Management Accounting Essay

Economists and comptrollers set out diametrically opposite views of exist- hatful proceeds (CVP) behaviour but only accountants have a CVP get that is appropriate for assisting management with ending devisingRyan BebbingtonWord Count 1796Economists and accountants have diametrically opposite views of equal-volume profit (CVP) behaviour but only accountants have a CVP exemplar that is appropriate for assisting management with decisiveness makeCost volume profit compendium looks into the relationship amongst a signs fixed and unsettled apostrophizes and join revenue enhancements across a varying aim of action. The computer simulation allow for give a cryed level of profit at a given(p) level of production. There be m any ways that CVP analysis stinkpot be useful for decision making, it is Copernican to distinguish between the diametric applications of the Economists and Accountants definitions, as well as new(prenominal) factors involved in decision making .CVP analysis is used in management decisions when forecasting production levels. To use this feign effectively, Management testament look at different scenarios of output, prices and personifys, and see where the model predicts the fast(a)s revenues testament cover its centre be. This point is known as the breakeven point. Management can investigate the do of price step-ups, changing costs from fixed to variable much(prenominal) as salaries to commission ground pay. Managers can also investigate the outcomes from decisions such as making components in house or buying in, retaining or permutation equipment and marketing decisions. They can also investigate the sales mix. By having a prediction of the effects of these variables, managers will be able to make remedy decisions, as they have much(prenominal) study.CVP is a simplified model and indeed has limitations to its analysis and predictions. When managers be aw atomic number 18 of the limitations and how to corr ectly use CVP analysis it can be a powerful tool. Managers must be aware that at that place are assumptions that are made to simplify the CVP tool, as it can non truly model the actually business, as it would be farthest too complicated.The economists interpretation of the CVP graph, Figure 1, is based on two main assumptions, which formulate the shape of the cost and revenue curves. The early assumption, which affects the revenue curve is that the unfaltering is competing on price competition, this means that in order to increase sales, the firm must reduce the marginal ex flip-flop price of the product. This causes the firms revenue curve to level off, as the marginal revenue falls to 0, as in material body 1b. After this point the firm is selling at a negative price, ca victimisation the firms chalk up revenue to fall. The second assumption is based on the firms cost curve, is based on economies and diseconomies of scale. The firms economies of scale cause the variabl e cost per unit to decrease as production increases, as in sign 1b.This can be due to any of the economies of scale, such as purchasing, where a discount for bulk buying is received, managerial, where managers can become more specialised, financial where the firm is offered lower interest rates as there is a lower risk of lending. The Total cost curve will level off as these change magnitude returns to scale cause the production to tip over a level of most(prenominal) efficient output. After this the firm will experience decreasing returns to scale, as the plant is operating at a higher production level than it was designed for, causing problems in production, such as bottlenecks in the production line of merchandise. This causes the average unit cost to increase again, giving the curve its shape. It is important to understand that Economists are trying to most accurately model real world situations, rather than create a tool for management decisions.The accountants CVP model , shape 2, is based on a simpler interpretation of the cost and revenue functions, this is because Accountants are not interested with provided an accurate theatrical performance of the cost and revenue functions, instead they wish to display the relevant ranges, figure 3, of production for the firm. As this is the randomness that is used for shortsighted-run decision making, as this is the time frame where the information is most useful for management decision making, information for in confinesinable term decision making is required for progress level decisions, to do with the colossal term objectives of the company. The information that the firm uses to invoke its cost and revenue curves is extracted from previous operating costs and revenues, this ensures that the information is reliable.The Accountants cost function, is a straight line, which assumes that for each additional unit produced, a meter variable cost is incurred, the assumption that production will only be o ccurring in a relevant range means that the firms production will not alter decent to cause increasing or decreasing returns to scale. The Accountants interpretation of the fixed cost curve is different to the Economists view because it meets the Y bloc at a higher point, which indicates that the Accountants believe that firms are committed to a higher minimum level of fixed costs. This is because although a firm whitethorn reduce its fixed costs to a lower level, as in the Economists interpretation, the firm can only do this by redundancies and shutting down plants.As the Accountants model only represents a relevant range, the fixed