Question

Q 2 a - Discuss why managers estimate a cost function and use Cost volume Profit analysis? Give numerical example of cost function and Cost Volume Profit Analysis and analyze how it will be used by managers?

           b- Suppose actual costs are higher than estimated cost. Analyze why you may have this difference between actual and estimated costs?

Answer 1

Answer:

a)

The primary concern for managers is the means by which their decisions affect the profitability of a concern.

Consequently they are concerned about volume, price and the expense brought about in manufacturing a item.

So the managers need to comprehend the connection between revenue, cost, volume and profit.

To help accomplish the over the managers utilize the procedure of Cost Volume profit analysis (CVP examination) to dissect changes in profits because of an adjustment in volume, expenses and prices.

The basic formula for CVP analysis is :

• Profit = Total Revenue - Total expenses.
• or on the other hand, Profit-Total Revenue = (Total Variable expenses +Total Fixed expenses)

The above analysis can be performed utilizing either Units(quantity) of items sold or Revenue (in dollars).

As an example, refer to the below example:

Volume (a)	Fixed expenses(b)	Variable expenses(c)	Total expenses (D = b + c)	Revenues (E)	Net profit / net loss F = E - D
0	$ 1,00,000	$ 0	$ 1,00,000	$ 0	($ 1,00,000)
5,000	$ 1,00,000	$ 50,000	$ 1,50,000	$ 80,000	($ 70,000)
10,000	$ 1,00,000	$ 1,00,000	$ 2,00,000	$1,60,000	($ 40,000)
15,000	$ 1,00,000	$ 1,50,000	$ 2,50,000	$2,40,000	($ 10,000)
20,000	$ 1,00,000	$ 2,00,000	$ 3,00,000	$3,20,000	$ 20,000
25,000	$ 1,00,000	$ 2,50,000	$ 3,50,000	$4,00,000	$ 50,000
30,000	$ 1,00,000	$ 3,00,000	$ 4,00,000	$4,80,000	$ 80,000

There are certain assumptions while utilizing the cost volume profit (CVP) analysis:

• The sole reason for cost and revenue changes will be changes in production/sales volume.
• Total expenses comprise of fixed and variable expenses.
• Revenue and expenses can be charted as a linear function.
• Selling price, variable expense per unit, and fixed expenses are completely known and constant.
• The time value of cash (Interest is disregarded).

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b)

The reasons behind actual expenses being higher than the estimated expenses might be as below:

• Increase in actual costs when contrasted with the estimated costs.
• Increment in crude materials bought than the estimated quantity as normal production loses were not considered.
• Increase in labor hours to unforeseen loss in labor hours because of strike.
• Absorption(allocation) of fixed expenses among different items done another way than estimated.