CHAPTER ONE

INTRODUCTION

Introduction

This chapter comprises the following subtopics: background of the study, statement of the problem, objectives of the study, research questions, research hypothesis, justification of the study, the definition of terms.

1.1 Background information of the Study

The unpredictable nature of business and the constant changing conditions of their activities is very important to every organization engaged in the production and sale of goods. In this light, management is therefore frequently faced with the task of making decisions that relate to the effects of such changes on its costs and revenues. Therefore, the success of a business is generally attributable in great measure to the ability of its management personal to cope with probable conditions of the future.

Short-range as well as long-term plans must be made accomplished through sound management evaluation.  However, many tools are used in controlling and coordinating the activities of the business.  One of the tools which encompass vitally and needed information in guiding companies’ profit path is the cost volume profit analysis or Break-Even theory.  This is an extension of marginal costing; basically, it is concerned with the point at which revenue and cost intercede.

A Break-Even system is a simple and easily understandable method of picturing to the management the effect of changes in volume on profits.  It predicts the effects of managerial actions today on future profits and company survival.

With the aid of Break-Even theory, they will be able to understand more and data revealed by the Break-Even analysis.  This system involves the marshaling of the cost – volume – profit data and other data to guide managers in their day-to-day decisions.  Some of the data are best seen in a chart form for management to get a perspective view of the profit structure.

Moreover, at the beginning of the 21stcentury, a planning tool was developed by WALTER RAUTENSTRAUCH called the Break-Even chart. This development made a major contribution as a management aid in profit planning, forecasting, and decision-making. The concept shows the significance in a firm between its costs, volume, and profit. And also illustrate the relationship between cost, selling price, and volume.

In a nutshell, cost volume profit (CVP) is an application of marginal costing techniques and is sometimes called ‘’Break-even analysis’’ The analysis has an interrelationship at various levels of activity. When this is analyzed we have the breakeven point in units or FCFA. Mathematically, CVP analysis is taken from two analyses which are total revenue given as price multiply by quantity (P x Q) and the total cost which is equally given as Fixed cost (FC) plus variable cost (VC) i.e.

TC = FC + VC.

CVP analysis is defined by warren Reeve and Fess (1999) as the systematic examination of the interrelationship between selling price, volume of sales and production, cost and expenses not living out profits.

From the aforementioned definition of CVP analysis, it is obvious that this analysis is a complex matter to management since these relationships are often affected by some measures or forces entirely or partially beyond management control. For example, the determination of the selling price of a product is often affected by not cost alone but also by other uncontrollable forces in the market like competition, seasonal changes, congestion among others.

Moreover, cost as a concept represents one of the significant factors in cost volume profit analysis.

A more convenient way of categorizing cost is to define it as either fixed or variable cost. Fixed cost is that cost that remains constant, whether the firm is producing or not. Examples include rental charges and senior management salaries, whereas, variables cost is a cost that changes as the volume of production changes. The firm can only spend more when an additional unit is produced. For example; fuel, energy etc. thus the CVP analysis is better and more appropriately appreciated by the cost accountants to the management of the organization.

The cost accountant of every organization plays an important role in CVP analysis by providing management with the necessary information on the relative profitability index of the various products and the probable effects of changes in selling price and other variables.

1.2 Problem Statement.

Cost volume profit analysis as an important or fundamental tool to management in decision making never the less, management still faces a lot of difficulties in applying this technique in the organization. The main difficulty faced by profit-making organizations is the fact that the actual cost tends to be higher than the budgeted cost. Managers in companies/organizations like CDC find it difficult to decide on the best cost techniques to apply or implement in order to achieve the companies objectives.

The importance of cost in the determination of prices is very necessary to management since, without the knowledge of the cost incurred in production, determination of prices becomes difficult thus leading to inaccurate prices and profits. To come out with decisions that can be followed to remedy or ameliorate this situation is too centered on questions like;

1.3 Research Questions

1. What level of output can be produced in order to break even in CDC?
2. How is the behavior of cost in CDC?
3. What is the effect of sales volume on the break-even point of CDC?
4. What are the problems faced by CDC in applying the CVP analysis and possible recommendations that could be used to improve on its application?

1.4 Objectives of the Study

The objectives are subdivided into main and specific objectives.

1.4.1 Main Objectives

The main objectives of this research are to examine the application of cost volume profit analysis in most profit making organizations in decision making process.

1.4.2 Specific Objectives

1. To identify the level of output that can be produced in order for CDC to operate at the break-even point.
2. To examine the behavior of cost in CDC.
3. To examine the effect of sales volume on the break-even point of CDC.
4. To examine the problems faced by CDC in applying the CVP analysis and the possible recommendations that could be used to improve on CVP application.