Chapter 7 (A. part 4, and B part 1)

Chapter 7 (A. Writing algebraic expression part 3)

Chapter 7 (A. Writing Algebraic Expression Part 2)

Chapter 7 (A. Writing algebraic expression part 1)

4.1 Customer And Product Line Decisions Based On Differential Analysis

Differential analysis or incremental analysis is one of management accounting techniques by only examining the differences in profits, costs, and revenues resulting from decision of business rather than reporting the full statements of income for every alternative (Jan, 2019). This means in general, the types of financial data that might be excluded are the cash flow statements and balanced sheet’s Krakatau Steel Inc, since it is mentioned in the above definitions that the creation of income statements can be simplified by the above three terms for our differential analysis.     

To use differential analysis for decisional evaluation whether we need keeping or dropping customers based on the profits, specific costs and revenues need to be considered. For the purpose of our study, the specific costs which can be variable costs, direct fixed cost, and allocated fixed costs (Management, 2017) in relation to tracking information by real potential customers of Krakatau Steel’s Inc with unreal financial data can be presented by the analysis of the following table (Saylor, n.d.),

The above results mentioned that dropping the energy company's account as the customer of Krakatau steel is not recommended due to the final loss of profit. In fact, even though the energy company’s contribution to the Krakatau steel is giving the lost of -15000 usd, if we keep it becoming the valuable customer, aggregated profits  with all customers are better than those if the energy company is dropped.

The same way can be used to decide whether to keep or drop the product lines of Krakatau steel due to the existing competitors which result in profit or loss of the financial information (Dotorg, n.d.). This way we can just put the existing product lines based on the company profile of Krakatau steel Inc including Hot Rolled Coil (HRC), Cold Rolled Coil (CRC), and Wired Rod (WR) in place of the above three customer names with the same names of specific cost and revenues (Management, 2017)   

In addition, other important cost definitions in the discussions of differential analysis of every company are the sunk and opportunity costs. Sunk cost of Krakatau Steel Inc can be defined as the unrecovered cost that has already been spent by the company such as the heavy machineries and equipment which is hugely expensive. The sunk cost will remain constant regardless of the impact of the final decision. This is why the so called sunk cost is not considered in differential analysis (Tuovila, 2021). Another one is the opportunity cost which can be defined as the cost we need to pay or lost benefit (Anonimous, n.d.) as a result of choosing an alternative and neglecting the others. The examples of the cost were previously explained in choosing alternatives of decisions to keep or drop product lines and customer. As a matter of fact, this opportunity cost will be different in relation to different choices of available alternatives. This is the reason why opportunity cost is fully considered for differential analysis.   

 

References

Jan, O. (2019, March 31). Differential analysis. Differential (Incremental) Analysis in Accounting | Example. Retrieved September 27, 2021, from https://xplaind.com/478812/differential-analysis.

Management, K. R. A. S. (2017). Krakatau Steel's Company Profile. Cilegon; PT. Krakatau Steel.

Saylor. (n.d.). Customer Decisions. Customer decisions. Retrieved September 28, 2021, from https://saylordotorg.github.io/text_managerial-accounting/s11-04-customer-decisions.html.

Dotorg, S. (n.d.). Product line decisions. Retrieved September 28, 2021, from https://saylordotorg.github.io/text_managerial-accounting/s11-03-product-line-decisions.html#heisinger_1.0-ch07_s03_s02_f01.

Tuovila, A. (2021, September 19). Sunk cost. Investopedia. Retrieved September 28, 2021, from https://www.investopedia.com/terms/s/sunkcost.asp.

Anonimous. (n.d.). Opportunity Cost. Review of cost terms used in differential analysis. Retrieved September 28, 2021, from https://saylordotorg.github.io/text_managerial-accounting/s11-05-review-of-cost-terms-used-in-d.html.

 

3.3 CVP Analysis, Break-Even Point And Their Impacts To The Financial Statements

 

Cost – Volume – Profit (CVP) analysis is a technique used to evaluate the viability and ability to scale or grow a business. It is also used to understand the relation between costs, volume and profits.  The focus of the analysis is based on the interaction of product mix, fixed & variable costs, volume and pricing. The CVP analysis will direct decisions on the kinds of offered products, how the products are priced, and how to control or manage the cost structure of an organization. Considering the contribution margin as a starting point, CVP analysis is a vital technique in the calculation of levels of volume required to realize the levels of targeted income, and other similar calculations including the break-even point (BEP) (Walter & Skousen, 2009).

As we previously discussed, BEP in units is division of fixed cost with contribution margin, and BEP in sales is the same way but we use the contribution margin ratio. Further supporting calculation used the fact that Contribution margin is subtraction of sales revenue with variable cost and the ratio is division of the contribution margin with the sales revenue (Walter & Skousen, 2009). Based on that formula, we can recognize the terms involved in detail of financial statement’s specific lines in general are everything in the category of fixed costs, variable costs, and sales revenues. Another name of the addition between fixed and variable cost is the so called cost structure (anonymous, 2020). That’s why the previous discussion forum use this cost structure term to compare only two terms between sale revenues or net revenues which are the total sale revenues of a company in a financial period after subtraction with certain items (Rivers, 2021). All of the terms impact the financial statement (income statement, statement of cash flows and balanced sheets) reports.         

