Examining the appropriateness of the accountants method of analyzing costs Essay

This study serves two chief intents. The first is to explicate why the comptroller ‘s manner of analysing costs is suited to be used for the intent of finding the budgeted gross revenues for 2010 for Sri Melati Sdn. Bhd. The 2nd intent is to cipher the expected net income for the company under different scenarios. It is hoped that the study will be utile for determination devising intents.

2. Analysis of Costss

The chief issue faced by the direction of the company is make up one’s minding which method is better for analysing costs – the economic expert ‘s manner or the comptroller ‘s manner? Before replying this inquiry, allow us first analyze some of the cardinal characteristics of each method.

2.1. The Economist ‘s Way

First of wholly, the economic expert ‘s manner of analysing costs has its virtues. It involves ciphering costs, volume and net income over a broad activity scope. As such, when shown diagrammatically, grosss move in curvilineal manner. This is because the company can merely sell more by cut downing the merchandising monetary value per unit so entire gross does non increase proportionally with end product ( Drury, 2006, p. 242 ) . On the other manus, variable costs increase aggressively at lower gross revenues and production degrees because of the high operating costs. However, one time the concern operates expeditiously, costs rise less steeply and addition in additive manner. Yet, one time the company has produced beyond capacity, costs rise steeply one time once more because of jobs of scheduling and works dislocations. As a consequence, the concern is likely to hold two breakeven points.

2.2. The Accountant ‘s Way

On the other manus, the comptroller ‘s manner of analysing gross and costs is that they have a additive relationship. While this may ab initio look to be rather different from the economic expert ‘s manner, basically they are the same. The major difference between the two methods is that the comptroller ‘s manner is aimed at foretelling cost-volume-profit ( CVP ) relationship within the relevant scope where a concern is likely to be runing on changeless returns to scale, whereas the economic expert ‘s manner takes a wider range, that is from the lowest to the highest extremes. This is why both methods reveal similar costs and gross figures within the relevant scope ( Drury, 2006, p. 259 ) .

While Mr. Goodare may hold scruples about the comptroller ‘s manner of analysing costs, his frights are undue. The comptroller ‘s manner is valid and besides accurate at ciphering costs and gross within the relevant scope.

2.2.1. Cardinal Premises of CVP Analysis

Before explicating the virtues of the comptroller ‘s manner, we foremost need to understand the assorted premises underlying it. First is the premise that all costs can be resolved into fixed and variable elements. It is assumed farther that fixed costs are costs that remain changeless regardless of production and they are for capacity intents, for illustration mill lease. On the other manus, variable costs vary proportionally with end product so when the house produces more, the more it spends on variable costs. Raw stuff and labor costs are common illustrations of variable costs.

For the interest of simpleness, it is assumed that the lone factor impacting costs and gross is volume. Technology, production methods and efficiency are assumed to stay unchanged, even though in world such factors have been proven to increase efficiency. The computations for CVP are for an single merchandise or a changeless mix of merchandises, as in this study. Finally, it is assumed that there will be no uncertainness. Hence, price reduction and hazard factors are non included, unlike in more complex investing assessment methods.

2.2.2. Restrictions of CVP Analysis

Many people criticize CVP because of its restrictions. For illustration, CVP can non be used to foretell with truth results outside of the relevant scope. While it is conventional to pull charts with lines get downing from zero, relationships at the extremes of activity can non be relied upon. Besides, fixed costs are likely to alter at different degrees of activity. Therefore, a stepped fixed cost line is likely the most accurate representation. Furthermore, variable costs and gross revenues are improbable to be additive. Excess price reductions, overtime payments, the consequence of the acquisition curve, particular monetary value contracts and other similar affairs make it likely that the variable costs and gross lines are some signifier of curve instead than a consecutive line. In this regard, the economic expert ‘s manner of ciphering costs is superior. In add-on, it is hard to sort all costs as either fixed or variable because some costs are semi-variable in nature.

Another unfavorable judgment is that CVP is merely utile in the short term. Different methods need to be used to foretell cost behaviour over a longer clip skyline. CVP besides assumes that alterations in the degree of end product are the exclusive determiner of cost and gross alterations. This is likely to be a gross over-simplification in pattern although volume alterations do hold a important consequence on costs and gross. In add-on, CVP assumes that there is a changeless mix of merchandises although in world, multi-product houses do non fabricate goods in a fixed proportion. Normally, production of merchandises depends on demand and it is hard to use CVP in such cases. Similarly, CVP assumes that there is a changeless rate of mark-up on fringy cost though this is non the instance in pattern. The concluding unfavorable judgment of CVP is that it takes no history of hazard and uncertainness and this may falsify existent cost figures.

2.2.3. Uses of CVP Analysis

I suppose Mr. Goodare is cognizant of these unfavorable judgments, hence his incredulity about the advantages of CVP. However, this is unjust and ignores the intents of CVP. It should be remembered that CVP is meant for the short term and for a narrow scope, as reflected in the premises made. In no manner is CVP appropriate for computations at the low and high extremes of end product nor is it suited to foretell cost behaviour in the long-run. Alternatively, it serves short term determination devising and if applied right, it can be vastly utile.

