Analysing Information for Control and Decision Making

This section aims to develop your decision-making skills. You will be taken through break– even analysis and relevant decision-making. In Year 1, you were introduced to break– even. You examined the importance, assumptions, and limitations of break–even analysis.

Furthermore, you were taken through relevant cost and decision-making processes.

Therefore, this section seeks to build on what you have learnt in the previous years.

Emphasis will be placed on the analytical issues and computations that aim at developing your thinking capacities through various scenarios.

By the end of this section, you should be able to make multiple decisions based on the analysis of complex scenarios and advise management on the best approach.

You will explore the following

• Compute in break–even analysis, plot break-even chart, and apply break–even analysis in planning for production and profits targets.

• Compute relevant costs to make decisions relating to make/buy and special order acceptance, and their implication for decision making.

KEY IDEAS

• Break-Even Point is the point of sales where total revenue is equal to total cost. At this point, there will be no profit or loss. The break-even point can be calculated in units or in terms of sales revenue (value).

• Contribution is the difference between sales revenue and variable cost. It is also known as Gross Profit Margin or Contribution Margin.

• Contribution to Sales Ratio is also known as the profit/volume ratio. It expresses the relationship between Contribution and sales.

• Margin of Safety (MOS) is used to assess the economic viability of a productivity level. It is the amount by which actual output or sales can fall short of the budget without incurring a loss.

• Relevant Costing focuses on future costs and revenues that differ between alternative decisions. It helps management make informed decisions by considering only the costs and revenues that will be impacted by the choice they make.

You have been introduced to break-even analysis, its importance, assumptions and limitations in year 1 (Week 21). In this lesson, you will be taken through the computations of break-even analysis.

1. Contribution This is the amount left over from sales revenue after subtracting variable costs. It is also known as Gross Profit Margin or Contribution Margin. It is the amount that contributes to paying off fixed costs and generating profits.

Contribution = Sales - Variable Costs

Example: If Akua Tawiah sells a ball of kenkey for GH¢2.00 and the variable cost is GH¢0.50, the contribution is GH¢1.50 (GH¢2.00 - GH¢0.50).

2. Contribution to Sales Ratio (C/S Ratio)

This ratio shows the proportion of sales revenue that contributes to paying off fixed costs and generating profits.

C/s Ratio = Contribution × 100% Sales

Example: Contribution is GH¢1.50 and the sales are GH¢2.00, the C/S Ratio is 75%.

C/s Ratio = 1.50 × 100% = 75% 2.00

3. Break-Even Point (BEP)

The break-even point is the level of sales at which the business neither makes a profit nor a loss. It is the point where total revenue equals total costs. Break-even point can be calculated in units or in terms of sales revenue (value).

4. Margin of Safety (MOS)

The margin of safety is the difference between actual sales and the break-even sales. It shows how much sales can fall before the business starts making a loss. The higher the value of the margin of safety, the more profitable a project will be. Margin of safety can be calculated in units, percentage and revenue.

Activity 6.1 Computations in Break-even analysis

1. Recall what you learnt in year one on Break-even Analysis.

2. Share your reflections with another group by answering the following questions:

a. Explain break-even analysis.

b. Discuss the assumptions underlying break-even analysis.

3. In groups, explain the objectives of break-even analysis.

4. Read the scenario below and answer the questions that follow.

Malibu company recorded the following costs for its production.

Productions - 2,000 units Variable cost - GH¢15,000 Fixed Cost - GH¢64,000 Selling price - GH¢10 Calculate:

a. Variable cost per unit.

b. Break-even point in units

c. Break-even point in value

d. The number of units to produce to obtain a profit of GH¢50,000

5. Present your answer to the whole class for discussion and feedback.

A break-even chart is a visual representation of break-even analysis. It helps businesses determine the point at which they will break-even, that’s when total revenue equals total costs. A break-even chart not only shows the break-even point but also shows profit and loss at various levels of activity.

An example is included below.

Sales at selected activity } Angle of incidence Selected

activity

(profit) Selected

activity

Fixed cost line Margin of Safety (units) Selected activity (losses) Output Cost/Revenue Break-even Point Break-even point

Figure 6.1: Break-even chart Steps to Draw a Break-Even Chart ₁. Determine the fixed costs: Identify the fixed costs and draw a horizontal line on the graph to represent them.

2. Calculate the variable costs: Determine the variable costs per unit and calculate the total variable costs at different levels of production.

3. Plot the total costs line: Add the variable costs to the fixed costs to get the total costs and plot this line on the graph.

4. Plot the total revenue line: Calculate the total revenue at different levels of sales and plot this line on the graph.

5. Identify the break-even point: Find the point where the total revenue line intersects the total costs line. This is the break-even point.

6. Label the chart: Label the axes, lines, and break-even point clearly.

Example

Let’s say you’re selling kenkey at school. Your fixed costs are GH¢100, and your variable costs are GH¢0.50 per kenkey. You sell each kenkey for GH¢2.

