26 Jun acc dis
It is important to use Cost-Volume-Profit (CVP) analysis to understand how profits respond to prices, costs and volume. This model can be used to predict a company’s break-even volume, and what is likely to happen if specific changes are made in prices, costs or volume. A CVP graph depicts these relationships visually, and is useful for estimating how costs and profits will respond to changes in sales.
Another tool that is very closely related to the CVP graph, is the Profit graph. A profit graph is simpler than a CVP graph and shows how profits depend on sales. The graph uses information about the per unit contribution margin (sales revenue – variable costs), projected sales quantity and the fixed costs.
Profit Graph
Managers often use profit graphs to make budget presentations. These graphs give a visual representation to the accounting calculations, and make it easy for executives to readily grasp how changes in sales volume affect the bottom line.
Instructions:
Read the following scenario and respond to the questions below.
Scenario
Susan Roberts is a managerial accountant for Consolidated Tires, Inc. Consolidated manufactures tires for heavy trucks at a plant on the outskirts of town. They also produce tires for off-road vehicles at a plant in Green Bay. Due to the recent down-turn in the economy, Consolidated has lost sales and been forced to reduce prices.
One of Susan’s responsibilities is to prepare and present the company’s financial plan for the upcoming year to the senior executives and the board of directors. In this capacity, Susan asks the two plant managers to prepare a budget. While reviewing these budgets for the presentation, Susan notices that the budget for the Green Bay facility includes a profit graph that projects an increase in profits and a lower break-even point. Curious as to how this would be possible given the recent sales trend, Susan asks the Green Bay manager to explain. The Green Bay manager, Tim Sarvis indicated that a planned increase in worker productivity would reduce variable costs, thereby increasing the Contribution margin ratio. Tim went on to explain that the productivity increase would come from a subtle increase in the speed of the production line.
Discussion Questions
•Susan is concerned about this strategy for several reasons. Why is Susan concerned?
•Is the plant manager correct in her assessment of the effects of increased productivity on the contribution margin?
•Are the manager’s actions ethical? Are they legal? Explain your opinion.
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