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Techniques of accounting

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Cost Volume Profit Analysis and Variance analysis

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Introduction to Accounting Techniques

Cost volume profit analysis and standard costing are traditional techniques of accounting but these are still applied in present commercial era (Bhimani and Bromwich, 2009). Present study is based on the assessment of suitability of CVP analysis and variance analysis on hospitality and healthcare industry. In this report, description will be provided regarding advantages and disadvantages of these models in the context of selected industries.

Cost Volume Profit Analysis

CVP analysis is a managerial accounting technique which is concerned with the impact of product costs and sales volume on profit of business. This analysis is based on the following assumptions:

  • Entire costs can be categorized as fixed or variable cost
  • There is consistency in sales price per unit, variable cost per unit and total fixed cost
  • All products and services produced will be sold by business organization

With this analysis, organizations are able to determine their break even point and units to be sold to attain desired profit (Jiambalvo, 2001). By considering result of this analysis viable decisions are made by businesses in order to achieve their aims and objectives in an effective manner.

Hospitality and tourism industry

Cost volume analysis is appropriable for hospitality and tourism industry because it assists in examination of behavior of revenues, total costs and operating income with the change in no. of units to be sold (Terpstra and Verbeeten, 2014). Organization operating in this industry wants to prevent operating losses thus they compute break even points by making use of CVP analysis.

Example

A hotel is preparing strategies for the next accounting year. In accordance with their estimation 1000 guests will arrive. Fixed cost of hotel is £120000 per annum. Variable cost per guest will be £100. On the basis of CVP analysis, they will be able to determine minimum point of sales to be attained to recover all the expenditures. By considering this aspect, they are planning to charge £500 from each guest for accommodation.

BEP units= Total fixed cost / contribution margin per unit
£120000 / (£500 - £100)
=300 guest
BEP revenue = Total fixed cost / contribution margin percentage
£120000 / 80%
=£150000

For the recovery of all fixed and variable cost hotel is required to serve at least 300 guests.

Advantages

Organization operating in hospitality industry will be able to make appropriate decision regarding price to be charged from customers in order to attain desired profit. By considering the computation of break even point, management of businesses will be set target for employees in order to assure attainment of standard profit (Freedman and Media, 2015). Further, this computation can include tax effect to determine units to sold for the desired profit. This approach also assists in developing effective sales mix. Business entities can set their product portfolio in an optimum manner.

Disadvantages

This approach is based on the various assumptions which are not viable for the hospitality industry. Determination of variable cost is not feasible in computation of hospitality industry. It is because; organizations operating in this industry have to incur overall amount on transport or food or on accommodation which does not change with the per unit approach.

Health care industry

Cost profit analysis is also applicable on the hospitality industry but it cannot be employed with any degree of reliability. However, this approach assist them in determining their production capacity (Seal and Mattimoe, 2014). With this analysis, organization operating in healthcare industry can determine the economic benefits for government and patients. On the basis of this analysis, they can influence authorities for subsidy for better conduct of operational activities.

Example

A hospital is planning to provide therapy for arthroscopic hysterectomy at a package deal of £30000 per operation. Variable cost of this operation will be £20000. Further, annual fixed cost of this operation is £6000000.

BEP units= Total fixed cost / contribution margin per unit
£6000000 / (£30000 - £20000)
=600 operations
BEP revenue = Total fixed cost / contribution margin percentage
£6000000 / 33.33%
=£18000000

Advantages

With CVP analysis, health care organization can determine fees to be charged from the patients in order to recover their cost along with the consideration of welfare aspects (Enthoven, 2014). In addition to this, managers can consider future changes in this analysis in order to make viable decision for organization. They can accept or reject the medical proposals on the basis of this evaluation.

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Disadvantages

Assumptions of CVP in healthcare industry is not easy because in various situation organization have to viral disease of which standard measures are not available. Further, it will make reduction in the flexibility of strategies as approval is provided by government authorities due to which alteration ins not possible (Oracle white paper, 2011). If pattern accordance in this model is not followed by business organizations, then they will be liable to penalty charges. It is because; CVP analysis is not beneficial if there frequent change in sales mix ratio.

Standard Costing

Standard costing can be defined as practice of substituting an expected expenditure from the actual expenditure in the accounting records. These variances are computed on periodical basis to assess performance of business (Brent, 2014). This financial tool assess business organizations in budgeting, overhead application, price formulation and inventory costing in an appropriable manner.

Hospitality and tourism industry

In present competitive environment, service industries aims to manage their cost in a proper manner for the increment in productivity and profitability. By considering standard costing, organization can determine difference between actual and estimated costs to make valuable changes in operating strategies in order to achieve their objectives in an effective manner.

