Cost Volume Profit Analysis And Management By Exception

Solution To Question 1

Based on the calculation it has been seen that cash at the end of the October, November and December is negative which indicates Cash Position Of The Company is not good. It also means that more money is going of the business than coming in. It also means that the company does not cover the expenses from the sales alone. Hence, the company should focus on improving the cash position of the company.

There are various ways of improving cash position. They are discussed below:

• By offering discounts for early payments the cash position of the company is improved. Getting the cash early helps in proving the cash position.
• By taking an inventory check the cash position of the company can be improved which means that the goods that are not adding any value should be removed as they carry a lot of cash[1].
• Use of electronic payment saves time which in turn helps in improving the cash flow.
• Use of high-interest saving accounts provides liquidity which in turn helps in improving the cash flows. 

The calculation of cost per unit has been done by considering total direct cost, total indirect cost, and units. Calculation of total direct cost has been done by adding direct material and direct labor. Calculation of total indirect cost has been done by adding machining costs, logistic costs, and inspection costs. Based on the calculation it has been seen that the total cost of model A amounted to 2106000, model B amounted to 1089500, and model C amounted to 3716500. Calculation of cost per unit has been done by dividing total cost and units. Based on the calculation it has been seen that the cost per unit of model A is 210.6, model B is 1089.5, and model C is 247.8. Calculation of selling price per unit has been done by considering cost per unit and mark-up price. Based on the calculation it has been seen that the selling price per unit of model A is 273.8, model B is 1416.4, and model C is 322.1.

The above calculation shows the cost per unit of model A is 210.6, model B is 1089.5 and model C is 247.8 which means that cost of model A is the lowest and the cost of model B is the highest. This has been calculated by using the activity-based costing method. The use of the ABC costing method provides a true picture of the performance of each model and its costs. By using this method correct decisions can be made. Hence, based on calculation it can be said that model B should adopt appropriate measures for cutting costs as higher costs are resulting in higher selling prices. It can change the process of production or outsource the activities. Therefore, the company should focus on reducing the cost and improving the quantity of model B.  

The above table shows the calculation of sales volume that the company needs to achieve at the current operating income. It has been ascertained by considering contribution margin per unit and desired contribution. Calculation of contribution margin per unit has been done by deducting variable cost per unit from sales and the desired contribution has been calculated by considering current operating income and fixed costs. Based on calculation it has been seen that sales volume of 9333 is needed for achieving the current operating income of 300000. 

The cost volume profit analysis is an important approach that is taken by a company. This analysis helps the managers and the operations department of the company to analyse potential losses which can occur in the operations of the company[1]. This analysis helps the management of the company to keep the operations and profits of the company on track while allowing them to identify any issues. The cost volume profit analysis is useful as it helps the company to determine the break-even point of the operations of the company. This analysis allows the company to determine the minimum level of sales which has to be met by the company or the operations to be profitable[2].

The major benefits of the cost volume profit analysis are provided below.

• It analyses the various operations and products of the company. It allows the company to determine the products which are more profitable and generate the maximum revenue for the company[3].
• The breakeven point analysis helps the company to determine the minimum level of sales required to meet the cost of the company.
• The analysis helps the company to budget its operations. It allows the company to maintain the expenses which would be incurred by the company in a year, month, or even a day.
• It identifies the fixed expense for the company and also identifies the risks associated with the same.
• The cost volume profit analysis helps the managers in the decision-making process. It however reduces the decision time which is taken by the managers[4].
• This is a suitable approach for all types of business and can be employed in multinational corporations or small businesses.
• The managers are able to identify and control the cost of operations, hence allowing the benefits of the business to generate profits.
• It also assists the managers to determine the price at which they can sell their products. Hence allowing to set up an optimal selling price.

Along with the benefits, there are certain disadvantages of cost volume profit analysis to the company as well. They are discussed below:

• The managers of the company are human and a factor of error in the analysis is always probable. The analysis provides a situation of profits can occur, however, if the manager misses an important critical factor in the analysis, it can make all the projections incorrect and the company can face a loss.

• The analysis is limited to operations related to a single product business or a limited number of products business. In the case of a multi-product business, the analysis becomes complex as the variable cost fluctuates and it is not similar to all the products which in turn makes the analysis complicated.
• The analysis considers only two types of cost where one is the fixed and the other variable. The other types of costs such as semi-fixed or variable are not considered in the analysis by the managers
• It makes one critical assumption that the selling price of the product would remain the same which is not true. Hence this creates an effect on the analysis of the company.
• Approximation is also made sometimes in the cost volume profit analysis which can impact the overall observation from the analysis. Hence any assumption which is made needs to be critically evaluated by the management. 

