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THE EFFECTIVENESS OF COST VOLUME PROFIT

ANALYSIS IN MANUFACTURING INDUSTRIES:


[A CASE STUDY OF THREE SELECTED COMPANIES]

BY

OBETA, NGOZI JOY


PG/MBA/07/46890

DEPARTMENT OF ACCOUNTANCY
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA, ENUGU CAMPUS

NOVEMBER 2008

THE EFFECTIVENESS OF COST-VOLUME-PROFIT


ANALYSIS IN MANUFACTURING INDUSTRIES:
(A CASE STUDY OF THREE SELECTED COMPANIES)

BY

OBETA, NGOZI JOY.


PG/MBA/07/46890

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT


OF THE REQUIREMENT FOR THE
AWARD OF MASTERS DEGREE IN ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA, ENUGU CAMPUS

NOVEMBER 2008

CERTIFICATION
This is to certify that Obeta, Ngozi Joy

is a postgraduate

student in the Department of Accountancy with Registration Number,


PG/MBA/07/46890 has satisfactorily completed the requirements for
project research in partial fulfillment of the requirements for the award
of Masters Degree of Business Administration [MBA] in Accountancy.

Obeta, Ngozi Joy


PG/MBA/07/46890
Date: .
.

..

Dr. [Mrs.] R.G. Okafor

Dr. [Mrs.] R.G. Okafor

Supervisor

Head of Department

Date: ..

Date:

DEDICATION

To God, the Father Almighty, my beloved husband: Mr.


Alloysius Obeta, and children Ebubechukwu and Chinemerem.

ACKNOWLEDGEMENT

I am grateful to God, the father Almighty, who in his love and


special grace has kept me alive to work on this project.
I am very much delighted to express my profound gratitude to
those who in one way or the other contributed immensely to the
success of this research work.
First and foremost is my supervisor, who is also the Head of my
Department, Dr. [Mrs.] R.G. Okafor for her advice and guidance at
every stage of this research work. My thanks also goes to all the
lecturers in the Department of Accountancy especially S.N. Kodjo for
his lectures on Managerial Accounting.
My gratitude also goes to the management and staff of Emenite
limited, Innoson Nigeria limited and Hadis & Dromedas limited for
their co-operation while undergoing this research work.
I also owe a lot to my beloved husband, Mr. Alloysius Obeta, for
his help both morally and financially and also to my children,
Ebubechukwu and Chinemerem and my sister Amarachi for bearing
with me when I was undergoing the research work.
Also acknowledged are my brother-in-law and the wife, Barr. &
Mrs. Ike Obeta for their financial support; my mother, mother-in-law
and also my brothers and my sisters-in-law for their prayers.
Finally acknowledged is the typist Mrs. Ezeokonkwo for doing a
good job to the work. To them all, I pray that the blessings of our God
Almighty showers on all of them. Amen.

ABSTRACTS

The utility of Cost-Volume-Profit analysis lies in the fact that it


presents a microscopic picture of the profit structure of a business
enterprise. It does not only highlight the area of economic strength
and weakness in the firm but also sharpens the focus on certain
leverage which can be operated upon to enhance its profitability. The
objective of this study is to find out the effectiveness and also factors
affecting the implementation of this Cost-Volume-Profit analysis in the
manufacturing Industry. The researcher in the findings observed that
most Industries aim at profit maximization and paid little or no
attention to the effect of Cost-Volume-Profit analysis. It was also
discovered that the more the cost acquired for a particular production
without corresponding increase in the volume of production reduces
profit. Therefore, manufacturing Industries should ensure that when
cost increases the raw material should equally increase to
manufacture more products to cover the variable and fixed cost and
also retain a reasonable profit for the firm. Finally, in the office
operation budget should be made more detailed, religiously adhered
to and controlled more vigorously so as to reduce total operation cost
and maximize profit.

TABLE OF CONTENTS
PAGE
Title Page .

Certification ...

ii

Dedication ..

iii

Acknowledgement

iv

Abstract ..

Table of Contents .

vii

CHAPTER ONE:
1.0. Introduction .

1.1

Background of the Study ..

1.2

Statement of Problems .

1.3

Objectives of the Study ...........

1.4

Research Questions .

1.5

Statement of Hypothesis .

1.6

Significance of Study

1.7

Scope of the Study

1.8

Limitations of Study ..

1.9

Definition of Terms

10

References

11

CHAPTER TWO:

LITERATURE REVIEW

2.0

Overview of Cost-Volume-Profit Analysis..

12

2.1

Cost Accounting.

17

2.1.1 Ascertainment of Cost ..

18

Production Capacity/Volume

21

2.2

2.2.1 Factors Combination ..

22

2.3

Operating Leverage

23

2.4

Ascertainment of Profit

26

2.5

Determination and Analysis of Breakeven Point

26

2.5.1 Margin of Safety/Margin of Distress

29

2.6

Concept of Contribution Margin ..

31

2.7

Application of Cost-Volume-Profit analysis

35

2.8

Assumptions underlying Cost-Volume-Profit

2.9

Analysis ..

39

Cost-Volume-Profit Analysis by formulae .

41

2.10 Cost-Volume-Profit Relations and sensitivity


Analysis .

41

2.11 Impact of Taxes on Cost-Volume-Profit Analysis

41

2.12 Managerial Uses of Break-Even Analysis .

44

References

51

CHAPTER THREE:
3.0

Research Design and Methodology ..

53

3.1

Sources of Data

53

3.1.1 Primary Data .

53

3.1.2 Secondary Data

53

3.2

Method of Investigation ..

54

3.3

Population of the Study .

55

3.4

Determination of Sample Size..

55

3.5

Analytical Techniques

56

CHAPTER FOUR:
4.0

Data Presentation and Analysis .

57

4.1

Analysis of Responses

57

4.2

Test of Hypothesis

64

CHAPTER FIVE:
5.0

Summary of Finding, Recommendations,


Conclusions and Suggestion for Further Study

73

5.1

Summary of Findings ..

73

5.2

Recommendations ..

75

5.3

Conclusion

76

5.4

Suggestions for Further Study ..

77

Bibliography .

78

Appendix ..

80

10

CHAPTER ONE
INTRODUCTION
1.1

BACKGROUND OF THE STUDY


Cost Volume Profit analysis is a useful tool in understanding

the inherent relationship between Cost, Volume of operation and


profit. Don and Jack [1991:223] described Cost Volume Profit
analysis as a method of estimating how changes in unit variable
cost, Unit Sales Price, Total Fixed Cost per Period, Sales Volume
and Sales mix affect profit.
Jhigan and Stephen [2007: 653] defined Cost Volume Profit
analysis as a vital importance in determining the practical application
of cost function, i.e. function of three factors; Sales Volume, Cost and
Profit. It aims at classifying the dynamic relationship existing
between total cost and sale volume of a company. Hence it is also
known as Break-Even Analysis. It helps to know the operating
condition that exists when a company breaks-even, that is when
sales reach a point equal to all expenses incurred in attaining that
level of sales.
Jack, Robert and Williams [1988:129130] also recognized that
Cost Volume Profit analysis evaluates the relationship among
these interacting variables and the effect the changes in these
variable have on an organizations profits. The analysis proceeds on
the basis of cost in an organization and the profit. In other words, the
inter-play of cost and quantity enables the organization observes its
profit motive.
This inter-play follows a regular pattern or a steady state [i.e. at
equilibrium].

11

Cost Volume Profit analysis enable us answer such


question as:
[a]

What volume of operation must be achieved in order to make a


particular target profit.

[b]

At what point will all cost be recovered.

[c]

If variable cost were to change in a particular manner, and a


given rate, how will this affect the profit plan?

[d]

If there is a sudden shift in the level of Fixed Cost, what will be


its impact on operations?
Richard and Wai ]1991:109] in describing the purpose of Cost

Volume Profit analysis, said that it enables management to select


the most desirable operating plan for achieving the enterprises profit
objective under the circumstances foreseeable at the time the
decision is to be made. They also stated that Cost Volume Profit
analysis can be viewed as a way of translating a given objective [e.g.
profit level] into a more operational sub-objective [e.g. Sale Volume]
and thus aids planning considerably. It provides a tool for planning
operations especially in a situation where costs do not fluctuate
uncontrollably. The technique is designed for planning in situation
that are predictable and fairly stable. It does not require that cost do
not change at all because it has an inherent mechanism for adjusting
for reasonable changes.
However, where cost fluctuates widely as a situation of
uncontrolled inflation this technique will not be of much help in
planning. Richard and Wai [1991:109] also stated that Cost Volume
Profit analysis can aid decision making in the following typical
areas:

12

[a]

The identification of the minimum volume of activity that the


enterprise must achieve to avoid incurring a loss.

[b]

The identification of the minimum volume of activity that the


enterprise must achieve to attain its profit objective.

[c]

The provision of an estimate of the probable profit/loss at


different levels of activity within the reasonable expected.

[d]

The provision of data on relevant costs for special decisions


relating to pricing, keeping or dropping product lines, accepting
or rejecting particular orders, make or buy decision, sales mix
planning;

altering

plant

layout,

channels

of

distribution

the

practical

specification, promotional activities and so on.


Finally,

there

is

no

doubting

effectiveness/usefulness of the technique but its successful use


requires knowledge on such matters as the following:
[a]

Capacity

[b]

Variable Cost

[c]

Fixed Cost

[d]

Behaviour of cost with change in capacity or other relevant


factors.
But not all companies have been prepared to invest in the

knowledge and facilities necessary to make application of effective


Cost Volume Profit analysis worthwhile and unwillingness of
manager to use modern ideas and their lack of education in
management has impeded progress.

13

1.2

STATEMENT OF PROBLEMS
Due to the state of our economy and the various governmental

policies, managers have to choose from the alternative course of


action which are conducive for their production and services. Also
skyrocketing cost of production in recent and past years, made our
home-based industries to experience critical economic situation and
management difficulties.
The problem of these indigenous industries is basically
managerial/management incompetence owing to their inability to
predict and estimate properly the cost behaviour patterns. Cost
behaviour is the attitude of cost and including pattern that cost
behaviour follows a particular pattern which can be predicted. Since
the Cost Volume Profit analysis forms the framework for analysis,
a vehicle for appraising overall performance and a planning device,
there is need for management to evaluate these cost behaviour
pattern to ease decision making and avoid unprecedented collapse of
the industry.
Cost Volume Profit analysis is a tool for planning operations
especially in a situation where costs do not fluctuate uncontrollably.
Because Cost Volume - Profit analysis is more helpful in stale
industries than in dynamic ones. However, if cost fluctuates, the
management should know that where costs undergo changes, the
selling price and the quantity produced and sold also undergo
changes.
Therefore, this research work, aims at adequate analysis and
evaluation of the different aspect of cost and cost behaviour and

14

effectiveness of Cost Volume Profit analysis towards achieving


organizational goal.
1.3

OBJECTIVES OF THE STUDY


The study of the effectiveness of Cost Volume Profit

analysis has the following objectives:


[a]

To ascertain the effect of variations on the cost of production to


profit.

[b]

To determine the extent to which the variation/changes in Cost


affects the Volume of production and Profit.

[c]

The effect of the variations on the Cost of production to Profit.

[d]

To determine the extent to which variations in Volume of


production affects the total Cost of production.

[e]

To ascertain the relationship among the firms cost structure,


volume of output and profit in determining the breakeven quality
of output.

1.4

RESEARCH QUESTIONS
The research question which at the end of this work would have

been answered includes:


[a]

What is the effect of the alternative mode of production to the


breakeven point?

[b]

In case of a reduction in production due to unfavourable factors,


what price should a manufacturing firm charge for its products
in order to maintain some profit?

[c]

What product mix decision must a firm take in case of a multiproduct firm?

15

[d]

Of what importance is the contribution margin to a manager in


making decision on sales mix?

1.5

STATEMENT OF HYPOTHESIS
Based on the statement of the problem, objectives and

research question, the hypotheses are stated as follows:


1.

High degree of Operating Leverage does not affect Cost


Volume Profit in manufacturing Industries.

2.