• Plot the fixed costs line at GH¢100

• Calculate total costs and plot the total costs line

• Calculate total revenue and plot the total revenue line

• Find the break-even point where the two lines intersect

Activity 6.2 Plotting of Break-even Chart

1. In groups, read the scenario below:

A student, Dokua, is selling pastries at school for GH¢ 1 each. Her fixed costs are GH¢50, and her variable costs are GH¢0.25 per pastry.

2. Draw a break-even chart to determine how many pastries Dokua needs to sell to break-even.

Assume: Ama can sell a maximum of 100 pastries.

3. Share your work with another group for feedback and discussion.

In this lesson, you will compute relevant costs and the implications of decisions made.

Relevant costing focuses on only the costs that are relevant to a specific business decision. It ignores sunk costs, committed costs and other irrelevant costs that do not affect the decision at hand. It helps management make informed decisions by considering only the costs and revenues that will be impacted by the choice they make.

Principles of Relevant Costing

₁. Future Costs: Only future costs that will be incurred as a result of the decision are considered.

2. Differential Costs: Costs that differ between alternatives are considered relevant.

3. Avoidable Costs: Costs that can be avoided if a particular decision is made are considered relevant.

4. Opportunity Costs: The cost of choosing one option over another is considered relevant.

5. Sunk Costs: Sunk costs are ignored as they have already been incurred and cannot be changed.

Activity 6.3 Compute Relevant Costs to Make Pricing Decisions

1. In groups, explain the term - relevant cost.

2. Discuss the importance of relevant costs in decision-making.

3. Read the passage and answer the questions that follow.

The management of a printing house has received an enquiry from a customer to print 30,000 leaflets for a political rally. The customer is prepared to pay GH¢25,000. Details on the cost of producing the leaflets are as follows:

• Labour cost of producing these leaflets is GH¢80 per 1,000 leaflets.

• The paper to be used would cost GH¢500 per 1,000 leaflets. There is sufficient paper to print only 20,000 leaflets. The excess must be purchased at GH¢600 per 1,000 leaflets.

• Administrative overheads would be charged at 20% of factory cost.

a. Calculate the relevant and irrelevant costs of printing the leaflets.

b. Calculate the profit that would be obtained as a result of accepting this job

4. Present your work to another group for feedback and discussion.

In cost accounting, shutdown or deletion decisions involve determining whether to discontinue a department or product that is not profitable. The decision is based on relevant costs and revenues.

Before a department or product is dropped or deleted, one must consider the following.

1. Relevant Costs: Identify costs that will be avoided if the department or product is shut down or deleted.

2. Lost Contribution: Consider the contribution margin lost if the department or product is discontinued.

3. Opportunity Costs: Consider alternative uses of resources.

4. The reaction of customers, especially if two goods are demanded jointly.

5. The redundancy cost to workers

6. The future use of machines/equipment.

Steps in Shutdown or Deletion Decision

₁. Identify relevant costs: Determine costs that will be saved if the department or product is discontinued.

2. Calculate lost contribution: Calculate the contribution margin lost if the department or product is discontinued.

3. Compare costs and lost contribution: Compare the relevant costs saved with the lost contribution.

Decision Rule

₁. Shutdown or delete if the relevant costs saved exceed the lost contribution.

2. Continue if the lost contribution exceeds the relevant costs saved.

Example: Suppose a company has a product line with the following data:

Sales: GH¢100,000

Variable Costs: GH¢60,000

Fixed Costs: GH¢30,000

Contribution Margin: GH¢40,000

If the product line is discontinued, GH¢20,000 of fixed costs can be avoided.

Calculation

• Relevant Costs Saved: GH¢20,000 (avoidable fixed costs)

• Lost Contribution: GH¢40,000 (contribution margin) Since the lost contribution (GH¢40,000) exceeds the relevant costs saved (GH¢20,000), it is more profitable to continue the product line.

Activity 6.4 Shut Down of a Department / Removal of a Product Decisions

1. In groups, read the case: The departmental accounts of JosKBaff Shopping Mall are given as follows.

Groceries Detergents Clothing Pharmacy

GH¢’000 GH¢’000 GH¢’000 GH¢’000

Sales 680 190 150 80 Cost of sales 490 100 110 30 Gross profits 190 90 40 50 Expenses Direct expenses 70 50 25 10 Allocated Fixed cost 65 20 25 15 Profits/ Loss 55 20 (10) 25

2. Advise whether the Clothing Section should be closed down because of the losses?

3. Explain other factors that management should consider before closing down the loss-making department?

4. Present your work to the whole class for discussion and feedback.

You have been introduced to the principle of relevant costing and decision-making involving the deletion of a product or the discontinuation of a department or section. In this lesson, you will make special pricing decisions.

This involves determining prices for specific products or services in unique circumstances, such as:

• One-time orders: Pricing for a single, non-recurring order.

• Special contracts: Pricing for long-term contracts or agreements.

• Bulk orders: Pricing for large quantity orders.

