MBA7001 CVP analysis studies the relationship of cost-volume-profit at different levels of output: Accounting for Decision Makers Assignment, CMU, SRL
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BUY NOWA. CVP analysis studies the relationship of cost-volume-profit at different levels of output. This analysis is an important tool for profit planning. The three factors of CVP analysis, namely, costs, volume, and profit are interconnected and dependent on one another. For example, profits depend upon the selling price. The selling price, largely, depends upon the cost of production. The cost of production, in turn, depends upon the volume of production.
i) Business Firms have to experience various types of costs in producing their products or in providing their services. Explain the basis of cost classification as “Direct-Indirect” and “Fixed-Variable” using examples of a selected manufacturing or trading company. What are the main criteria that should be taken into account in determining whether a particular cost is relevant for business decision-making?
ii) Let Us Grow Ltd (LUG) is considering producing a new product that has the following revenue and cost estimates.
Per Unit (£)
Selling price 100
Direct material 20
Direct labour 30
Variable overhead 25
Rent charges* 20
Insurance charges* 20
Other fixed overhead 10
Profit / (Loss) (25)
* Rent charges represent the monthly rent payable for the building used to produce the new product and monthly insurance premiums for the vehicles used for the product are included under Insurance charges. These per unit rates have been calculated assuming 2000 units of these products will be produced per month.
A Senior Manager of LUG has recommended that this new product should not be produced under these conditions, since there is a loss from this product as per the above analysis. He has also proposed two more alternatives in order to consider recommending the production of the above product.
(a) Increasing the selling price by 25%.
(b) Using materials with lower cost (lower quality) and using more unskilled labour, in order to reduce the cost of the production.
Critically analyze the information relating to the above product using the appropriate concepts relevant to Cost-Volume-Profit (CVP) analysis.
iii) Explain the meaning of “limiting factor decision making” under CVP analysis and the process of selecting the best production mix stating clearly the other factors that should be considered in such a situation.
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