Cost Control [i.e. Cost Volume Profit] technique will not help
to develop and expand manufacturing Industries as well as not
resulting to high profitability.

3.

Volume of production and quality of the products do not depend


on the strategies adopted by the management of manufacturing
Industries.

1.6

SIGNIFICANCE OF THE STUDY


The study is to show the effectiveness of Cost Volume

Profit analysis in manufacturing Industries. It is significant in that it


will:
[a]

Assist the industries in analyzing its own budget of cost of sales


structure

[b]

Help to evaluate the effect of an almost unlimited range of


contemplated changes of Variable Cost Changes.

[c]

Form a useful device to show top management the effect on


profit that changes in costs and volume would tend to have or
to demonstrating to lower level supervision such as Foreman,
the factors influencing profit

16

[d]

Assist in making short-term range tactical decisions relating


sales effort and prices.

[e]

Help to provide a tool for planning operations especially in


situations that are predictable and fairly stable.

1.7

SCOPE OF THE STUDY


The scope of the work covers three selected Industries. The

population will be taken from these industries which includes: Emenit


Nigeria Limited Enugu; Innoson Nigeria Limited and Hardis &
Dromedas Limited Enugu. The production will be taken from these
industries. The restriction to these industries is intended to ensure
that proper coverage is made and reasonable work done.
Also the study will be based on the knowledge and
understanding Cost Volume Profit analysis.
1.8

LIMITATIONS OF STUDY
Research project in a developing nation like Nigeria is still

looked upon with skepticism by most people. There is always an


element of suspicion in them as to the intention of the researcher.
They feared research because of the notion that it might expose
certain deficiencies.
Due to the stated apathy to research the researchers found it
difficult to collect information. Some were unwilling to supply any
information at all while others unwillingly supplied inaccurate
information or at times became aggressive.
Also, the researcher in organizing her materials for this work
had difficulties hence:

17

[a]

The major limitation is financial inadequacy. The wave of the


present economic hardship did affect the researcher to a great
deal.

[b]

In carrying out this study the researcher restricted herself to


selected manufacturing industries and this is informed by the
lack of time in carrying out an in-depth study in all
manufacturing industries.

1.9
Cost:

DEFINITION OF TERMS
Cost simply means the resources used up in achieving a

particular objective measured in money terms.


Cost Behaviour: This considers how a given cost reacts in totals to
changes in output of production.
Profit Volume Chart:

This is a chart that shows basically the

relationship between the profit/loss and the volume of sales.


Contribution Margin Approach: This approach revolves around
and important idea that contribution margin is an attempt to recover
the fixed costs.
Graphical Technique:

This approach involves representing the

idea on a graph religiously drawing to scale.


Margin of Safety:

It shows the amount by which forecast sales

shall fall before a loss is made.


Target Profit:

The break-even analysis can be utilized for the

purpose of calculating the volume of sales necessary to achieve a


target profit.

18

REFERENCES
Jack, L.S.; M.K. Robert and L.S. Williams [1988], Managerial
Accounting, McGraw-Hill Book Company, U.S.A.:129 13, 2nd
Edition.
Jhingan, M.L. & J.K. Stephen [2007], Managerial Economics,
Vrinda Publication Ltd, Delhi: 653, 3rd Edition.
Richard, M.S. & F.C. Wai [1991], Managerial Accounting Method &
Meaning, Chapman & Hill, London: 109, 3rd Edition.
Ricketts, D & G. Jack [1991], Managerial Accounting,
Houghton miffin Coy, U.S.A. 223, 2nd Edition.

19

CHAPTER TWO
LITERATURE REVIEW
2.0

OVERVIEW OF COST VOLUME PROFIT ANALYSIS


The relation between costs of production, volume of production

will result in profit the organization will make. Because the


relationship is stable, it is then possible for it to be analyzed to enable
for decision making. The relationship between cost and profit must be
an inverse one, the higher the cost, the lower the profit. Profit is the
financial benefit of gain which a firm realizes from its transactions and
business dealings. Profit is an important factor in any business
transaction. The main motive of engaging in any business is to make
profit.
There is the necessity, therefore, to understand the exact
nature of this relationship in order to:
[i]

Control the Level of Costs and

[ii]

Manipulate Volume

These Cost Volume Profit analysis is a study of the inherent


relationship between Cost and Profit at various level of volume of
activity.
Nweze, [2004: 212] said that Cost Volume Profit relation is
a planning device that considers the inherent relationship between
Cost, Volume of production and the profit that is made.] It asks such
question as: why, how and what and tries to give solution to them.

20

Pierre, [1987:254] defined Cost Volume Profit analysis as a


technique for evaluating the effect of changes in Cost and Volume on
Profit. Cost includes Variable and Fixed Costs that are expenses of
the period, Volume represents the level of sales activity either in units
or Naira and Profit for the firm may be net income of operating
income.
Morse and Roth [1986:288] also stated that in Cost Volume
Profit analysis, the word Cost is restricted to cost that are deducted
from revenues to determine profit. Normally these deductions are
called expenses. Consequently all product Costs are charged
against revenues in the period they are incurred.
Ray, [1991:207], also stated that an overview of Cost Volume
Profit analysis begins with the study of cost behaviour patterns with
the contribution income. The contribution income statement has a
number of interesting characteristics that can be helpful to the
manager in trying to judge the impact on profits of changes in selling
price Cost or Volume. One of the characteristics includes the
facilitation of profitability analysis by management of an organization.
Behaviour means attitude that is what is likely to happen, so
cost behaviour means attitude of cost including pattern that cost
behaviour follows a particular pattern which can be predicted. Cost is
not synonymous with expenditure. In government, its services are
measured by equating it in Naira. In accounting, cost cannot be
incurred unless there is necessity. Before incurring cost, there must
be a necessity. Cost is meant, resources necessarily expended in
pursuant of a defined objective. The based idea behind cost includes:
objectivity, expenditure of resource and necessity. There are at least

21

three different ways in which cost behaves viz: Variable, fixed and
mixed or semi-variable.
[a]

Variable Cost:

It is also referred to as direct cost. These are

the cost of raw materials and the direct cost of converting the raw
materials. The cost increases or decreases in a proportionate manner
but arbitrarily. These are costs that vary in total accounting to
changes in output. Example of Variable Cost includes: direct labour,
material, energy costs, packaging sales commissions, etc.
The behaviour of total cost with respect to relevant range of
output is shown in a table and graph form.
Table 2.1 Variable Cost schedule
ITEM IN UNITS Q

COST PER UNIT [N]

TOTAL COST [N]

10

10

10

10

100

20

10

200

30

10

300

400

300
200

100

10

20

30

40

Figure 2.1: Variable Costs, Graph


Quantity

[volume]

22

[b]

Fixed Cost: It is Cost that does not vary in total amount as sales

volume or the quantity of output changes over some relevant range of


output. For as long as output changes, that is increase or decrease
within these relevant ranges, there will not be additional fixed cost.
For this reason, this cost does not change with changes in output
within the relevant, range rather it shifts within that range. Example of
Fixed Costs includes: Rent depreciation, Fixed Salaries, Insurance
etc
TABLE AND DIAGRAMATICAL PRESENTATION OF FIXED COST

Table 2.2: Fixed Cost schedule


ITEM IN UNITS Q

COST PER UNIT [N]

TOTAL COST [N]

1000

1000

10

100

1000

20

50

1000

30

25

1000

Total Cost

N
1000

Fixed Cost

0
1
Figure 2.2:

Quantity
10

20

30

40

Fixed Cost Graph

Notice in Variable Cost that if zero units of product are


manufactured, then Variable Cost is zero, but Fixed Cost is better
than zero. This implies that some contribution to the coverage of

23

Fixed Costs occurs as long as the selling price per unit exceeds the
Variable Cost per unit. This helps to explain why some firms will
operate a plant even when sales are temporarily depressed, that is to
provide some increment of revenue towards the coverage of Fixed
Cost.
[c]

Mixed Cost or Semi-Fixed or Semi-Variable Cost refers to cost

that are neither strictly fixed nor strictly variable. It will be strictly fixed
and at a point, it will be variable and it will be strictly variable and at a
point it will be fixed. It is difficult to analyze mixed
cost but in doing so, add the total fixed cost and trace that point up to
the point where it varies and add to that total variable.
N

cost

Units produced and sold


Figure 2.3: Semi Variable or Mixed Cost graph.
Nweze [2000: 273] also noted that the above presentation of
Cost behaviour has substantial effect for Cost Control and recovery
and consequently, on the short and long-term attitude of a firm under
varying macro-economic conditions.
In terms of sequence, the Fixed Costs must be incurred first
since they are concerned with acquisition of productive capacity once
incurred they need not be incurred again until the expiration of the
period or range of activities to which they apply. While all cost,

24

including fixed cost must be recovered in the long-run, emphasis on


the recovery of fixed cost in the short-run is not essential to
production.
On the other hand, Variable Costs which must be incurred each
time a new activity is embarked upon must be recovered from that
activity, otherwise, these will ensure serious cash flow problem and it
may not be possible to continue operations even temporarily in the
short-run. Recovery of Variable Cost is important for short-term cash
flow purposes whereas recovery of Fixed Cost is essential for
profitability.
It is important, therefore, for every enterprise to have an idea of
its total Variable Cost. This will enable it change a price not below this
figure to ensure short-term survival.
The concept of Cost Volume Profit analysis is so pervasive
in managerial accounting that it touches on virtually everything that
managers do. Because of its wide range of usefulness, Cost
Volume Profit analysis is undoubtedly the best tool the manager
has for discovering the untapped profit potential that may exist in an
organization.
2.1

COST ACCOUNTING
Owler and Brown [1984:1] defined Cost accounting as that part

of management accounting which establishes budgets and Standard


Costs and actual Costs of Operations, processes, departments or
products and the analysis of Variance, profitability or social use of
funds.

25

Ezeugwu [1999:1] also defined Cost accounting as the set of


techniques whereby transactions are recorded and cost ascertained,
classified and allocated to products or activities within the
organization.
Cost accounting forms the basis from which data is obtained
from the organization for the purposes of management decision
making. Cost is a measure of the resources used up to achieve a
certain aim and can be expressed as so much per unit of production
or the cost of operating a section of an organization.
The Cost accountant uses the information provided by the
financial accountant and other information obtained from the internal
working of the organization to prepare cost information.
Data is needed in monetary and non-monetary forms such as, bonus
worked, materials used etc. This enables him to determine the actual
cost of the product, operations and departments and compare thus
with estimated or projected cost. Estimates are based on present or
prospective market prices of materials and labour.
Cost accounting however, records the actual or may be
Standard Costs of materials, wages and overhead. An estimate is an
opinion, Price, policy and Cost a fact
2.1.1 ASCERTAINMENT OF COST
Owler and Brown [1984:2] stated that cost may be ascertained
as follows:
[a]

Historically, that is after they have been incurred.

26

[b]

By predetermined Standards, combined with subsequent

analysis of variances between those standards and the actual cost


incurred.
[c]

By the use of marginal methods of presentation for either [a] or

[b], involving the differentiation between fixed and Variable Costs.


Lucey [1992:7] also noted that the whole process of cost
ascertainment is directed towards the establishment of what is
actually cost to produce an article, run a department or complete a
job. The cost ascertainment process [like financial accounting] is
concerned with collecting, classifying, recording, analyzing and
reporting upon the financial consequences of past actions. The
knowledge of past activities is necessary because it helps in control,
inventory valuations and profit determination and most importantly,
they provided a guide to the future but this historic emphasis is in
contrast to the future orientation of much management accounting
work, like the provision of information for planning and decision
making.
It is because of this and the fact that cost ascertainment
involves

numerous

conventions

and

assumptions,

that

any

information derived from the cost accounting system is critically


examined and if necessary, adjusted before it is used for
management accounting purposes.
[a]

Cost Units:
Cost unit is that unit of output, service or time to which costs

can be allocated and for which it is convenient to express a cost unit.