• Export pricing: Pricing for products sold in foreign markets.

They normally involve selling below the market price or making special orders of goods to customers at lower prices.

Things to consider

a. Relevant Costs: Identify costs that are relevant to the special pricing decision.

b. Target Pricing: Determine the desired profit margin and set prices accordingly.

c. Market Conditions: Consider competition, demand and market conditions.

d. Negotiation: Consider the bargaining power of buyers and sellers.

e. Sunk costs are historical costs and normally not relevant.

f. Replacement costs are necessary and should be considered.

g. Where there is spare capacity, relevant cost becomes irrelevant.

h. Consider the cost of overtime and the cost of diverting labour.

Activity 6.5 Acceptance or Rejection of a Special Order Pricing - I

1. In groups, read the case below.

Zuma Ltd produces tiger nut drinks and is currently producing 35,000 bottles. The full capacity of the company is 45,000 bottles per month. The unit cost structure is as follows GH¢ Direct labour 12 Direct Material 8 Variable manufacturing Overhead 2 GH¢ Administrative overheads 8 Marketing overheads 3 Total cost 33 Selling Price 40 Additional Information

a. Another company, Caleb Ltd, has requested Zuma Ltd to produce 3,000 bottles of tiger nut drinks for a special programme next month at GH¢20 per unit.

b. Caleb Ltd wants its own logo to be placed on the 3,000 units. It would cost Zuma Ltd GH¢1 to insert the logo.

c. Direct labour is a fixed cost in the short term.

2. List three qualitative factors that Zuma Ltd should consider before accepting the offer.

3. Advise whether Zuma Ltd should accept the offer.

4. Calculate the total profit of Zuma Ltd if the offer is accepted.

5. Present your work to the class for discussion.

You have been introduced to the principle of relevant costing and decision-making involving the deletion of a product or the discontinuation of a department or section. This lesson is a continuation of accepting or rejecting special order pricing.

Activity 6.6 Acceptance or Rejection of a Special Order Pricing - II

1. In groups, read the following case.

Thrive employs 10 security personnel who are paid GH¢1,200 each per month.

In addition, they are paid transport and dressing allowance of GH¢100 and GH¢120 each per month, respectively. The company also pays social security of 10% of the basic salary on behalf of each worker to SSNIT. The chief supervisor of the ten security personnel is paid GH¢2,000.

Focus Securities has offered to provide security services to Thrive at a cost of GH¢2,000 per person per month for 8 workers.

2. Compute the total cost of providing security services internally.

a. The cost of outsourcing the security services

b. Advise whether Thrive should outsource its security services.

c. Present your work to the whole class for discussion.

1. Atoba Limited produces a product that sells for GH¢20 each. The company made the following projections for January 2026.

Production units Total cost First Week 2,000 40,000 Second Week 5,000 82,000 You are required to calculate

a. Variable cost per unit

b. Fixed for the month

c. Break-even in units

d. Break-even in value

2. The data below relates to the activities of Thrive Productions Production level 200 units 400 units GH¢ GH¢ Material 600 1,200 Direct Labour 300 600 Indirect Labour 250 250 Direct Expenses 500 1000 Rent 450 450 Advertisement 500 500 You are required to

a. Identify the relevant costs and irrelevant costs of MFS Productions.

b. Calculate the cost of producing 500 units of production.

3. Men’s Corner is a popular restaurant in Siwdu. The sale of okro soup is making losses, and Management has provided you with the following income statement for the year ending 31st December 2024.

Tilapia Banku Okro

Soup Total

GH¢ GH¢ GH¢ GH¢

Sales 340,000 260,000 200,000 800,000 Lower variable cost (136,000) (78,000) (140,000) (354,000) Contribution 204,000 182,000 60,000 446,000 Less Product Fixed cost 60,000 80,000 20,000 160,000 Administrative cost 30,000 30,000 60,000 120,000 Total cost 90,000 110,000 80,000 280,000 Profits/ Loss 114,000 72,000 (20,000) 166,000 Advise whether management should stop the sale of okro soup because of the losses.

4. Tanko Industries produces mobile phones which is marketed within West Africa.

Customers are given a power bank when they purchase the mobile phones. The cost of producing the power bank by Tanko Ltd is as follows.

Item GH¢

Direct Materials 250

Labour 200 Variable overheads 150 Additional Information.

a. Fixed overheads are absorbed at 20% of prime cost.

b. The material for the production of power bank is obtained as a by–product of another process. It can be sold for GH¢100 if it is not used for the power bank.

c. The existing labour force can be paid GH¢120 as overtime to work on the production of power bank.

d. Variable and fixed overheads are expected to remain unchanged throughout the year.

5. Abuga Ltd has offered to sell a similar quality power bank to Tanko Ltd for GH¢550.

Calculate the following.

a. The current cost of producing the power bank.

b. The relevant cost of producing the power bank.

c. Advise the management of Tanko whether to accept or reject the offer of Abuga Ltd.