The impact of getting or not getting the required BEP of a company based on the CVP analysis can be seen in the company’s financial statements especially the income statement. Further look at to the detail of an example of how this impacted financial report happens can be seen in specific lines of Krakatau Steel’s income statements ((Karim & Tardi, 2021)) mentioning the information that not only does the Krakatau Steel meet the required BEP but it also has good profit of the period because of the cost structure (Fixed and variable costs) is less than the net sales and other sale revenues based on the following report,

Krakatau Steel’s income statement (Karim & Tardi, 2021)

The above results also mean that after the fixed costs are covered, the remaining revenues are the ones generating the profit. (Team, 2021). In detail, based on the above statement, the profit which can be analyzed in the impacted specific lines is the fact that net revenues and other sale revenues such as sales of waste product are greater than Variable costs such as SG&A (Selling, General and Administrative) expenses (Garcia, 2019), and fixed costs such as final tax.

 The impacted specific lines of the statement of cash flow can be analyzed based on the fact that SG&A which has the same name as operating expenses is one of the input data of the previous cash flow file exercises besides two other data which are the investing and financing activities. The ending of this cash flow calculation is the cash balance at the end of the year.

Finally, the ending cash balance at the end of the period of the cash flow statement as one of the company’s asset in addition to the retained earnings at the end of the period as one of the stockholder’s equity becomes the inputs of the balanced sheet calculations.  By this analysis, it is true that the effect of BEP achievement based on CVP analysis affected all financial statements.

 

References

Walter, L. M., & Skousen, C. J. (2009). Managerial and Cost Accounting (Ser. 978-87-7681-491-5). bookboon.com.

Anonimous. (2020, March 23). Cost structure. Corporate Finance Institute. Retrieved September 22, 2021, from https://corporatefinanceinstitute.com/resources/knowledge/finance/cost-structure/.

Rivers, J. (2021). Net sales DEFINED: Net sales vs. gross sales . The Strategic CFO iCal. Retrieved September 24, 2021, from https://strategiccfo.com/net-sales/.  

Karim, S., & Tardi. (2021). Financial Reports / Statements of PT. Krakatau Steel. www.krakatausteel.com. Retrieved September 16, 2021, from https://www.krakatausteel.com/public/pdf/Financial%20Report%20KRAS%20June%202021.pdf.

Team, T. I. (2021, September 13). Understanding contribution margins. Investopedia. Retrieved September 21, 2021, from https://www.investopedia.com/terms/c/contributionmargin.asp.

Garcia, M. (2019, August 27). How to determine variable costs from financial statements. Bizfluent. Retrieved September 21, 2021, from https://bizfluent.com/how-12009134-determine-variable-costs-financial-statements.html.

 

3.2 Break-Even Point (BEP) Analysis of a Parasailing Company

 

A developing parasailing company has operational calculations mainly based on the number of flight basis.  The number of flights is really needed to be considered as a very important aspect of the break-even point calculation.

The calculation of break-even point of every company in general can be defined by the following formula (Walter and Shousen, 2009): 

Break-even point in units = total fixed cost / contribution margin per unit = fixed cost / (sales per unit – variable cost per unit) ………… (1)

Break-even point in sales = total fixed costs / contribution margin ratio ………… (2)

And the so called contribution margin can be defined as,

Contribution Margin (CM) per unit = Sales Revenue per unit – Variable Costs per unit ………………………….. (3)

CM ratio per unit = (Sales Revenue - Variable Costs) per unit/ Sales Revenue per unit………………………….. (4)

To proceed with the break-even calculation based on the above formulas, the required inputs are variable and fixed costs. Therefore, other than The Sales revenue per flight consisting of

1.     Sales price with the amount of $175 / flight , and

2.     Total sales revenue per flight  : $ 175 / flight,  

We also need to classify available data of our parasailing company to be between variable or fixed ones.

Variable costs (any expenses that we can control or anything that can be bought in a store ((Posner, n.d.))):

-        Fuel costs per flight (Battles, 2003) : $100 / flight

-    The boat crew with the amount of $30  / flight,

-    Total Variable Cost : $130 /flight

Fixed costs (any expense that does not change from period to period (Posner, n.d.)):

1.     Loan payments per month (Posner, n.d.) : $350

2.     Full time scheduler salary per month (Team, 2021) : $2,500

3. Dock fee and use of a small office on a pier Per month (Posner, n.d.) : $500
4. Total fixed costs : $350 + $2,500 + $500 = $ 3350 / month

Based on the available input, the calculation of break-even point (BEP) of the year 1 assuming the company has well – reputed name without the need of referrals fee can be done  by referring to equation …(1) and …(2) using the following ways,

Break-even point in units of flight = Total fixed cost / contribution margin per unit

= Total fixed cost /[sales revenue/unit – variable cost/unit] ………… (1)