27

The selection of cost is dependent on what is appropriate to the


business concerned.
Examples:
Unit of production includes: tables, tons of cement, liters of petrol, a
barrel beer etc.
Unit of services includes: consulting hours, kilowatt hours, questnights etc.
Within a given organization, there may be several different
Costs Units in order to cost various products or activities. The
manager should select the most appropriate cost unit relevant to the
production process.
[b]

Cost Centre:
This is any part of a form to which it is convenient to give up

certain costs. It can also be defined as, a location, function, or items


of equipment in respect of which costs may be ascertained and
related to cost units for control purposes.
Thus, through the cost centre coding system costs are gathered
together according to their incidence. The gathering together of the
indirect costs results in the establishment of the overheads relating to
each cost centre which is an essential preliminary to spreading the
overheads over cost units.
Examples of cost centres in a factory are the assembly
department, the printing department, the finishing department, the
power house, the canteen, the tool room, the stores, the cost office
and the maintenance department.

28

A cost centre is a focus of activity and as such it is convenient


to ascertain costs for that activity and to allocate responsibility to an
executive to operate it successfully.
In a manufacturing firm, as costs are incurred, they are
classified in various ways by means of the accounts coding system.
An important, primary classification is that into direct and indirect
cost.
Direct costs consist of direct material, direct labour and direct
expenses. They are directly charged as part of the prime cost. In
other words, it is the material which can be measured and charged
directly to the cost of the product.
Examples of direct material includes, raw materials used in
the product, parts and assemblies incorporated into the finished
product, cement used on a contract, etc.
Direct labour is incurred in altering the construction,
composition, conformation or condition of the product. The wages
paid to skilled and unskilled workers for this purpose can be allocated
specifically to the particular cost account concerned.
Examples of direct labour includes: wages paid to production
workers for work directly related to production, salaries directly
attributable to a saleable service etc.
Direct expenses include any expenditure other than direct
material or direct labour directly incurred on a specific cost unit.
Example of direct expenses include: expenses incurred
specifically for a particular job tool hire for a particular job etc.
Indirect costs consist of all material, labour and expenditures
which cannot be identified with the product. The total of indirect costs

29

is known as overhead which is normally separated into categories


such as production overheads, administration overheads, selling
overheads etc.
Indirect in this connection is meant, that which cannot be allocated
but which can be apportioned to/or absorbed by cost centres or cost
units.
2.2

PRODUCTION CAPACITY/VOLUME
Production capacity/volume is defined as the maximum level at

which the plant or department can operate efficiently. Measurement


of capacity [also called maximum or idea capacity] assumes the
production of output 100%. Profitability is important when budgeting
the level of activity at which the manufacturing unit is to be operated.
In budgeting for production or sales, it is very important to
consider the key factor, sometime termed the limiting or principal
budget factor. This factor limits the production and/or sales potential
and is to be found in many industries.
Examples of the key factors are as follows:
[a]

[b]

[c]

Material:
[i]

Availability of supply

[ii]

Restrictions imposed by licenses, quotas, etc.

Labour:
[i]

General shortage

[ii]

Shortage of certain grades

Plant:
[i]

Insufficient capacity due to shortage in supply

[ii]

Insufficient capacity due to lack of capital

30

[iii]
d]

Insufficient capacity due to lack of space

Management:
[i]

Insufficient capital, restricting policy

[ii]

Policy decisions, e.g. maintaining sales prices by limiting


production

[e]

Sales:
[i]

Consumer demand

[ii]

Inefficient or insufficient advertising

2.2.1 FACTORS COMBINATION


Generally, firms can use factors of production in two different
ways. The two modes of factor combinations are:

[i]

[i]

Labour intensive

[ii]

Capital intensive

Labour Intensive:
Firms can make use of human labour in their production

processes. A firm is said to be labour intensive when they have


employed more of human labour than the extent it was mechanized
or automated form of production when labour intensive is used more
than mechanized, it gives rise to higher direct labour cost. Hence
there will be less fixed cost as labour attributable to production is
higher.
[ii]

Capital Intensive
Conversely, in capital intensive mode of production, the firm

makes use of higher degree of mechanized/automated manner of

31

production than human labour employed. An in-depth study of the


companies under study indicates that more of automation is
employed in production. The implication is that more cost will be
incurred on the use of factory machinery hence, higher charges
attributable to depreciation. Fixed cost in this case is grater as human
labour attributable to production is less.
2.3

OPERATING LEVERAGE
To the manager, leverage explains how one is able to achieve

a large increase in profit [in percentage terms] with only a small


increase in sales and/or assets.
Nwude [2001:200201] stated that operating leverage relates to
the extent to which the means of carrying out operations is enhanced.
It reflects the use of fixed cost in an attempt to increase profitability.
The enhanced means can attract higher fixed cost which must be
covered before the firm can think of profit.
He defined operating leverage as, simply the fixed operating
costs that enable the firm to greatly increase the operating income
with relatively small increase in sales volume.
Ray [1991:212] also defined Operating Leverage as a measure
of the extent to which fixed costs are being used in an organization. It
is greatest in companies that have a high proportion of fixed costs in
relation to variable costs. Conversely, operating leverage is lowest in
companies that have a low proportion of fixed costs in relation to
variable costs. If a company has high Operation Leverage [that is,
high proportion of fixed costs in relation to variable costs], the profit
will be sensitive to changes in sales.

32

The degree of Operating Leverage is a measure at a given


level of sales, of how a percentage change in sales volume will affect
profits.
Degree of Operating Leverage can be measured by the
following formula:
DOL =

% change in operating income


% change in sales

for single product:

Q [SP VC]
Q [SP VC] FC

For multi product:

Gross profit
EBIT

Data availability will sometimes dictate which formulation can


be applied.
Emekekwue [2002:498] stated that the implication of Operating
Leverage to a firm is that as the firms scale of operations moves in a
favourable manner above the breakeven point, the degree of
operating at each subsequent [higher] sales base will decline.
The greater the firms degree of operating leverage, the more its
profits will vary with a given percentage change in sales. Thus,
Operating Leverage is definitely an attribute of the business risk that
confronts the company if the firm with a high degree of Operating
Leverage fails to breakeven at the high breakeven point, it will incur
huge losses.
He also stated that when the Operating Leverage is high a
slight change in sales bring a more than proportionate change in
profit. It should not, therefore, be assumed that high Operating
Leverage is best for a firm because this is not so. Leverage is a

33

double-edged sword that cut for and against the organization. In


prosperous years, high Operating Leverage can be a blessing to the
organization. But when economy is experiencing a down turn such
that there are no sales high operating leverage will prove to be a
curse.
Ray [1991:213] also observed that the Operating Leverage
concept provides the manager with a tool that can signify quickly
what impact various percentage changes in sales will have on profits,
without the necessity of preparing detailed income statements. This
explains why management should often work very hard for only a
nominal increase in Sales Volume.
Illustration I
Assume that here are three selected firms A, B, and C. If their
fixed capital are N5,000, N7,000, and N8,500 respectively. Each of
these firms is selling portable radio sets at a unit price of N15.00. If
the various cost for each radio set as it affects the firms are as
follows: A =
[a]

N12.00,

B = N10.00 and

C = N9.00.

Calculate their break even point.

Solution:
Bu

F
SV

Bu [A]

5,000

5,000

15-12

1,666.67 units

1,400 units

Bu [A]

1,667 units [approx]

Bu [B]

7,000
15-10

7,000
5

34

Bu [B]

1,400 units

Bu [C]

8500 =

8,500

15-9
Bu [C]

1,416.67 units

1,417 units approximately.

This shows that for the firms to break even, A firm have to sell
1,667 radio sets, B firm will have to sell 1,400 radio sets, while C
firms will have to sell 1,417 radio sets.
2.4

ASCERTAINMENT OF PROFIT
Profitability is a primary measure of the overall success of a

company. Indeed, it is a necessary condition for survival what


determines profit is the interaction between cost and level of activity.
Profit is ascertained where all the cost of production or mix
products is deducted from the revenue realized from the disposal of
the products or mix products.
It can be expressed in equation or by formula thus:
Profit

Total revenue

Where Total Cost [TC] =

Total Cost.

fixed cost + Variable Cost.

Both total revenue and total cost are likely to be affected by changes
in the quantity of output. A statement of the profit equation that takes
quantity of output into account adds useful information for examining
the effects of revenue, cost and volume on operating profit.

35

2.5

DETERMINATION AND ANALYSIS OF BREAKEVEN POINT


The technique of breakeven analysis is familiar to legions of

business people. It is useful applied in a wide array of business


settings, including both small and large organizations.
Breakeven analysis is a profit planning tool normally used to
determine the point at which sales revenue covers the total cost of
operations. It is an analytical technique that shows how total cost
[TC], total revenue [TR] from sales volume, and total profit [TP] are
related. It is concerned with predicting the effect of changes in cost
and sales on profit. The point at which sales revenue equals the total
cost of operations is called the breakeven point. The breakeven point
is not the sales level at which neither profit nor loss is made by the
firm.
Nweze [2004: 218] stated that breakeven point is level of
operations at which all costs variable and fixed cost are
recovered, but before the making of profit. Thus, at breakeven, profit
is zero.
He also stated that while every company is out to make profit
and consciously plans to produce at the point of breakeven except
during a distress, no company can make profit without first crossing
the breakeven point. When a company is producing at a loss, the
breakeven point serves as an important beacon of encouragement
which the management realistically hopes to reach before erasing all
loses. Without knowledge of the breakeven point, the company may
not realize when it has got out of the quagmire, it may erroneously
regard it to be farther or nearer.

36

The breakeven point may be found using graphical approach.


This may be preferred where:
[a]

A simple overview is sufficient

[b]

There is a need to avoid a detailed, numerical approach when

for example; the recipients of the information have no accounting


background.

Total sales
revenue

Figure 2:4 Graphical Representation of Break-Even Analysis

Total sales revenue


and Total Cost

400
BEP

300

Profit

Loss

Total Cost

200
A

Fixed Cost

100

BEP
Sales Volume

Source: An unpublished MBA Lecture note by Kodjo.


The breakeven point is the point at which the total revenue line
and the total costs line intersect.
The fixed curve is read off the graph as a straight line which is
parallel to the horizontal quantity axis. This shows that fixed costs are
fixed in total, no matter the quantity produced within the relevant
range of activity and the variable cost curve is platted starting from
the level of fixed costs as the base and is proportional to the level of
output. This shows that the greater the quantity the higher the

37

variable cost, that is positive relationship. The variable cost line


represents the total cost curve when read off in addition to the fixed
cost below it.
The revenue curve is then superimposed on the cost curve
starting from the origin of the graph. This shows that, at zero activity
there will be a zero income. The curve is a straight line rising at a
constant angle reflecting the constant unit of selling price. Where the
total cost and income curves intersect, there is break-even [that is
cost equal to income]. Hence, no profit is made. The vertical distance
between the cost and income curve at any given level of activity
measures the profit or loss depending on which is higher.
Beyond the breakeven point, the contribution margin begins to
outstrip the total cost as the activity level rises. This indicate that
when production is below the level necessary to break-even, there
will be loss which equals in low the contribution margin has failed to
meet up with the fixed cost. Conversely, there will be profit after the
break-even point which will exactly equal how much the contribution
margin outstrips the fixed cost. The difference made by the total cost
and the revenue curve below break-even point is called the Loss
Region. An angle is usually formed between the total cost line and
the revenue line. The angle measures the profit when revenue is
above the break-even point. The angle is called the angle of
incidence.
2.5.1 MARGIN OF SAFETY MARGIN OF DISTRESS
Ray [1991: 225] defined margin of safety [ms] as the excess of
budgeted [or actual] sales over the breakeven volume of sales. It

38

states the amount by which sales can drop before losses begin to be
incurred in an organization.
The formula for its calculation:
Total Sales Breakeven Sales

Margin of Safety

It can also be expressed in percentage form. This percentage is


obtained by dividing the margin of safety [ms] in Naira terms by total
sales.
MS in Naira

