Case Scenario 

case scenario

You want to start a restaurant business in Oman. The proposed business will have a variety of fast foods. The cost components include materials, and overheads based on sales unit. Fixed cost include salary and rent of the premise. Materials = $ 10 per unit Overheads = $ 20 per unit Sales = $ 50 per unit Fixed cost = $ 20,000 per month Materials include vegetables, groceries, and poultry products. The company will buy materials from the local suppliers daily. Suppliers will be paid after 60 days. Customers of the firm are youngers and families. Customers will pay immediately and therefore there is no credit sales. Noncurrent assets for the proposed firm include furniture, machinery, and equipment.

q1: What is the difference between step-wise cost and curvilinear cost? Elaborate the methods to measure the cost behavior?

q2:  A) The proposed business comes under which industry type? Write a brief discussion about the length of operating cycle and capital investment cycle for the proposed business? Use illustrations from the case scenario to support your answer.

q3:  C) Do you feel that the firm will be effectively managing its operating and capital investment cycle? Which among these are favourable and unfavourable for the firm? Justify.

Chapter 4
Theoretical Background
& Implications on COST
STANDARDS
1
What is an Industry ?
2
Overview of Industry Types
An industry is classified according to :
• The customer needs it satisfies
• Whether it sells a product, a service, or some
combination of the two
• Whether it makes the product or service;
distributes it to an intermediary (middleman); or
sells it to a customer who is the end user
3
Overview of Industry Types
4
Manufacturer
5
Wholesaler
6
Retailer
7
Check your Understanding
• Retailer
• Manufacturer
• Wholesaler
8
9
Service Industries
10
11
12
Hybrid Industries
13
Check Your Understanding
14
15
Cost Structure & Operating Leverage
16
Industry Maturity Stages
17
Terms used in Tutorial
• Break Even Analysis
• Limiting Factor
• Costing – budgeting
• Budgets
• Variance analysis
18

Chapter 6
Costing Approach
1
Purpose of Managerial Accounting
Planning
• Develop new products?
• Expand into new markets?
• Build a new factory?
Control
• Are costs too high?
• Are services profitable?
• Are customers satisfied?
2
Fixed Costs
3
Variable Costs
4
Mixed Costs
5
Step-Wise Costs
6
Curvilinear Costs
7
Measuring Cost Behavior
The objective is to classify all costs as either fixed or
variable. We will look at three methods:
1. Scatter diagram
2. High-low method
3. Regression
8
Scatter Diagrams
9
The High-Low Method 1
The following relationships between units
produced and total cost are observed:
Month Units Produced Total Cost
January 27,500 $21,500
February 22,500 20,500
March 25,000 25,000
April 35,000 21,500
May 47,500 25,500
June 17,500 18,500
Month Units Produced Total Cost
July 30,000 $23,500
August 52,500 28,500
September 37,500 26,000
October 62,500 29,000
November 67,500 31,000
December 57,500 26,000
Using these two levels of volume, compute:
1. The variable cost per unit.
2. The total fixed cost.
10
The High-Low Method 2
Change in cost $31,000 $18,500 $12,500 $0.25 per unit Change in units 67,500 17,500 50,000 −
= = =
−
Total cost Fixed cost (Variable cost per unit Units)
$31,000 Fixed cost ($0.25 per unit 67.500 Units)
$31,000 Fixed cost $16,875
$14,125 Fixed cost
= + 
= + 
= +
=
Total cost = $14,125 + $0.25 per unit produced
11
Question: Calculate variable cost &
fixed cost using high low method
12
•Highest output = 1,000 units
•Lowest output = 200 units
•Total cost at highest output = $ 3,000
•Total cost at lowest output = 1,400
Regression
It is commonly used with spreadsheet programs or
calculators.
The objective of the cost analysis remains the same:
determination of total fixed cost and the variable unit
cost.
13
Contribution Margin and Its Measures
Contribution margin per unit = Selling price per unit Total variable cost per – unit Contribution margin per unit Contribution margin ratio =
Selling price per unit 14
Break-Even Point
Sales level at which total sales equal total costs.
Company neither earns a profit nor incurs a loss.
Can be expressed in units or dollars of sales.
Three methods to find break-even point:
• Formula.
• Contribution margin income statement.
• Cost-volume-profit chart.
15
Formula Method
$24 000 $30
800 units per month
Fixed costs Break – even point in units = Contribution margin per unit
= , =
$24,000 30
$24 000 0 30

Fixed costs Break – even point in dollars = Contribution margin ratio
%
, . =
=
$80 000 of monthly sales = ,
16
Contribution Margin Income Statement
Method
17
Graphing—Cost-Volume-Profit Chart
18
Changes in Estimates
Blank Selling Price per
Unit
Variable Cost per
Unit
Total Fixed
Costs
Optimistic $105 $68 $21,000
Most likely 100 70 24,000
Pessimistic 95 72 27,000
( ) $24,000 Revised break-even point in units 686 units rounded
$35
= =
19
Computing the Margin of Safety
( )
$100,000 $80,000
$100,000

Expected sales Break – even sales Margin of safety in percent =
Expected sales
−
−
=
$20 000 $100,000
20
, %
=
=
20
Computing Sales for a Target Income 1
$24,000 + $12,000 $120,000
30
Fixed costs + Target income Dollar sales at target income = Contribution margin ratio
%
= = 21
Computing Sales for a Target Income 2
$24,000 + $12,000 1,200 units $30
Fixed costs + Target income Unit sales at target income = Contribution margin per unit
= = 22
Computing Sales for a Target Income 3
23
Sales Mix and Break-Even 3
Hair-Today offers three cuts as shown below. Annual
fixed costs are $192,000. Compute the break-even point
in composite units and in number of units for each
haircut at the given sales mix.
24
Sales Mix and Break-Even 4
25
Sales Mix and Break-Even 5
Contribution margin per composite unit = Selling price per composite unit Variable cost per composite unit
$64 = $160 –
– $96 26
Computing a Multiproduct
Break-Even Point 1
Fixed costs Break-even point in composite units = Contribution margin per composite unit
$192,000 = = 3,000 composite units $64
$192,000 Break-even poi
composite
composite
nt in units compo
Fixed costs Break = $64.00 per
-even point in units = Contribution margin per unit
unit
Break-even po
site
composite
int in units = 3,00 composite 0 u composite nits
27
Computing a Multiproduct
Break-Even Point 2
28
Assumptions in Cost-Volume-Profit Analysis
CVP analysis relies on several assumptions:
• Costs can be classified as variable or fixed.
• Costs are linear within the relevant range.
• All units produced are sold.
• Sales mix is constant.
29
Degree of Operating Leverage
A measure of the extent to which fixed costs are being
used in an organization.
A measure of how a percentage change in sales will
affect profits.
( )
$36 000 $12 000 3 0
DOL = Total contribution margin in margin Pretax income
DOL = , , . =
30
Operating Leverage
( )
DOL = $36,000 $12,000 3.0 =
DOL = Total contribution margin in margin Pretax income
If Rydell increases sales by 10 percent, what will the percentage
increase in income be?
Change in income % DOL Change in sales % ( ) ( )
3.0 10% 30%
= 
=  =
31