Management by exception is a practice used for examining the operational as well as financial results of the business and it is also used for highlighting the issue to the management when there is a substantial difference in the results from the budgeted or expected amount[7]. The main purpose of the concept of management by exception is to bother the management with the important variances in the results of the business. Hence, managers will spend more time and give more focus on attaining and correcting larger variances[8].

This technique is used for various reasons such as:

• The amount of financial and operational results reviewed by the management is reduced which is a sign of efficient use of time.
• Through this method the employees follow their own approaches that are necessary for achieving the budget of the company. Management only steps in when there arises an exceptional condition.

Variances are being viewed as negative which means that unfavourable variances exist between the two amounts that is the amount by which actual expenses are more than the budgeted expenses and the amount by which the actual revenues are less than budgeted revenues. Negative variances result in severe damage and consequences to the business. The negative variances arise due to poor estimation of future spending[9]. The company might also assume that cost of the project will be lower than it ends up costing whether it is due to a lack of accurate information about costs or unexpected revenues. Negative variances can also be due to the reason that company allows industry politics to dictate a target spending that is low.

While investing variances there are certain factors that need to be considered. They are discussed below:

• Materiality: The size of variances might denote the scale of problems and also the benefits from its correction.
• Reliability and the accuracy of the figures: Mistakes in ascertaining figures of budget or recording actual costs and revenues might lead to variance being reported where the process is actually in control.
• Possible independencies of variances: Variance in one area is related to the variance in another sometimes. For example, favourable raw material price variance might result from a low grade of material which might result in adverse labour efficiency variance as low-grade material is very difficult to work with. Hence, while making an investigation decision it is important to consider the two variances jointly[10].
• The inherent viability of the cost or revenue: The variances are not surprising for those costs that are volatile in nature. Other costs such as labour rate are more stable and smaller variance can denote a problem.
• Adverse or favourable variances: Adverse variances generally denote a problem and most attention is given to the adverse variances. Hence, there is an argument for the investigation of favourable variances so that something can be learnt by the business from its success.
• Trends in variances: By any random event adverse variances may be caused. Hence, a series of adverse variances denotes that process is out of control.
• Cost and benefits of correction: The investigation should be done further when the cost of correcting the problem is more than the benefit.
• Controllability of correction: When the costs and revenue are outside the control of the manager then there is little point in investing its cause.

Reference

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“Managing Negative Cash Flow: How To Improve Cash Flow Effectively”. Essential Business Guides, 2021, https://www.zoho.com/books/articles/how-to-improve-cash-flow.html. Accessed 23 Apr 2022.

Punniyamoorthy, R. “Examining Cost Volume Profit and Decision Tree Analysis of a Selected Company.” International Journal 9 (2017): 224-233.

Ihemeje, J. C., Geff Okereafor, and Bashir M. Ogungbangb. “Cost-volume-profit analysis and decision making in the manufacturing industries of Nigeria.” Journal of International Business Research and Marketing 1.1 (2015): 7-15.

“Cost-Volume-Profit Analysis: Advantages And Disadvantages”. Fundamentals Of Accounting, 2020, https://fundamentalsofaccounting.org/cost-volume-profit-analysis-advantages-and-disadvantages/. Accessed 23 Apr 2022.

“Advantages & Disadvantages Of Cost Volume Profit Analysis”. Your Business, 2022, https://yourbusiness.azcentral.com/advantages-disadvantages-cost-volume-profit-analysis-25366.html. Accessed 23 Apr 2022.

“Advantages Of Cost Volume Profit Analysis | Benefits-Drawbacks”. Benefits-Drawbacks.Blogspot.Com, 2022, https://benefits-drawbacks.blogspot.com/2018/03/advantages-of-cost-volume-profit.html. Accessed 23 Apr 2022.

“Advantages & Disadvantages Of Cost-Volume-Profit Analysis”. Small Business – Chron.Com, 2022, https://smallbusiness.chron.com/advantages-disadvantages-costvolumeprofit-analysis-35135.html. Accessed 23 Apr 2022.

Moore, Sian, and Kirsty Newsome. “Management by exception? The Taylor Review and workforce management.” New Technology Work and Employment (2019).

Penno, Mark. “A positive theory of accounting-based management by exception.” Available at SSRN 3952050 (2021).

“What Do Negative Variances Indicate? | Accountingcoach”. Accountingcoach.Com, 2022, https://www.accountingcoach.com/blog/what-do-negative-variances-indicate. Accessed 23 Apr 2022.

“Variance Investigation “. Default, 2022, https://kfknowledgebank.kaplan.co.uk/variance-investigation-. Accessed 23 Apr 2022. 

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