MS in percentage

Total Sales
It can also be expressed in terms of units of product [if a
company is a single product firm] by the formula:
MS in Naira
Unit Selling Price
If the margin of safety [ms] is low, management effort must be
directed toward reducing the breakeven point or increasing the
overall level of sales in the company margin of safety is a tool
designed to point out a problem, the solution to which must be found
by analyzing the Company Cost Structure and by applying the
general Cost Volume Profit technique.
Kodjo [lecture note] also observed that the breakeven point signal the
beginning of the danger zone. The further away a firm is from the
breakeven point, the more comfortable it will be. The margin of safety
is the different between the firms actual output achieved and its
breakeven output where the firm is producing above the breakeven
point, it measures by how much an output will fall before there is no
more profit, that is, before the entire profit is wiped out. For this

39

reason, it is considered that the wider the margin of safety, the more
comfortable the firm will be.
Mathematically: Margin of Safety + Contribution Margin = Profit
He also observed that margin of distress which means the
amount of additional volume that must be achieved before the
enterprise wipes out all losses and breakeven measure the amount of
unit and Naira Sales Volume respectively, that must be achieved
before the enterprise get out of its distress.
When a firm finds itself producing at a point below the
breakeven point, the firm must be making a loss; in that case, we say
that the firm is in distress. It is possible to measure the extent of
distress. It is the difference between the actual output of the firm
[which is below the BEP] and the breakeven point. It shows by how
much output must increase before the entire loss will be wiped out
and the firm break even.
The margin of the firm in distress will do well to keep the margin
of distress in focus this way he can chase it as a target.
To get out of distress, the management could seek to
manipulate its unit contribution margin to advantage where possible.
Conversely anything that tampers with the contribution margin in unit
to a disadvantage has the potential of adversely affecting the margin
of safety.
2.6

CONCEPT OF CONTRIBUTION MARGIN


Kodjo [2004:127] defined contribution margin as the difference

between sales and total variable costs. It is not the same as gross

40

margin which is the difference between sales and total cost of goods
sold [including fixed cost]. The relevance of the contribution margin is
that under certain short term conditions it becomes critical for
management to know what productive effort are making towards the
recovery of those costs which, because they are fixed, are known to
be unaffected by changes in production levels. These conditions are
very many indeed and include decisions to drop product lines,
change prices, choose alternative product route etc. also under
condition where some resources impose constraints on decision by
reason of their importance or relative scarcity, the contribution
approach to the decision is helpful. Under any or all of these
conditions [mainly short-term] fixed cost largely unaffected and are,
therefore, unimportant in making the decision.
Where sales and variable costs are determined on unit basis
the contribution margin, which is then per unit, now conforms to what
the economics refer to as marginal income, in which case the
optimum volume of production is determined at where marginal cost
and marginal revenue are equal, and the price at which this volume is
obtained is the optimum price.
Nweze [200:161] also stated that the assumptions underlying
the contribution margin concept includes:
[a]

The manufacturer has only one source of income

[b]

Total revenue that the trader will make will be equal to the

number of items he sold multiplied by price of each item.


Mathematically:
Let R

Total revenue

Revenue per unit/price

41

Note that, C
Where C

V + F - - - [I]

= Total Cost V= Variable Cost and F= Fixed Cost

V =
Where v

quantity

Vq - - - - - - - - - [2]

= Total Variable Cost, v= Variable cost per unit and

= quantity per unit

Then R

Where R

= Total revenue, r revenue per unit and

rxq=

rq - - - [3]

= quantity per unit.

This implies that total revenue must be large to recover cost


[both fixed and variable] and make his profit
R

P _ - - - [4]

Substitute for C [recall that C


R

= V +
+

F]

P - - - [5]

This implies that our R must be large enough to recover our


Variable Cost, fixed cost and then make profit.
Taking away V from both sides
R - V + F + P - - - [6]
This implies that if we deduct our Variable Cost from total
revenue, we have a residue and the residue will be enough to recover
our fixed cost and then make profit.
Then

R - V is the contribution margin.

Nweze [lecture note] also stated that the contribution margin is


an important decisional concept in business. Its measure as the
difference between total revenue and total variable cost. However,
especially in merchandising firm [i.e. buying and selling firm] it does
not occur in toto at the beginning. Its rather a margin contained within

42

the price of the product. The accumulation of this margin per unit into
the total units achieved equals the total cumulative margin. The
margin provides a fund for achieving two important business
objectives.
[a]

To recover fixed cost which are recoverable in the long-run.

[b]

To meet the profit motive


The contribution margin is a concept which provides an

inevitable tool for analysis of a host of business decisions. The


decisional situations include, pricing decision, decision to make a
product component within or to buy it from outside supplier, decision
to sell a by product or joint product now or to process it further,
decision to replace an existing equipment or not, decision to embark
on sales promotion or not, decision to accept a special sales order or
not, decision with scarce resources etc.
In all these decision the accountant is seeking to discover the
relative impact of the alternatives on the total contribution margin.
Generally, the accountants will advice that decisions make a positive
impact on the total contribution margin, that is that increase in the
total contribution margin are worthy alternatives. It follows therefore,
that the higher the positive impact of the contribution margin, the
more attractive that alternative will be.
He further said that the concept of contribution margin appears
to be indigenous to most African cultures where haggling [bargaining]
is the preferred method of agreeing on a price among
parties. For the seller with the knowledge of his Variable Cost, his
objective in the haggling process is to obtain from that particular
buyer as high a unit contribution margin as possible in the

43

circumstance. For the buyer who unfortunately is ignorant of the


sellers Variable Cost, the onerous task before him is to attempt to
reduce the contribution margin which the seller can exact from him.
Note that, generally the seller does not want his Variable Cost to
come into contention in the price fixing or haggling process.
The roles of the contribution margin are easily understandable.
For instance, to decrease the volume to be attained in pursuit of a
profit target, the decision-maker should either:
[a]

Reduce his Variable Cost while ensuring that fixed cost and
price remain constant or decrease more slowly.

[b]

Increase price, while ensuring that Variable Cost [and also fixed
cost] do not increase or do so more slowly.

[c]

Reduce fixed cost while not simultaneously affecting the


Variable Cost and price in the same magnitude.

[d]

or combination of the above.


The first two steps above imply an improvement in the unit
contribution margin. The steps can thus be summarized into:

[a]

Improve the contribution margin

[b]

Reduce fixed costs


The contribution margin does not assume that any profit

whatsoever can be made until:


[a]

All Variable Cost are recovered

[b]

All fixed costs are recovered.


What the contribution margin does is to emphasize the process

by which this recovery is done, firstly, Variable Costs in the short-run


and then fixed costs in the long-run. Only after this

44

can any profit is made at all. It is only by achieving volumes [of sales]
that these targets can be attained.
To improve performance, management should focus its
attention on the contribution margin. Once revenue outstrips Variable
Costs, there is a contribution made to this fund from which static
fixed cost and profits are satisfied.
2.7

APPLICATION OF COST VOLUME PROFIT ANALYSIS


The concept of Cost Volume Profit analysis has many

applications in planning and decision making. The application of Cost


Volume Profit analysis aids management in making decision
relating to the following situations:
[a]

Change in fixed costs and sales volume

[b]

Change in Variable Cost and sales volume

[c]

Change in fixed costs, sales price and sales volume

[d]

Change in Variable Cost, fixed cost and sales volume

[e]

Change in regular sales price.


Ray [1991: 214 216] illustrated some of these application

using company x which manufactures microwave Ovens. Company x


basic cost and revenue data are:
Per Units [N]

Percent

Sales price

250

100

Less Variable expenses

150

60

Contribution margin

100

40

Fixed expenses are N35,000 per month. These data will be


used to show the effect of changes in Variable Costs, fixed costs,
sales price and sales volume on Company x profitability.

45

[a]

Change in fixed costs and sales volume


Assume that Company x is currently selling 400 ovens per

month [monthly sales of N100,000]. The sales manager feels that a


N10,000 increase in the monthly advertising budget would increase
monthly sales by N30,000. Should the advertising budget be
increased?
Solution:
N
Expected total contribution margin
N130,000 x 49% C.M. ration

52,000

Present total contribution margin


N100,000 x 40% cum ratio
Incremental contribution margin

40,000
12,000

Change in fixed cost:


Less incremental advertising expenses
Increased Net Income

10,000
2,000

Yes, the advertising budget should be increased! Notice that


this approach does not depend on the knowledge of what sales were
previously. It is also unnecessary under this approach to prepare an
income statement. This solution above involves an incremental
analysis in that they consider only those items of revenue, cost and
volume that will change if the programme is implemented.
[b]

Change in Variable Costs and Sales Volume:


Refer to the original data. Assume again that Company x is

currently selling 400 ovens per month. Management is contemplating


the use of less costly components in the manufacture of the ovens,

46

which would reduce Variable Costs by N25 per oven. However, the
sales manager products that the lower overall quality would reduce
sales to only 350 ovens per month. Should the change be made?
Solutions:
The N25 decrease in Variable Costs will cause the contribution
margin per unit to increase from N100 to N125.
N
Expected total contribution margin
350 ovens x N125

43750

Present total contribution margin


400 ovens x N100
Increase in total contribution margin

40000
3750

Yes, the less costly components should be used in the


manufacture of the ovens. Since the fixed costs will not change, net
income will increase by the N3750 increase in contribution margin.
[c]

Change in Fixed Cost, Sales Price and Sales Volume


Refer to the original data. Assume again that Company x is

selling 400 ovens per month. To increase sales management would


like to cut the selling price by N20 per oven and increase the
advertising budget by N15000 per month. Management feels that if
these two steps are taken, unit sales will increase by 50 percent.
Should the change be made?

47

Solution:
A decrease of N20 per oven in the selling price causes the unit
contribution to decrease from N100 to N80.
N
Expected total contribution margin
400 ovens x 150% + N80

48,000

Present total contribution margin


400 ovens x N100
Increase in total contribution margin

40,000
8000

Change in Fixed Cost:


Less incremental advertising expense
Reduction in net income

15000
[7000]

No, the change should not be made


[d]

Change in Variable Cost, Fixed Cost and Sales Volume


Refer to the original data. Assume again that Company x

currently selling 400 ovens per month. The sales manager would like
to place the sales staff on a commission basis of N15 per oven sold
rate than on flat salaries that now total N6,000 per month. The sales
margin sales by 15 percent. Should the change be made?
Solution:
Changing the sales staff from a salaries basis to commission
will affect both Fixed and Variable costs. Fixed Cost decrease by
N6000 from N35000 to N29000. Variable Cost increase by N15 to
N165 and the unit contribution margin decrease from N100 to N85.
N
Expected total contribution margin
400 ovens x 115% xN85

39,100

48

Present total contribution margin

40,000

Decrease in total contribution margin

[900]

Change in Fixed Costs:


Add salaries avoided if a commission is paid

6000

Increase in net income

5100

Yes, the changes should be made.


2.8

ASSUMPTIONS

UNDERLYING

COST-VOLUME-PROFIT

ANALYSIS
Cost Volume Profit analysis is a technique that helps
management in decision making. It merely provides information that
management can analyze and use to make its final decision. Certain
assumptions underlie Cost Volume Profit analysis. The data that
result from the analysis are only as valid as these assumptions. As
long as management understands the assumptions, it can adjust its
final data to meet the actual situation under study.
Nweze [2004: 224] made the following Cost Volume Profit
analysis assumptions:
[a]

Costs have Been Accurately Distinguished as Variable or


Fixed.
It is not always easy to separate costs into Variable or fixed

furthermore, some costs may be mixed and some may be step


variable. Thus, classification is not always accurate.

49

[b]

Fixed Costs Remain Constant with the Relevant Range of


Analysis
Obviously, if Fixed Costs are expected to change, the changes

must be considered in Cost Volume Profit analysis. However, the


basic assumption is that they will not change.
[c]

Total Variable Costs are affected Only by Changes in


Volume
In other words, Variable Costs always are linear. This means

that total Variable Costs increase or decrease only because of


increases or decreases in the number of units sold. Changes in
efficiency may result in a higher or lower total Variable Cost. As
volume increases, materials sometimes can be purchased for a lower
price per unit. Thus, other factors normally affect total Variable Costs.
But for Cost Volume Profit analysis, these factors are ignored. As
always, management can adjust

its data according to the

circumstances in the particular firm.