costs cannot be reduced to this level in the short run, when this interpretation is extended outside of the relevant range, a stepped fixed cost and come in function will be seen, as in figure 3. The former(a) difference is that the revenue function is linear. This is because in the short run, firms cannot change the price of their products easily it may also be because of firms competing on non-price, rather than price competition. As Accountants make no attempt to extend the revenue function outside of the relevant range, there is no need to model the firms decrease in product price to increase demand.The Accountants interpretation of the Cost Volume Profit model is more appropriate for Management decisions, as management decisions are not concerned with long term information. This is because the Board of Directors will be making the firms long term decisions. The information that the Economists model provides, includes a lot of information outside of this relevant range, this will affect the reliability of the data in the model. The data in the model will be less reliable as it is more difficult to accurately predict the behaviour of the cost and revenue functions, outside of the relevant range, as it is not based on past sales data. It will also be more expensive to compile the information needed as it is a more complex m odel. It can also be argued that some managers will find it difficult to interpret the Economists model, as the information will be more complex.Managers may wish to extend the CVP model to cover longer term decisions, will need to be aware of the long term behaviour of fixed costs. In the long term, firms will have a greater control over fixed costs, they can expand force by increasing floor space, hiring more supervisors and upgrading or purchasing spic-and-span machinery. Which will give the firms fixed cost line a step function. Other factors will also affect the firms revenue and cost curves, such as advertising strategies, changes in political, environmental, social, economical, and legal factors, such as a change in tub rate. These factors cannot easily be planned for and are not easily shown in long term CVP analysis, which is the main reason that CVP cannot accurately model long term production.One of the features useful for decision making, is the ability to display the information in different methods, one of these is the Margin of safety. This is the difference between the expect sales and break even sales, expressed as a portion of the expected sales. It shows management the level that sales can fall by before the companys revenue falls below the breakeven point. The information can also be displayed as two other charts. The first is a contribution chart, figure 4, in this chart, the fixed costs are shown as the difference between the variable cost line and the nitty-gritty cost line. The total contribution is displayed as the difference between the revenue line and the variable cost line.It is useful for showing a total contribution level at any level of output. The other foundation is the Profit volume graph, figure 5 this graph is useful because the other two charts to not directly display the profit at any given level of production as it must be calculated. The P-V graph simply displays the firms profit or loss at any given level of produc tion. These two graphs will be useful for management decisions concerned with contribution or profits at a given level of production. Once again, the economists version of these two graphs would be far too complicated, and the information will not be reliable enough to base management decisions on.In the real world, firms will be producing multi products, and diffusion the overhead costs across each of these products. A firm may wish to alter the CVP analysis to reflect their product mix. This is done by grouping production into batches. The batches revenue and variable costs will be defined as the total of the products in the batch. The values for the batch are then applied to the CVP chart in the same way as a single product.For the CVP model to be used effectively by managers, they must be aware of the assumptions made whilst preparing and hookup the information. If management are not aware of the assumptions made in the data, then they will be unable to draw relevant conclusion s from the information. The assumptions i are that all other variables remain constant there is a constant sales mix, total costs and revenues are linear functions of output, profits are calculated using variable costing, the analysis only applies to the relevant range, costs can be divided into fixed and variable elements, it only applies to the short term, and fixed costs do not change.In conclusion, the Accountants interpretation of the CVP analysis, as shown by the underlying assumptions, will allow managers to develop a more relevant understanding of the information, so that it can be used more effectively in decision making. If managers tried to use the economists CVP graph, the cost of gathering and interpreting the data would be high, as well as making the information more difficult to understand and less reliable. In the real world, the Accountants model may be considered too simplistic, as it relies on many assumptions and conditions, which are often not met. This is why i t important to understand that the Accountants CVP model may not be applicable. For the CVP analysis to be effective, managers must be aware of the limitations of the model, otherwise they will be unprepared for any deviations from the outputs of the model.