Management Accounting Essay

economists and accountants have diametrically opposite views of personify-volume lucre (CVP) demeanour but only accountants have a CVP mould that is appropriate for assisting management with finale devisingRyan BebbingtonWord Count 1796Economists and accountants have diametrically opposite views of toll-volume profit (CVP) demeanor but only accountants have a CVP model that is appropriate for assisting management with decision devisingCost volume profit compend looks into the relationship between a bulletproofs refractory and protean be and totality tax incomes across a varying take of drudgery. The model impart give a predicted level of profit at a prone level of occupation. There are many ways that CVP analytic thinking gouge be expendful for decision making, it is important to distinguish between the diverse applications of the Economists and controllers variants, as well as different factors involved in decision making.CVP analysis is used in manage ment decisions when forecasting production levels. To use this model effectively, Management go out look at different scenarios of output, scathes and considerationss, and fulfil where the model predicts the unwaverings revenues will cover its total courts. This transport is known as the breakeven point. Management send away investigate the effects of charge increases, changing cost from fixed to variable quantity such as salaries to committee establish pay. Managers privy also investigate the outcomes from decisions such as making components in house or buying in, retaining or replacing equipment and selling decisions. They can also investigate the sales mix. By having a forecasting of the effects of these variables, managers will be able to make better decisions, as they have more than(prenominal) selective discipline.CVP is a simplified model and thus has limitations to its analysis and predictions. When managers are aware of the limitations and how to cor rectly use CVP analysis it can be a powerful ratified instrument. Managers moldinessiness be aware that there are assumptions that are made to simplify the CVP withall, as it can non truly model the strong business, as it would be far too complicated.The economists description of the CVP graph, Figure 1, is undercoatd on devil main assumptions, which explain the reach of the cost and revenue twist arounds. The first assumption, which affects the revenue curve is that the firm is competing on price competition, this means that in order to increase sales, the firm must sink the marginal selling price of the product. This causes the firms revenue curve to level glowering, as the marginal revenue falls to 0, as in figure 1b. After this point the firm is selling at a negative price, causing the firms total 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 variable co st per social unit to decrease as production increases, as in figure 1b.This can be due to any of the economies of scale, such as purchasing, where a subtraction for bulk buying is received, managerial, where managers can become more specialised, financial where the firm is offered glare interest rates as there is a lower risk of lending. The Total cost curve will level off as these increasing returns to scale cause the production to reach a level of most efficient output. After this the firm will bewilder decreasing returns to scale, as the plant is operating at a high production level than it was designed for, causing problems in production, such as bottlenecks in the production term. This causes the average unit cost to increase again, fully grown the curve its shape. It is important to go steady that Economists are trying to most accurately model real world situations, rather than create a tool for management decisions.The accountants CVP model, figure 2, is based on a s impler interpretation of the cost and revenue departs, this is because controls are not relate with provided an accurate representation of the cost and revenue functions, instead they call to display the germane(predicate) ranges, figure 3, of production for the firm. As this is the information that is used for short-run decision making, as this is the metre frame where the information is most useful for management decision making, information for persistenter border decision making is required for board level decisions, to do with the prospicient term objectives of the company. The information that the firm uses to produce 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 standard variable cost is incurred, the assumption that production will only be occurring in a relevant range means that the firms production will not alter enough 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 axis at a higher(prenominal) 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 may reduce its fixed costs to a lower level, as in the Economists interpretation, the firm can only do this by redundancies and shut 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 total function will be seen, as in figure 3. The other difference is that the revenue function is linear. This is because in the short run, firms cannot change the price of their products comfortably 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 net 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 hoi polloi of information outside of this relevant range, this will affect the reliability of the info in the model. The data in the model will be slight reliable as it is more difficult to accurately predict the demeanor 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 model. It can also be argu ed that some managers will ascertain 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 capacity by increasing floor space, hiring more supervisors and upgrading or purchasing new 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 VAT 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 met hods, one of these is the Margin of safety. This is the difference between the evaluate sales and break even sales, expressed as a percentage of the expected sales. It shows management the level that sales can fall by beforehand the companys revenue falls below the breakeven point. The information can also be displayed as two other charts. The first is a division chart, figure 4, in this chart, the fixed costs are shown as the difference between the variable cost line and the total 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 presentation is the Profit volume graph, figure 5 this graph is useful because the other two charts to not directly display the profit at any addicted level of production as it must be calculated. The P-V graph exactly displays the firms profit or loss at any given level of production. These two grap hs will be useful for management decisions concerned with contribution or profits at a given level of production. at 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 spreading the operating cost costs across each of these products. A firm may wish to alter the CVP analysis to reflect their product mix. This is done by classify production into batches. The batches revenue and variable costs will be delineate as the total of the products in the batch. The values for the batch are because 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 gathering the information. If management are not aware of the assumptions made in the data, then they will be uneffective to draw relevant con clusions from the information. The assumptions i are that all other variables await 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 change integrity 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 rendition 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 it 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.