[d]

Revenue is Linear; that is, selling price does not change


over the Range of Activity
This is not necessarily so, sometimes, economic factors require

that the selling price be changed. For example, competition may


require that management lower the selling price or management may
decide to change the selling price in order to increase volume.
[e]

There is No Change in Inventory Levels


In other words, whatever is produced in the current period is

sold in the current period. In using Cost Volume Profit analysis,

50

we assume that inventory levels do not change, so that all fixed Costs
are subtracted from the contribution margin in arriving at net income.
Cost Volume Profit analysis is only as valid as the
assumptions that underline it. Management must consider these
basic assumptions. To the extent that any assumption is not valid in a
specific situation, management must adjust its data to meet the
realities of the situation.
Cost Volume Profit analysis is a useful technique for
management. It must be remembered, though that appropriate
information, management can have more confidence in a decision
based on the data that result from Cost Volume Profit analysis.
2.9

COST VOLUME PROFIT ANALYSIS BY FORMULAE


Cost Volume Profit analysis can be undertaken by graphical

means or by simple formulae which are listed below.


[a]

Breakeven point [in unit] =

Fixed Cost
Contribution/unit

[b]

Breakeven point [N sales] = Fixed Cost x Sales Price/unit


Contribution/unit

[c]

Contribution to Sales ratio [c/s ratio] = Contribution/unit x 100


Sales Price/unit

[d]

Level of Sales to result in target profit [in units]


= Fixed Cost + Target
Contribution/unit

[e]

Level of Sales to result in target profit after tax [in units]


= Fixed Cost + Target profit/1 tax rate
Contribution/unit

51

[f]

Levels of Sales to result in target profit [N sales]


= [Fixed Cost + Target] x Sales Price/unit
Contribution/unit
Note that the above formula relate to a single product firm.

2.10 COST- VOLUME PROFIT RELATIONS AND SENSITIVITY


ANALYSIS
Sensitivity analysis is defined as the mathematical tool of
determining how a basic feasible solution will be affected by given
margins of prediction error. In Cost Volume Profit analysis, rather
than assume that all the parameters; Price, Variable cost per unit and
fixed costs can be predicted with foolproof accuracy. Sensitivity
analysis allows for a certain percentage for the error-margins and
sometimes, equally calculating the cost of prediction error. In Cost
Volume Profit relations, two types of prediction error can generally
be determined.
[a]

Errors affecting the contribution margin e.g. Price Variable Cost


and Production/Sales mix prediction errors.

[b]

Errors not affecting the contribution margin e.g. fixed costs.


Sensitivity analysis involves simply re-working the problem

allowing for the error, obtaining fresh results [and if desired


comparing this new result with the basic feasible solution, thereby
generating the cost of prediction error.
The technique of sensitivity analysis has often been used to
build in some dynamism and flexibility into this important planning
tool. The technique allows a consideration of what the combined

52

affect of percentage changes of underlying cost and revenue


assumptions in either direction will have on target profit or
contribution margin.
Morse and Roth [1986: 309] observe that sensitivity analysis is
a technique used to answer, what if type of questions. Using
expected profit as the dependent Variable, typical questions include:
What will happen to profit if ..
-

Selling price increase

Direct labour increase

Sales Volume increase and selling prices decreases.

By determining the answer to such questions, management


becomes aware of the potential impact of uncertainty. This helps in
determining whether to accept or reject a proposed project or to
obtain additional information before making a decision. If a project is
undertaken, sensitivity analysis assists management in determining
these aspects of a project that should be closely monitored: namely,
those that have the greatest potential impact on one or more
important dependent variables such as profit or cash flow.
2.11 IMPACT OF TAXES ON COST VOLUME PROFIT
ANALYSIS
Taxation may be defined as the imposition of an obligatory levy
or contribution on an individual or corporate donor by a recipient
public authority. Taxation involves an element of obligation or
compulsion as opposed to voluntaries. It may be imposed on income,
on profit, on cost of production. The primary purpose is to raise
revenue for financing various government project and services.

53

Income taxes must be considered in determining possible


results when a profit is expected. An income tax is a tax levied on the
profit of an organization. Income taxes have no effect on the
breakeven point because; there are no taxes when there is no net
income.
If a businessman intends to make N1.5m profit and assuming
that the requirement of the law is that 25 percent should be paid as
tax and after paying tax the profit target could not be met. The impact
of tax is that it reduces the N1.5m profit target. Therefore, the
decision-maker knowing that tax will be deducted is faced with the
plan that after paying tax, he will still maintain his profit target of
N1.5m.
When a firm does not make profit, its charged a levy because
some companies intentionally declare loss in order to evade tax and
that is why government came up with the regulation in order to deter
firms from evading tax. The effect of this is that companies which
make no profit, i.e. which operate at the breakeven point or a loss
must pay this levy in lieu of tax. The effect of this levy on Cost
Volume Profit analysis is to increase the level of operation required
to breakeven.
Also at breakeven, this levy is added to the fixed cost and the
impact is that it increases the fixed cost and when divided by the
contribution margin will give us the revenue required to breakeven.
Mathematically, BEP =

Fixed Cost + Levy


Contribution margin

54

2.12 MANAGERIAL USES OF BREAK-EVEN ANALYSIS


Jhingan and Stephen [2007: 658], they said that to the
management, the utility of break-even analysis lies in the fact that it
presents a microscopic picture of the profit structure of a business
enterprise. The break even analysis not only highlights the area of
economic strength and weakness in the firm but also sharpens the
focus on certain leverages which can be operated upon to enhance
its profitability. It guides the management to take effective decision in
the context of changes in government policies of taxation and
subsides. The Cost Volume Profit analysis can be used for the
following decision analysis.
NOTE:

The principle of contribution margin is often found

useful in the analyses of these special decisions. The decisions or


project are directly costed, i.e. the cost [and of course revenue] which
will be necessarily and directly occasioned by the projects are the
only ones relevant in deciding whether or not to embark on them.
This method is called direct costing.
It involves identifying the marginal revenue and cost [which of
course will yield the contribution margin]. Therefore, the method is
also called the marginal [differential] costing technique or the
contribution margin approach to decision making. This approach is
often found useful in decisions or pricing [especially under distressing
circumstances, promotional campaigns, profit planning, make or buy,
add or drop, sell or process further decision etc.
To show how these principles are used in special decision
analysis, some special decisions are analyzed in some detail below.

55

[a]

Decision Regarding Addition or Deletion of Product Line


If a products has outlived its utility in the market immediately,

the production must be abandoned be the management and


examined what would be its consequent effect on revenue and cost.
Alternatively, the management may like to add a product to the
existing product line because it expects the product as a potential
profit spinner. Cost Volume Profit analysis helps in such a
decision.
Illustration I:
Emenite, An Asbestors manufacturer possesses the following
data regarding his Industry:
Total Fixed Cost =

N1,50,000

Volume of sales =

N500,000 unit

Table 2:3 Decision Regarding Adding or Deletion of product line.


TYPE OF PRODUCT

PRICE

VARIABLE

PER UNIT

COST
UNIT

SHARE

IN

PER SALES
VOLUMES
[%]

Roofing product

360

240

50

Ceiling product

600

360

30

Garden items

800

480

20

Source: An unpublished material from Emenite Nig. Ltd.


The manufacturer is considering whether or not to drop Garden
items from its product line and replace it with a Decorative ceiling tile.

56

He knows that if he takes the decision of dropping Garden items and


replaces it with Decorative ceiling tiles his output and cost data would
be
Total Fixed Cost

N1,50,000

Likely volume of sales =

N500,000

Table 2:4 Decision Regarding Adding Ceiling files & Delotion of


Garden items.
PRODUCT

PRICE

VARIABLE

SHARE IN

PER UNIT

COST PER

SALES

UNIT

VOLUMES
[%]

Roofing products

360

240

50

Ceiling product

600

360

20

Decorative ceiling tiles

850

450

30

Source: An unpublished material from Emenite Nig. Ltd.


To find out the impact of proposed change, we need to
compare profits in the two situations.
Firstly, we have to find out the contribution ratio of each
product.
Contribution Ratio of a product

Price Average Variable Cost x Share in total sales


Price
Product Line
Roofing product

Contribution Ratio
=

360 240 x 50%


360

0.167

57

Ceiling product

600 360 x 30%

0.12

0.08

600

Garden items

800 480 x 20%


800

Total Contribution ratio


Total contribution
Profit

0.367

N500,000 x 0.367

N183,500

Total contribution Total fixed cost

N183500 N1,50,000 =

N33500

Similar analysis is followed for the second situation.


Product

Contribution Ratio

Roofing product

360 240 x 50%

0.167

0.08

0.141

360
Ceiling product

600 360 x 20%


600

Decorative ceiling tiles =

850 450 x 30%


850

Total Contribution ratio


Total contribution
Profit

0.388
=

N300,000 x 0.388

N194,000 N1,50,000

N194,000
N44,000

From the above analysis, we can infer the manufacture; should


drop Garden items from product line and add Decorated ceiling tiles
to his product line so as to earn more profit.

58

[b]

Contribution Margin Approach to Make or Buy


This is a non-routine type of decision. This decision depends on

idle facilities. The choice to prefer will be the one to increase the
contribution margin or the one that will reduce the total cost.
When an enterprise faces the decision to purchase from an
outside supplier, a product/component that it has the capacity to
make within the enterprise is said to be faced with a make-or-buy
decision.
In making this decision, a lot of factors, qualitative and
quantitative come into play in making such decisions. There may
be the concern to ensure a steady uninterrupted supply, or for the
reduction of dependence on outside suppliers, there may be the
desire to free facilities for more strategic use, there may also be a
consideration for costs. However, the analysis here will be restricted
to qualitative factors since such is the practice of accounting.
Illustration II:
Suppose Emenite, a manufacturer of Roofing products
considers sub-contracting the vitta tile sheets to an outside supplier
Innoson Nig. Plc, although it can make it in its factory at the following
cost.

59

Table 2:5 Contribution margin Approach to make or buy


PARTICULARS

COST PER
UNIT

Direct material

TOTAL COST
FOR 100,000
UNITS
100,000

Direct labour

400,000

Variable factory overhead

200,000

Fixed factory overhead

400,000

Total Cost

Nil

N1,100,000

Source: An unpublished material from Emenite Nig. Ltd.


Innoson Nig. Limited has offered to supply the same
component at N10. The fixed factory overhead included in the data
above is an application of the total factory overhead to units at a predetermined application rate of N4.00 unit. Advice Emenite Nig.
Limited.
Table 2:6 Emenite Nigeria Limited
Make or Buy Roofing products Component Analysis
PER UNIT
Details

TOTAL 100,000 UNIT

Make

Buy

Make

Direct materials

100,000

Direct labour

400,000

Variable factory overhead

20,000

Purchase cost

N10

N7

N10

Total relevant cost


Difference in favour of

Buy

1,000,000

N700,000 N1,000,000

[N10 N7]

making
Source: An unpublished maerial from Emenite Nig. Ltd.

60

Decision:
Emenite will save N3.00 per unit or a total of N300,000 if it
made the component rather than buy it. This is because; the fixed
factory overhead of N4.00 irrelevant to the decision since it will be
incurred whether or not the component is made within.
[c]

Contribution Margin Approach to Decision with Scarce


Resources or Decision Regarding Scarce Resources
A production or service process involves a combination of

factor in a proportion when the proportion is applied, we arrive at our


production. If the proportion is altered, it might not be the same
product, as it ought to be. The purpose for combination of proportion
is to achieve our organizational objective. Also this is to generate and
enhance contribution margin.
If factors to be combined, from time to time, one becoming in
short supply, that will affect our contribution margin. Short supply of
factor limits our ability to enhance our contribution margin and this
understanding will help the accountant in advising management on
what to do like increasing the contribution margin despite the scarce
resources.
When there is a limiting factor, the accountant, is faced with the
task of mapping out strategy on how to maximize the contribution
margin per unit of limiting factor. When there are more than two
limiting factors, we use linear programming to solve the problem.