Table 1: Variance analysis of 500 tourists

Particulars Budgeted Budgeted Actual Variance Nature of variance
  Per unit Total Total    
Sales revenue (A) 400 per tourist 200000 220000 20000 Adverse
Variable cost (a) 100 per tourist 40000 48000 8000 Adverse
Labor charges (b) 8 per hour 28000 30000 2000 Favorable
Fixed cost (c)   0   0  
Total Cost (a + b + c)   128000 10000 10000 Adverse
Actual profit (A-Total cost)   82000 92000 10000 Adverse

There are minor variances in this table. By considering this statement modification can be made by tourism organization to prevent variances in future operational activities.

Advantages

Standard costing can be used in tourism in hospitality industry to differentiate between product and period cost. By considering this aspect, computation of volume variance analysis and labour variance analysis can be done to identify potential scope of improvement (Standard Costs and Variance Analysis, 2007). For example a tourist organization is planning their service for 100 visitors but in actual there were 70 visitors. On the basis of variation in volume difference can be determine regarding revenue and cost variables. Further, with the change in amount of expenditure labour variances can be determined.

Disadvantages

System of standard costing is expensive and time consuming for businesses. In addition to this, it ignores various crucial aspects such as customer satisfaction, service, lead time and quality. This approach is not effective for the hospitality organizations if they had selected principals of just in time (Seal and Mattimoe, 2014). Management of hospitality organization has the obligation for determine factors that lead to material or unusual variance. This aspect requires individual judgement, due to which several issues arises in setting materiality limits.

Health care industry

In health care industry, approach of standard costing is not completely applicable. It is because; in this aim of organization is welfare instead of profit maximization. However, this approach assists organization in minimizing wastage of available resource by detecting variance and providing suggestions for the corrective actions.

Table 2: Variance analysis of 100 operations

Particulars   Budgeted Actual Varience Nature of Varience
  Per Unit Total Total    
Fees from patients(A) 30000 per operation 30000000 2500000 -27500000 Adverse
Variable cost (a) 10000 per patient 1000000 900000 -100000 Favorable
Labor charges (b)   2000000 2500000 500000 Adverse
Fixed cost (c)   500000 500000 0  
Total Cost (a + b + c)   3500000 3900000 400000 Adverse
Actual profit (A-Total cost)   26500000 -1400000 -27900000 Adverse

This budget shows high variances due to uncertainty in budgeted figures. Due to this factor, management of hospital will face issue in funding.

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Advantages

The standard costing system draw attention of management of healthcare organizations towards those operational activities which are not proceeding in accordance with the planning document (Freedman and Media, 2015). By making use of this approach, health care organizations can prepare effective budgets to attain government grants and subsidiaries.

Disadvantages

However, there are certain disadvantages of this approach of standard costing to the healthcare organization. It is because; all variances are not reported by organization because funds are provided by government authorities (Enthoven, 2014). This aspect makes reduction in efficiency of budget preparation. Further, management usually focuses on unfavourable variances due to which healthcare workers are not motivated to provide good performance.

CONCLUSION

In accordance with the present study, conclusion can be drawn that approaches of cost volume profit analysis and standard costing are appropriable in present era but they have certain limitations. However, these models provide estimation to managerial person for making viable decision for the business. By considering the outcome of CVP model allocation of resources can be done in an optimum manner. Further, outcome of standard costing can be used for making improvement in performance of business to prevent variances in standard and actual outcome.

REFERENCES

  • Bhimani, A., and Bromwich, M., 2009. Management Accounting: Retrospect and prospect. Elsevier.
  • Brent, R. J., 2014. Cost_Benefit Analysis and Health Care Evaluations. Edward Elgar Publishing.
  • Enthoven, A. C., 2014. Theory and practice of managed competition in health care finance. Elsevier.
  • Georgiev, D., 2014. Application of ‘cost-volume-profit’Analysis In The Hotel Industry (Based on Survey Data of High-ranking Hotels in the North-east Region of Bulgaria).Izvestiya, (3). pp. 48-60.
  • Jiambalvo, J., 2001. Managerial accounting. Wiley.
  • Seal, W. and Mattimoe, R., 2014. Controlling strategy through dialectical management. Management Accounting Research. 25(3). pp. 230-243.
  • Terpstra, M. and Verbeeten, F. H., 2014. Customer satisfaction: Cost driver or value driver? Empirical evidence from the financial services industry. European Management Journal. 32(3). pp 499-508.
  • Freedman, J. and Media, D., 2015. [Online]. Advantages and disadvantages of cost volume profit analysis.
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