                   = [$ 3350 / month] / [($ 175 / flight)-($130 / flight)]

= 3350 /45 flight/month

= 74.44 flight /month

≈ 74 flight / month in year 1

Break-even point in sales = Total fixed costs / contribution margin ratio ………… (2)

     = [$ 3350 / month] / [{($ 175 / flight)-($130 / flight)}/{($ 175 /    flight)}]

     = $ 13027.78 per month in year 1 

In the calculation of the break-even point of year 2 assuming the market becomes fluctuated and needs the assistance of reference or marketing agent causing the referral or marketing fees, we need to little bit change the conventional one to be the contribution margin after marketing (CMAM) by using the following formula (CFI, 2020),

CMAM = sales revenue – variable costs – marketing expense …………………………….. (5)

CMAM ratio = (sales revenue – variable costs – marketing expense)/sales revenue ………. (6)

 

Therefore, the BEP of year 2 becomes,

BEP in units of flights = Fixed cost / CMAM

= [$ 3350 / month] / [($ 175 / flight)-($130 / flight) – 2% * ($ 175 / flight)]

= 80.72 flight / month in year 2 ≈ 81 flight / month in year 2 (which is (80.72-74.44) = 6.28 ≈ 6. 3 greater in difference from the year 1).

BEP in sales = fixed cost / CMAM ratio

= [$ 3350 / month] / [{($ 175 / flight)-($130 / flight) – 2% * ($ 175 / flight)}/{($ 175 / flight)}]

= $ 14126.51 per month in year 2 which is $(14126.51-13027.78) = $1098.73 greater in difference from the year 1.

            In the year 3, assuming we still need to pay for the referral / marketing fee and requiring the profits of $10,000, the targeted units of flight and sales can be determined by adding target income with fixed costs and dividing both of them with the CMAM 

BEP in units of flights = (Fixed cost + target income) / CMAM

= [{$ 3350 / month] + $ (10,000/12)/month} / [($ 175 / flight)-($130 / flight) – 2% * ($ 175 / flight)]

=100.8 flight/month ≈ 101 flight/month in year 3 (which is (100.8-80.72) = 20.08 ≈ 20 greater in difference from the year 2)

BEP in sales = (Fixed cost + target income) / CMAM ratio

= [$ 3350 / month + $ (10,000/12)/month] / [{($ 175 / flight)-($130 / flight) – 2% * ($ 175 / flight)}/{($ 175 / flight)}]

= $17640.56 per month in year 3 which is $(17640.56-14126.51) = $3514.05 greater in difference from the year 2.

The above results may be limited due to the limited variable cost data which only include fuel cost/flight, and the cost of both crew service. Other kinds of variable cost which may be missing can be the selling, general and administrative expenses (SG&A) (Garcia, 2019) such as that of the ticket production cost, overtime bonus for the employees, accounting costs, legal costs, etc (Beaver, n.d.).

As a matter of fact, the above results of year 1 to 3 tell us that if the company keeps going in a good progress of maintaining the good sale revenues then the parasailing company will be able to exactly or even more than overcome all costs including the non-interest bank loan payments as one of the company’s fixed costs meaning that the bank should invest in the parasailing company rather than giving the loan. That way means If the company gets profit, then the bank will get profit, and if the company gets loss, the invested money from the bank has to be lost. All of them should be calculated in such a good manners and proportional way that all parties can be well satisfied, no forbidden religious rules are neglected and no usury is involved.          

 

Reference

Walter, L. M., & Skousen, C. J. (2009). Managerial and Cost Accounting (Ser. 978-87-7681-491-5). bookboon.com.

Posner, C. (n.d.). What are fixed, savings and variable costs and expenses, and how will they help me learn how to budget my money properly? My Money Coach. Retrieved September 22, 2021, from https://www.mymoneycoach.ca/blog/what-are-fixed-savings-variable-costs-expenses-and-learn-to-budget-money.html.

Battles, B. (2003, February 1). Costs come in many flavors: Variable vs. fixed. StackPath. Retrieved September 22, 2021, from https://www.aviationpros.com/home/article/10387227/costs-come-in-many-flavors-variable-vs-fixed.

Team, T. I. (2021, September 13). Do minimum wage laws make labor a fixed or variable cost? Investopedia. Retrieved September 22, 2021, from https://www.investopedia.com/ask/answers/012915/do-minimum-wage-laws-make-labor-fixed-or-variable-cost.asp.

CFI. (2020, December 7). Contribution margin after marketing (CMAM). Corporate Finance Institute. Retrieved September 22, 2021, from https://corporatefinanceinstitute.com/resources/knowledge/accounting/contribution-margin-after-marketing-cmam/.

Garcia, M. (2019, August 27). How to determine variable costs from financial statements. Bizfluent. Retrieved September 21, 2021, from https://bizfluent.com/how-12009134-determine-variable-costs-financial-statements.html.

Beaver, S. (n.d.). The costs behind selling, General & Administrative expenses. Oracle NetSuite. Retrieved September 22, 2021, from https://www.netsuite.com/portal/resource/articles/accounting/selling-general-administrative-sga.shtml.