61

lustration III:
Suppose Emenite makes two products Duraceil and Emlux with
the following data:
Table 2:7: Decision Regarding Scarce Resource
DURACEIL

EMLUX

Selling price

N40

N60

Variable expense

N32

N42

Contribution margin

N8

N18

Quantity Produceable per hour


Total hours available

1,000

Source: An unpublished material from Emenite Nig. Ltd.


The company can sell all the unit produced of Duraceil and
Emlux. Which product should the enterprise produce?
Solution:
Table 2:8 Emenite
Analysis of Optimum product mix
DURACEIL

EMLUX

Contribution margin per unit

N8

N18

Contribution margin per unit of

N24

N18

N24000

N18000

Unit produceable per hour

limiting factor [hour] UCM x UPH


Total contribution in 1000 hours

Source: An unpublished material from Emenite Nig. Ltd.

62

Decision:
Although Emlux has a higher contribution margin per unit, it has
a lower contribution margin per unit of limiting factor [hours] than
Duraceil. It is better, therefore, to employ the limited time in producing
only Duraceil product.

63

REFERENCES
Ezeugwu, V.U. [1999], Intermediate Accounting, Cost and
Management, Hugotez publication, Enugu:1, 1st Ed.
Jhingan, M.L. & J.K. Stephen [2007], Managerial Economics, Vrinda
publication Ltd. Delhi: 68, 3rd Edition.
Kodjo, S.N. [Lecture Note], Managerial Accounting
Kodjo, S.N. [2004], Decision Accounting for Managers,
Oketek publishers, Enugu : 127, 1st Edition.
Keen, R. [1992], Managerial uses of Break-Even Analysis, Journal of
Management Issues, Winter,17[1] December:10 27.
Lucey, T. [1992], Management Accounting, progressive
Printers, UK: 7, 3rd Edition.
Morse and Roth [1986]; Cost Accounting Processing, Evaluating
And Using Cost Data, Addison Wesley Publishing, USA: 309,
3rd Edition.
Nweze, A.U. [2004], Quantitative Approach to Management
Accounting, Computer Edge publisher, Enugu: 212, 4th Ed.
Nwude, C. [2001], Basic Principle of Finance Management,
Eldemak publishers, Enugu: 80, 1st Edition.
OP. Cit: 218
OP. Cit : 161
Owler, L.W.J. & J.L. Brown [1984], Weldons Cost Accounting,
Pitman publishers, London: 1, 15th Edition.
Patric, E.E. [2002], Corporate Finance Management, Bureau of
Education Sciences, African: 498, 3rd Edition
Pierre, L.T. [1987], Management Accounting, USA:
The Dryden Press, A Division of Holt Pine hart and Wington

64

Int, USA: 254, 2nd Edition


Ray, H.G. [1991], Managerial Accounting, Library of
Congress Cataloging in Publication Data, USA: : 207, 6th
Edition.
Ray, H.G., OP Cit., : 212; : 213; 225.

65

CHAPTER THREE
3.0

RESEARCH DESIGN AND METHODOLOGY


This chapter presents the procedures which were adopted by

the researcher in the data collection for the study. The data collected
involves primary and secondary sources. The case studies are:
Emenite Nigeria Limited, Innoson Technical and Industrial Company
Ltd. and Hardis & Dromedas Ltd., Enugu
3.1

SOURCES OF DATA
The researcher of this work made extensive use of the different

sources of data collection. For this purpose data were collected from
both the primary and secondary sources so as to present a more
objective view in the end.
3.1.1 PRIMARY DATA
Primary data collected evaluated the use of personal interview
schedules. Appropriate questions were drawn up and asked during
the interview. Questions were drawn up in such a way that they were
general and specific in nature. Moreover, the primary data collected
involved

the

examination

of

the

available

records

of

the

organizations.
3.1.2 SECONDARY DATA
Secondary data covers the data which might have been
previously published and which might have been existing before the
need for this study. In order words the data are not specifically meant
for this particular study but have been found to be relevant by the

66

researcher. In this vein, the researcher availed herself of the following


sources:
Relevant textbooks, lecture notes, monographs, and journal of
managerial issues.
Data were also extracted from unpublished works.
3.2

METHOD OF INVESTIGATION
The instrument used in the collection of relevant data were

questionnaires and personal interview but more of questionnaire.


Specific questions were asked in some area while general questions
were asked in other areas to enable the respondents express their
opinion on the issues.
The use of the questionnaire means that the respondent is not
constrained by the time schedule as in the interview method; thus,
there is the element of convenience on the part of the respondent.
However, the importance of interview will not be overemphasized because, in the interview process, fact that might have
escaped the researchers mind may emerge the process as one
question leads to another.
Besides the use of personal interviews will help to eliminate the
bias that would have resulted from forcing respondent to choose from
options supplied by the researcher.
3.3

POPULATION OF THE STUDY


The population was chosen from Emenite Nigeria Limited,

Emene Enugu; Innoson Technical & Industrial Company Ltd., Emene

67

Enugu and Hardis & Dromedas Ltd., Hardis & Estate, Airport Road,
Emene, Enugu.
Emenite consist of top officials of some departments and the
workers in the production unit and sales unit, which totals one
hundred and fifty five [155] workers.
While Innoson Nigeria Ltd., consist of top officials of some
departments and the workers in the production unit and sales unit,
which totals ninety five [95] workers.
Finally, Hardis & Dromedas Ltd., consist of 60 workers in both
the production and sales unit. The production of these companies is
three hundred and ten [310] workers.
3.4

DETERMINATION OF SAMPLE SIZE


This inclines taking a portion of the population for study and

making generalization based on the result. To obtain the sample size


of the study, the formula below was used.
Yaro Yamani
S

Formula:
N

1 + N [E]2
Where :
S

Sample size [n]

Population size

310

Error of Margin

10%

The error of margin of 10% was used:


Thus:-

N
1 + N [e]2

310
1 + 310[0.1]2

68

310
1 + 310[0.1]

310
1 + 3.1

310
4+1

75.6

76 workers.

A total of 76 questionnaires was proportionately distributed to


the respondents, ten [10] was returned unanswered while another [6]
six copies was not returned. Therefore, it remains 60 questionnaires.
:.

60

To determine the sample size for each company:


Emenite Nig. Ltd.,

155 x 60
310

Innoson Nig. Ltd.

Hardis Nig. Ltd.

3.5

18 workers

12 workers

60 x 60
310

30 workers

95 x 60
310

ANALYTICAL TECHNIQUE
The percentage method was used to analyze the questionnaire.

It indicates the percentage of the respondent who chooses a


particular option.
In the test of hypothesis, Chi-square was used for testing the
null and alternative hypothesis.

69

CHAPTER FOUR
4.0

DATA PRESENTATION AND ANALYSIS


This chapter deals with the presentation, analysis and

interpretation of data generated by the researcher through the


questionnaire administered to the workers of Emenite Nig. Ltd.
Innoson Nig. Ltd. and Hardis & Dromedas Ltd, Enugu. However, the
data presented and analyzed in this chapter cover all and those
which bear direct relevance to the testing of hypothesis stated on this
study. The results of the questionnaires are presented in table form
and their responses also have the percentage rating.
A total of 76 questionnaires were administered. Out of it ten [10]
was returned unanswered while another six [6] copies was not
returned, so 60 was used.
4.1

ANALYSIS OF RESPONSES

Table 4.1.1. Whether firm have a Cost and Profit center?


OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

60

100%

No

Total
Source:

60
Data from field survey

70

The table shows the respondents to whether their firms have a


cost and profit center. All of the respondents agree that they have it,
this represent 100%.

Table 4.1.2: Is the firm is a multi-Product Company?


OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

56

93.33

No

6.67

Total

60

100

Source:

Data from field survey.

The table shows that 56 of the respondents confirmed that they


are

multi-product

company,

which

represents

93.33%.

respondents did not confirm that they are a multi-product company


which is represented by 6.67%.
Table 4.1.3: Type of product mix firms take to achieve maximum
profit.
OPTIONS

NO OF

PERCENTAGE

RESPONSES

[%]

Make or Buy decision

20

33.33

Add or drop decision

28

46.67

Scarce resources

10

16.67

All of the above

3.33

Total

60

100

Sources:

Data from field survey.

71

The table shows that 20 or 33.33 of them have the view that it
is make or buy decision that they take to achieve maximum profit, 28
or 46.67 says that it is add or drop decision, 10 or 16.67 agree that
their firm take scarce resources while the remaining 2 say it is all of
the above options.
Table 4.1.4:

The firms profit margin for the last five years.

OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
At breakeven

15

25

Above breakeven

45

75

Below breakeven

60

100%

Total
Source: Data from field survey.

The table represents how their profit margin is for the last five
years. The respondents to at breakeven are 15 which represent 25%.
45 respondents indicated that it is above breakeven which represent
75% while no respondent adopted below breakeven.
Table 4.1.5. Is inflation in the country affects the production and
quality of their product?
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

45

75

No

15

25

Total

60

100

Source: Data from field survey.

72

The table above shows that 45 workers responded positively to


the question and it represents 75 whereas 15 responded negatively
to the question and this also represented 25% of the total response.
Table 4.1.6: If whether high cost of goods and services depend on
the strategies adopted by the management.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

40

66.67

No

13.33

Total

12

20

Total

60

100

Source:

Data from field survey.

The table shows that 40 or 66.67% are of the view that it


depends on the strategies adopted by the management, 8 or 13.33%
does not depend on the strategies adopted by management and 12
or 20% has no idea.
Table 4.1.7: If their company go for loan when there is low
production and high demand
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

50

83.33

No

10

16.67

Total

60

100

Source:

Data from field survey.

73

This indicates that 50 of the respondents agree that their


industries goes for loan borrowing representing 83.33% while 10 of
them does not agree in loan borrowing at time of high demand and
low production and they represent 16.67%
Table 4.1.8: Whether high degrees of Operating Leverage affect
Cost Volume Profit of their firm.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

41

68.33

No

19

31.67

Total

60

100

Source:

Date from field survey.

This table indicates that 41 or 68.33 of them believe that it


affects Cost Volume Profit of their industries while the remaining
19 or 31.67% says it does not.
Table 4.1.9: Is Cost Control has any positive effects on the
development and expansion of their industry as well as
resulting in high profitability.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

42

70

No

21

35

Total

60

100

Source:

Data from field survey.

74

This shows that 42 or 70% of the respondent are of the view


that cost control affects development and expansions, resulting to
high profitability while 21 or 35% are not.
Table 4.1.10: The method used by the firms to determine their
breakeven point.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Equation Method

40

66.67

Graphical Method

None of the above

20

33.33

Total

60

100

Source:

Data from field survey.

The table above, shows that to of the respondents says that


they use equation method to determine their breakeven point and
they represent 66.67%, while no respondent adopts graphical method
of finding breakeven point and 20 says none of the above which
represent 33.33% of the respondent.
Table 4.1.11: The type of costing technique their industry use.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Marginal Costing

35

58.33

Absorption Costing

20

33.33

None of the above

8.33

Total

60

100

Source:

Data from questionnaire.

75

The table represents the type of costing technique their industry


use. The respondents to Marginal Costing method are 35 which
represent 58.33%. 20 respondents indicated that their firm use
Absorption Costing method and this represents 33.33% while 5 of the
respondent chooses none of the above and are represented by
8.33% of the total response.
Table 4.1.12: Whether the different techniques used by firms
have any varying impact on contribution margin.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

46

76.67

No

8.33

Dont know

15

Total

60

100

Source:

Data from field survey.

The table indicates that 46 or 76.67% of the respondents are of


the view that the different techniques have a varying impact on
contribution margin while 5 or 8.33 disagreed and remaining 9 or 15%
had no idea of that.

76

Table 4.1.13.
The response as to the method of Cost Volume Profit
analysis their company use.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Equation Method

20

Graphical Method

None of the above

40

66.67

Total

60

100

Source:

33.33

Data from field survey

Table above shows that 20 or 33.33% of the respondents says


that they use equation method while the remaining 40 or 66.67 say
none of the above method is being used.
Table 4.1.14: Whether Cost Volume Profit analysis of their
industry help in their management decision making.
OPTIONS

NO OF

PERCENTAGE [%]

RESPONSES
Yes

60

100

No

60

100

Total
Source:

Data from field survey.

