Monitoring and motivating
Since all products will lead to the same increase in sales, management should spend the advertising expenditure on the product with the highest contribution per limiting factor. The limiting factor in this case is the additional money available for advertising expenditure of ? 1,000,000. The calculation of this formulae and the resulting profit are shown in Exhibit 5. 2 below: As we can see from exhibit 5. 2 the advertising expenditure should be spend on the off road cars because they hold the highest contribution per limiting factor.
However when comparing Exhibit 5.2 with Exhibit 5. 1 we can see that the proposal of increasing advertising expenditure is not a feasible suggestion because it will lead to a decrease in expected profit of ? 588,400 (? 676,600 – ? 87,600). From the following hypothetical example we can therefore deduce that cost-volume profit analysis is a very helpful method at the planning stage. Apart from guiding management on which products or services to priorities, cost-volume profit analysis can also help management make business decisions on budgeted discretionary expenditure like advertising costs.
For instance, by utilising this technique management of Auto Ltd. realised that the ? 1,000,000 money should not be spend on advertising. It can be spend on other fruitful areas like product development or product design and more. Monitoring and motivating via cost-volume profit analysis Apart from planning, cost-volume profit analysis can also be useful for monitoring the firm’s operations and for motivating employee performance.
For instance if a firm owns different retail shops in selected regions, by analysing the revenue levels and cost functions management can determine the efficiency level of each shop. For example if a low-profit shop has high labour costs when compared to other outlets, this may indicate that this shop is overstaffed. By analysing the reasons for the different profits in each shop, management can emphasize its efforts on increasing revenues, reducing costs, or both.
This will ultimately hold managers more accountable for their work, which may also motivate and direct their actions in line with the strategic plan of the firm.
AAT Intermediate Unit 6 (2005). Recording and Evaluating Costs and Revenues. Third Edition. London: BPP Professional Education. Cambridge International College (2005). Managerial Economics. Second Edition. London: Pearson Education Limited. Drury C. (1996). Management and Cost Accounting. Fourth Edition. New York: International Thomson Business Press.