CVP is utile in breakeven analysis. Cardinal to this is the computation of the breakeven point, which is the gross revenues volume at which the company obtains neither net income nor loss. The breakeven point is important to place how much a house needs to sell to accomplish profitableness. CVP is used in the building of breakeven charts which range from traditional breakeven charts to gain graphs, an illustration of which is shown in a ulterior subdivision.

All breakeven charts portion a figure of features. A breakeven chart is additive and net incomes or losingss can be identified on the chart. The relationship between costs, volume and net income is revealed through the chart. The costs and gross revenues at different degrees of activity can be read from the chart and the breakeven point is highlighted by the intersection between the gross line and the entire cost line. The border of safety is the difference between the normal or existent gross revenues and the breakeven point. It can be read from the breakeven chart and the border of safety shows by how much the gross revenues volume must fall before a loss is made.

However, breakeven analysis is much more than that. It can be used in budget planning and control, as done by Sri Melati Sdn. Bhd. Besides, CVP is vastly utile for determination devising in footings of pricing, gross revenues mix and merchandise mix determinations ( Das, 2007, p.233 ) and it is a utile tool for sensitiveness analysis. As demonstrated in this study, CVP is really effectual in ciphering gross revenues and net incomes under different scenarios. Hence, directors can utilize it to find the consequence on gross revenues and net incomes when points such as unit costs and selling monetary values are changed. This can assist direction comptrollers make up one’s mind on the best class of action depending on the state of affairs.

Furthermore, breakeven analysis can be used for net income planning. It can be used to place profitable merchandise lines and overall profitableness of the concern. Hence, CVP can besides be used for merchandise analysis.

Therefore, the comptroller ‘s manner of analysing costs for the 2010 budget is suited and appropriate. CVP can be used to fix short term budgets. Owing to its simpleness, CVP is besides easy to utilize. It is much easier to cipher the breakeven point and mark net income utilizing CVP compared with the economic expert ‘s manner and this is why it is really popular. Similarly, it is much easier to plot a CVP breakeven chart that an economic expert ‘s breakeven chart because one merely needs to plot a few co-ordinates for the former, whereas the latter requires extended computations.

In short, the comptroller ‘s manner can be used to find costs for the following period. It is an effectual and simple manner and since it is within the relevant scope, calculations should be accurate.

Based on the initial budget, the company will enter a budgeted net income of RM2, 835, 000 in 2010. The above income statement is prepared in conformity with fringy costing and costs are separated as variable and fixed. It shows the part for each type of merchandise every bit good as the entire part.

In this new budget, gross revenues prognosiss have been revised downwards, reflecting the current glooming economic state of affairs. The gross revenues mix has besides been altered. As such, entire gross will drop to RM16, 021, 800 ensuing in an overall net net income of RM1, 760, 400. Below are the combined workings for the two budgets.

The breakeven point in the old prognosis is RM4, 095, 360 while it is RM3, 760, 00 for the new prognosis. This means that under the new prognosis, the company requires to sell less to interrupt even, which is better sing the current economic slack. Although fixed costs remain the same under both prognosiss, the difference is gross revenues mix causes the decrease in breakeven point. Therefore, the new gross revenues mix is more efficient than the initial estimations.

The above net income estimations are based on the two proposals put away by Mr. Goodare. Both are calculated based on the revised gross revenues mix provided by Mr. Goodare. Under Proposal 1, gross revenues of RM17, 690, 563 are required to bring forth RM2, 000, 000 in net incomes. Under Proposal 2, gross revenues of RM30, 861, 502 are required to bring forth RM2, 500, 000 in net incomes.

Even though concerns aim to gain as much net income as possible, it seems that Proposal 2 is less efficient at bring forthing net incomes. The difference in net income is merely RM500, 000, yet about RM13, 000, 000 more in gross revenues is required to accomplish the coveted net income under Proposal 2. Traveling farther, the C/S ratio besides drops significantly under Proposal 2. Therefore, it is non wise to cut down monetary values in a command to increase gross revenues. Proposal 2 besides seems oddly uneven because Mr. Goodare appears to be really prudent in his gross revenues estimations by revising them down, yet Proposal 2 would necessitate the house to bring forth even more gross revenues than the initial gross revenues prognosis. In a down economic system, Proposal 2 seems to be unrealistic.

Hence, Proposal 1 is the better option. Even though the mark net income is lower, its mark gross revenues are much more sensible and stand a greater opportunity of being achieved.

5. Profit/Volume Graph

The Profit/Volume chart depicts the net incomes obtained for the old and new prognosiss. The point where both lines intersect the x-axis is the breakeven point and the point they intersect with the y-axis is the fixed cost. Using a graph is a popular manner of reading the breakeven points and mark net incomes, even though they are estimates. A better manner of gauging the breakeven point and mark net income is through computations.

6. Decision

It is hoped that this study will show the rightness in utilizing the comptroller ‘s method of analysing costs and gross. While the economic expert ‘s manner has its strengths, the premises used in the comptroller ‘s methods are justifiable and CVP is utile for the intents of budgeting and short term determination devising. The 2nd portion of the study provides estimations for gross revenues and net incomes under different scenarios. These figures are calculated utilizing CVP, therefore exemplifying how utile and effectual CVP can be when applied right.