The overleaf table shows that all respondents are of the view
that Cost Volume Profit analysis help in their management
decision making.

77

4.2

TEST OF HYPOTHESIS
The objective of this analysis is to apply suitable statistical

techniques in testing the hypothesis formulated at the design stage of


this research. After due consideration of the various statistical
options, the researcher selected the chi-square test of independence
Variables as a tool of analysis. This is owing to the nature of data
collected in this study.
Chi Square
X2

Formula

[0-E]2
E

X2

Chi Square

Observed frequency

Expected frequency

Sum of.

Test of Hypothesis 1
Ho

Null Hypothesis:
That high degree of Operating Leverage does not affect Cost
Volume Profit in manufacturing industries.

Hi

Alternative Hypothesis:
That high degree of Operating Leverage affects Cost Volume
Profit in manufacturing industries.

78

To test this hypothesis, data from Table 4.1.8. will be used.


RESPONDENT

RESPONSE

TOTAL

Yes

No

Emenite Nig. Ltd.

25

30

Innoson Nig. Ltd.

18

Hardis & Dromedas

12

Total

41

19

60

Recall

X2

[0 - E]2

E
Operative Assumptions
Level of significance

5%

Determination of Expected Frequency


The expected frequency of each cell is computed and reflected
in the contingency table thus:
Formula:
E[RC]

FR x FC
N

Where:

E[RC]

Expected frequency of the cell.

FR

Total row frequency

FC

Total column frequency

Total frequency

Row 1

cell 1 [E]

30 x 41

20

9.50

60
Row 2

cell 2 [E]

30 x 19
60

79

Row 2

cell 1 [E]

18 x 41

12.30

5.70

8.20

3.80

60
Row 2

cell 2 [E]

18 x 19
60

Row 3

cell 1 [E]

12 x 41
60

Row 3

cell 2 [E]

12 x 19
60

Presentation of these expected frequency along with the


corresponding frequencies in 3 x 2 contingency table.

Table 4.2.1.
Contingency Table [3X2]
RESPONDENT

Emenite Nig. Ltd.

Innoson Nig. Ltd.

Hardis & Dromedas

Total

RESPONSE
Yes

No

25

[20]

[9.50]

12.30]

[5.70]

[8.20]

[3.80]

41

19

Calculation of Degree of Freedom


df

[R 1]

df

Degree of freedom

[C - 1]

where:

TOTAL

30

18

12

60

80

Number of rows

Number of columns

[3 1]

:. df

[2 1]

[.2]
df

[1]
2

Decision Rule
Reject Null Hypothesis if the critical Value is less than
calculated Value.
Computation of the Chi Square:
X2

[0 - E]2
E

X2

[25 20]2 x [5 9.50]2 x [9 2.30]2


20

9.50

12.30

x [9 5.70] x [7 8.20]2 x [5 3.80]2


20

9.50

12.30

X2

1.25 x 2.13 x 0.89 x 1.91 x 0.18 x 0.25

:. X2

6.61

Computed value of X2 =

6.61

Critical value X2 for 2df at 0.05 level of significance = 5.991


Decision
Since the calculated value is high than the critical value, we
reject the Null hypothesis. This implies that high degree of operating
Leverage affect Cost Volume Profit in manufacturing Industries.

81

Test of Hypothesis II
Ho:

Cost Control [i.e. Cost Volume Profit] technique will not help
to develop and expand manufacturing industries as well as not
resulting to high profitability.

Hi :

Cost Control [i.e. Cost Volume Profit] technique will help to


develop and expand manufacturing industries as well as
resulting to high profitability.

To test this hypothesis, data from Table 4.1.8 will be used.


RESPONDENT

RESPONSE

TOTAL

Yes

No

Emenite Nig. Ltd.

26

30

Innoson Nig. Ltd.

10

18

Hardis & Dromedas

12

Total

42

18

60

Recall X2

[0 - E]2
E

Operative Assumptions
Level of significance

5%

Determination of Expected Frequency


Row 1

cell 1 [E]

30 x 42

21

12.60

60
Row 2

cell 2 [E]

30 x 18
60

Row 2

cell 1 [E]

18 x 42
60

82

Row 2

cell 2 [E]

18 x 18

5.40

8.40

3.60

60
Row 3

cell 1 [E]

12 x 42
60

Row 3

cell 2 [E]

12 x 18

Table 4.2.2
Contingency Table [3 x 2]
RESPONDENT

RESPONSE

TOTAL

Yes

No

Emenite Nig. Ltd.

26 [21]

4 [9]

30

Innoson Nig. Ltd.

10

8 [5.40]

18

6 [3.40]

6[3.60]

12

42

18

60

[12.60]
Hardis & Dromedas
Total

Calculation of Degree of Freedom


Recall:

df

[R 1]

df

[3.1] [2.1] =

[C - 1]
2x1 =

Decision Rule
Reject Null Hypothesis of the critical value is less than
calculated value.

83

Computation of the Chi Square:


Recall: X2

[0 - E]2
E

X2

[26 21]2 + [4 9]2 + [10 12.60]2


21

12.60

+[8 5.40] + [6 8.40]2 + [6 3.40]2


5.40

:. X2

8.40

3.40

8.44

Computed value of X2 =

8.44

Critical value X2 for 2df at 0.05 level of significance = 5.991


Decision:
Since the calculated value is higher than the critical value, we
reject the Null hypothesis. This implies that Cost Control [i.e. Cost
Volume Profit] techniques will help to develop and expand
manufacturing industries as well as resulting to high profitability.
Test of Hypothesis III
Ho:

With high cost of goods and services and depreciation of Naira,


the volume of production and quality of the products do not
depend on the strategies adopted by the management of
manufacturing industries.

Hi :

With high cost of goods and services and depreciation of


Naira, the volume of production and quality of the products

84

depend on the strategies adopted by the management of


manufacturing industries.
To test this hypothesis, data from Table 4.1.6 will be used.
RESPONDENT

RESPONSE

TOTAL

Yes

No

Emenite Nig. Ltd.

26

30

Innoson Nig. Ltd.

14

18

Hardis & Dromedas

12

Total

42

10

60

Recall:

X2

No Idea

[0 - E]2

Operating Assumptions
Level of significance

5%

Table 4.2.3
Contingency Table [3 x 3]
RESPONDENT

Emenite Nig. Ltd.


Innoson Nig. Ltd.
Hardis & Dromedas
Total

RESPONSE
Yes

No

26
[21]
14
[12.6]
2
[8.4]
42

3
[4]
1
[2.4]
4
[1.6]
8

TOTAL
No Idea
1
[5]
3
[3]
6
[2]
10

30
18
12
60

85

Calculation of Degree of Freedom


Recall:

df

[R 1]

[C - 1]

:.

df

[3-1]

[3-1]

[2]

[2]

df

Decision Rule:
Reject Null Hypothesis if the critical value is less than the
calculated value.
Computation of Chi - Square
Recall: X2

[0 - E]2
E

X2

[2 21]2 + [3 4]2 + [1 5]2 + [14-12.6]2 + [1-2.4]2


21

12.6

2.4

+[3 3]2 + [2 8.4]2 + [4 1.6]2 + [6 2]2


3
X2

8.4
=

1.6

22.05

Computed value of X2

22.05

Critical value X2 for 4df at 0.05 level of significance = 9.488


Decision:
Since the calculated value is higher than the critical value, we
reject the Null hypothesis. This implies that with high cost of goods

86

and services and depreciation of Naira, the volume of production and


quantity of the products depend on the strategies adopted by the
management of the manufacturing industries.

87

CHAPTER FIVE
5.0

SUMMARY

OF

FINDINGS,

RECOMMENDATIONS,

CONCLUSIONS AND SUGGESTION FOR FURTHER STUDY


5.1

SUMMARY OF FINDINGS
This research work which was independently carried out by the

researcher led to some findings which are very important towards the
recommendations.
In the course of this research work, the findings show that,
Emenite Limited uses the job costing method. Because the company
uses job order costing method, which relates costs to a single order,
it was evidently clear that some of the raw materials used by the
company are imported and this makes procurement not to be very
efficient

and

easy.

The

constraining

circumstances

include

government restriction on importation and the uncertainty in terms of


lead-time between orders and receipt of raw materials from the
exporting countries.
The company does not determine its economic order quantity. It
only piles up as much of these raw material as possible subject to the
availability of fund and public requisition for its product moreover,
minimum and maximum level are not maintained.
Innoson Nig. Limited does not meet the demand for its product
by the numerous customers. Especially the demand for helmet. This
fact was evidenced by the large number of customers seen hanging
around the companys premises waiting for the quantity of their
ordered product to be completed.

88

Hardis and Dromedas Ltd., also have problem of raw materials


used in production. Most of them are imported from abroad. There is
under utilization of labour as a result of inadequate supply of raw
materials to be used in the production process.
The Hypothesis was also tested and a greater percentage of
the respondents confirmed that high degree of operating leverage
affect Cost Volume Profit in their firm. Although thirty two percent
[32%] percent were not in agreement. Also the second hypothesis
accepted alternative hypothesis, which also show that Cost Control
[i.e. Cost Volume Profit] technique will help to develop and
expand manufacturing industries as well as resulting to high
profitability.
Finally, the respondents asked on whether with high cost of
goods and services depend on the strategies adopted by the
management. Sixty seven percent [67%] agreed that it depend on the
strategies adopted by the management. Thirteen percent [13%]
claimed that it is not true while twenty percent [20%] claimed
that they dont know about such strategies adopted by the
management. It is an indication that some of the staff is not
adequately briefed or is not interested in how things are done in the
industries.
Although when the hypothesis was objectively tested, It
indicated that with high cost of goods and services and depreciation
of Naira, the volume of production and quality of the products depend
on the strategies adopted by the management of manufacturing
industries; it is the view of the researcher that there should be better
communication between the strategic, tactical and operational level of

89

management. It will without measure increase the motivation of the


staff to put in their possible best.
5.2

RECOMMENDATIONS
The study has afforded the researcher the opportunity to make

the following recommendations, Innoson Ltd, should on the short run


increase the production of Helmet and other product to meet the
demand of their customers. This will guarantee a rise in the daily
profit accruing to the company from the sale of their products.
Since the demand for the above mentioned product are high
relative to the demand to their other products. There will be savings in
the cost of production because fixed cost is not restricted to any unit
of production. In other hand Hardis and Dromedas should also learn
the concept of Cost Volume Profit analysis. They should increase
the quantity of their product so that they will maximize their profit. The
Industry should avoid the wastage of raw material during production
process. These will also reduce cost of production and increase
profit.
Emenite Company should practice the batch costing in its true
meaning for effective control. This means that cost should be
ascertained, analyzed and controlled among other characteristics at
each batch level. With adequate Cost Control, it will go a long way to
reducing the production cost of the company and increase profit. The
company should intensify its local raw material substitution drive so
as to reduce the imported content of its raw materials.

90

Finally, there should be adequate communication link between


the management level and the operational level in their industries.
This will help to minimize cost of production and maximize their profit.
5.3

CONCLUSION
Enterprises that must survive, and grow in these times must

consciously plan to do so. As the clichs goes, a failure to plan for


success is a plan to fail. While indeed planning is important for
success. It is more important that plans address the very pertinent
factors that influence success. For no matter how serious
management may be in its planning efforts, it may still not compete
effectively today if its decisional tools are archaic and antiquated.
Management should then realize that good analysis does not
necessarily have to follow the traditional classification of costs into
production and non-production and of profits into gross or net.
The modern tool, important in todays decision analysis requires
a different understandably of these relationships: relevant and
irrelevant items; variable and fixed cost; avoidable and unavoidable
cost etc.
It is important to emphasize the fact that the Cost Volume
Profit analysis in an organization is a necessity for such an
organization to know if they are surviving and growing much as we
agree that for an organization to be profitable, it must seek to obtain
as much revenue as possible. A well organized industry should have
an effective costing system so that proper costing of its material,
labour and overheads can be easily effected, so as to determine the
actual cost of production based on the analysis carried out.

