making implications based on cost behavior.