91

Documentation of cost data is not an end in itself rather, its


analysis and presentation as a basis for control and other vital
decisions should be emphasized. Linear programming, decision
model and costing techniques are tools of Cost Volume Profit
analysis, hence all manufacturing firms have to determine whether
their industries is maximizing profit or freezing out of the market by
using the above mentioned methods or techniques to analyze their
Cost Volume Profit.
The basic Cost Volume Profit analysis is a fundamental but
exceedingly useful technique for analyzing the impact of changes in
revenue, Cost or Volume on Profits.
5.4

SUGGESTION FOR FURTHER STUDY


This study does not treat various Inventory Control, budgeting

control. Hence it is important that the readers of this project should


study further in the above mentioned areas to know actually how cost
should be controlled to maximize profit and how the variances in
budgeted and actual production affected cost and profit.
Also to know more on Inventory Control in order to determine
the economic re-order quantities and to know the lead-time, minimum
and maximum level, re-order level and re-order quantity. This further
study will make the reader of this project to know more of Cost
Volume Profit analysis.

92

BIBLIOGRAPHY
Don, R. and Jack, G. [1991], Managerial Accounting,
Miffin Coy, USA: 223, 2nd Edition.

Houghton

Ezeugwu, V.U. [1999], Intermediate Accounting, Cost, and


Management, Hugotez publications [A Division
of Hugotez Investments limited], Enugu: 1.
Jack, L.M.; Kabith, R.M. and William, L.S. [1988], Managerial
Accounting, McGraw-Hill book, USA: 129 130, 2nd Edition.
Jhingan, M.L. and J.K. Stephen [2007], Managerial Economics,
Vrinda Publications ltd, Delhi: 653, 3rd Edition.
Kodjo, S.N. [Lecture Note], Managerial Accounting.
Kodjo, S.N [2004] Decision Accounting for managers; Oktek
publishers, Enugu:127, 1st Edition.
Keen, R. [2007], Managerial uses of Break-Even Analysis, Journal of
management Issues, Winter, 17 [1] December: 10 27.
Lucey, T. [1992], Management Accounting, Progressive Printers
UK:7, 3rd Edition.
Morse and Roth [1986], Cost Accounting Processing, Evaluating
And Using Cost data, Addison Wesley pub., USA: 309, 3rd
Edition.
Nweze, A.U. [2004], Quantitative Approach to Management
Accounting, Computer Edge publishers, Enugu: 212, 4th Edition.
Nwude, C. [2001], Basic Principle of Financial Management,
El demark Publisher, Enugu: 80, 1st Edition.
Onwumere, J. U.J. [2005], Business & Economic Research
Methods, Don Vinton limited, Lagos, 1st Edition.

93

Owler, L.W.J. and J.L. Brown [1984], Wheldons Cost Accounting,


Pitman publishers, London: 1, 15th Edition.
Patrick, E.E. [2002], Corporate Finance Management, Bureau of
Education Science, African: 498, 3rd Edition.
Pierre, L.T. [1987], Management Accounting, The Dryden
Press, a division of Holt Line hart and Wriston Int. USA, 2nd
Edition.
Ray, H.G. [1991] Management Accounting Library of Congress
Cataloging in publication data, USA: 207, 6th Edition.
Richard, M.S. and F.C. Wai [1991], Managerial Accounting
Method and meaning, Chapman and Hill, London: 109, 3rd
Edition.

94

QUESTIONNAIRE
University of Nigeria,
Faculty of Business Administration
Department of Accountancy
Dear Sir/Madam,
A Study on the Effectiveness of Cost-Volume-Profit analysis in
Manufacturing Industry [Case Study of Three Selected
Companies]
I am a student of the above named school currently conducting
a research on the Effectiveness of Cost-Volume-Profit analysis in
manufacturing industries.
This project is in partial fulfillment of the requirement of the
award of masters of Business Administration in Accountancy. I will be
grateful if you answer these questions for me.
This is purely academic exercise and you are assured that all
information given will be treated confidentially.
Thanks for your co-operation.

Yours faithfully,

OBETA, NGOZI JOY.


PG/MBA/07/46890

95

INSTRUCTION

Please read the question carefully and mark [] in the


appropriate boxes where necessary.
i.

What is your post in the company: ..

ii.

What is your age?


[a] Between 15 24years
[b] Between 25 35years

[c]

Above 35 years

iii

How many years have you been with the company

1.

Do your firm have a cost and profit center?

Yes

2.

No

Are you multi-product company?

Yes
3.

No

If yes in 2 above, what product mix decision to your firm take to


achieve maximum profit?
[a]

Make or buy decision

[b]

Add or drop decision

[c]

Scarce resources

96

[d]
4.

5.

All of the above

How is your profit margin for the last five years?

[a]

At breakeven

[b]

Above breakeven

[c]

Below breakeven

Does inflation in the country affect the production and quality of


your product?
Yes

6.

No

If yes, does the high cost of goods and services depend on the
strategies adopted by the management?
Yes

7.

No

No idea

If there is low production and high demand, does your company


go for loan?
Yes

8.

No

If yes, does high degree of operating leverage affect costvolume-profit of your firm?
Yes

9.

No

Will cost control have any positive effect on the development


and expansion of your industry as well as resulting in high
profitability?
Yes

No

97

10. What method do you use to determine your breakeven point?

11.

[a]

Equation method

[b]

Graphical method

[c]

None of the above

What type of costing technique does your industry use?


[a]

12.

Marginal costing

[b]

Absorption costing

[c]

None of the above

Does the different technique have any varying impact on


contribution margin?

Yes

13.

No

Dont know

What method of Cost-Volume-Profit analysis does your


company use?

14.

[a]

Equation method

[b]

Graphical method

[c]

None of the above

Does Cost-Volume-Profit analysis of your industry helps in your

management decision making?

Yes

No

98

THE EFFECTIVENESS OF COST VOLUME PROFIT


ANALYSIS IN MANUFACTURING INDUSTRIES:
[A CASE STUDY OF THREE SELECTED COMPANIES]

BY

OBETA, NGOZI JOY


PG/MBA/07/46890

DEPARTMENT OF ACCOUNTANCY
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA, ENUGU CAMPUS

NOVEMBER 2008

99

THE EFFECTIVENESS OF COST VOLUME PROFIT


ANALYSIS IN MANUFACTURING INDUSTRIES:
[A CASE STUDY OF THREE SELECTED COMPANIES]

BY

OBETA, NGOZI JOY.


PG/MBA/07/46890

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT


OF THE REQUIREMENT FOR THE
AWARD OF MASTERS DEGREE IN ACCOUNTANCY

DEPARTMENT OF ACCOUNTANCY
FACULTY OF BUSINESS ADMINISTRATION
UNIVERSITY OF NIGERIA, ENUGU CAMPUS

NOVEMBER 2008

100

CERTIFICATION

This is to certify that Obeta, Ngozi Joy

is a postgraduate

student in the Department of Accountancy with Registration Number,


PG/MBA/07/46890 has satisfactorily completed the requirements for
project research in partial fulfillment of the requirements for the award
of Masters Degree of Business Administration [MBA] in Accountancy.

Obeta, Ngozi Joy


PG/MBA/07/46890
Date: .
.

..

Dr. [Mrs.] R.G. Okafor

Dr. [Mrs.] R.G. Okafor

Supervisor

Head of Department

Date: ..

Date:

iii

101

DEDICATION

To God, the Father Almighty, my beloved husband: Mr.


Alloysius Obeta, and children Ebubechukwu and Chinemerem.

102

ACKNOWLEDGEMENT

I am grateful to God, the father Almighty, who in his love and


special grace has kept me alive to work on this project.
I am very much delighted to express my profound gratitude to
those who in one way or the other contributed immensely to the
success of this research work.
First and foremost is my supervisor, who is also the Head of my
Department, Dr. [Mrs.] R.G. Okafor for her advice and guidance at
every stage of this research work. My thanks also goes to all the
lecturers in the Department of Accountancy especially S.N. Kodjo for
his lectures on Managerial Accounting.
My gratitude also goes to the management and staff of Emenite
limited, Innoson Nigeria limited and Hadis & Dromedas limited for
their co-operation while undergoing this research work.
I also owe a lot to my beloved husband, Mr. Alloysius Obeta, for
his help both morally and financially and also to my children,
Ebubechukwu and Chinemerem and my sister Amarachi for bearing
with me when I was undergoing the research work.
Also acknowledged are my brother-in-law and the wife, Barr. &
Mrs. Ike Obeta for their financial support; my mother, mother-in-law
and also my brothers and my sisters-in-law for their prayers.
Finally acknowledged is the typist Mrs. Ezeokonkwo for doing a
good job to the work. To them all, I pray that the blessings of our God
Almighty showers on all of them. Amen.

103

ABSTRACTS

The utility of Cost-Volume-Profit analysis lies in the fact that it


presents a microscopic picture of the profit structure of a business
enterprise. It does not only highlight the area of economic strength
and weakness in the firm but also sharpens the focus on certain
leverage which can be operated upon to enhance its profitability. The
objective of this study is to find out the effectiveness and also factors
affecting the implementation of this Cost-Volume-Profit analysis in the
manufacturing Industry. The researcher in the findings observed that
most Industries aim at profit maximization and paid little or no
attention to the effect of Cost-Volume-Profit analysis. It was also
discovered that the more the cost acquired for a particular production
without corresponding increase in the volume of production reduces
profit. Therefore, manufacturing Industries should ensure that when
cost increases the raw material should equally increase to
manufacture more products to cover the variable and fixed cost and
also retain a reasonable profit for the firm. Finally, in the office
operation budget should be made more detailed, religiously adhered
to and controlled more vigorously so as to reduce total operation cost
and maximize profit.

104

TABLE OF CONTENTS
PAGE
Title Page .

Certification ...

ii

Dedication ..

iii

Acknowledgement

iv

Abstract ..

Table of Contents .

vii

CHAPTER ONE:
2.0. Introduction .

1.10 Background of the Study ..

1.11 Statement of Problems .

1.12 Objectives of the Study ...........

1.13 Research Questions .

1.14 Statement of Hypothesis .

1.15 Significance of Study

1.16 Scope of the Study

1.17 Limitations of Study ..

1.18 Definition of Terms

10

References

11

CHAPTER TWO:

LITERATURE REVIEW

2 Overview of Cost-Volume-Profit Analysis..

12

2.1

Cost Accounting.

17

2.1.1 Ascertainment of Cost ..

18

Production Capacity/Volume

21

2.2

105

2.2.1 Factors Combination ..

22

2.3

Operating Leverage

23

2.4

Ascertainment of Profit

26

2.5

Determination and Analysis of Breakeven Point

26

2.5.1 Margin of Safety/Margin of Distress

29

2.6

Concept of Contribution Margin ..

31

2.7

Application of Cost-Volume-Profit analysis

35

2.8

Assumptions underlying Cost-Volume-Profit


Analysis ..

39

2.13 Cost-Volume-Profit Analysis by formulae .

41

2.14 Cost-Volume-Profit Relations and sensitivity


Analysis .

41

2.15 Impact of Taxes on Cost-Volume-Profit Analysis

41

2.16 Managerial Uses of Break-Even Analysis .

44

References

51

CHAPTER THREE:
3 Research Design and Methodology ..

53

Sources of Data

53

3.1.1 Primary Data .

53

3.1.2 Secondary Data

53

3.2

Method of Investigation ..

54

3.3

Population of the Study .

55

3.4

Determination of Sample Size..

55

3.5

Analytical Techniques

56

3.1

106

CHAPTER FOUR:
4 Data Presentation and Analysis .

57

4.1

Analysis of Responses

57

4.2

Test of Hypothesis

64

CHAPTER FIVE:
5 Summary of Finding, Recommendations,
Conclusions and Suggestion for Further Study

73

5.1

Summary of Findings ..

73

5.2

Recommendations ..

75

5.3

Conclusion

76

5.4

Suggestions for Further Study ..

77

Bibliography .

78

Appendix ..

80