INTRODUCTION
Accounting is the information system that measures business financial activities and processes that information into reports, and communicates the results to decision makers. Accounting is therefore called "the language of business".Individuals,Businesses, Investors,Creditors,Government Regulatory Agencies,Taxing authorities,Nonprofit Organizations and Other users (Employees,labour unions,consumer groups and news media) are some of the people and organizations who use accounting to make decisions. Users of accounting information can be categorized as external users or internal users.This distinction allows us to classify accounting into fields-financial accounting and management accounting.
Financial accounting provides information to people outside the firm. Some examples of external users are creditors and outside investors who are not part of the day-to-day management of the company. Government agencies and the general public are also external users of a firm's accounting information. Financial Accounting provides financial statements based on GAAP or Generally Accepted Accounting Principles.Financial Accounting reports what happened in the past.
Management accounting generates information for internal decision makers,such as top executives,department heads, college deans and hospital administrators. Management accounting measures and reports financial and non financial information that helps managers to fulfil the goals of an organization. Managers use management accounting information to choose, communicate and implement strategy coordinate product design, production and marketing decisions.Management Accounting is future oriented.
Cost accounting is a central element of managerial accounting. Cost accounting establishes budget and actual cost of operations, processes, departments or product and the analysis of variances, profitability or social use of funds. Managers use cost accounting to support decision-making to cut a company's costs and improve profitability. As a form of management accounting, cost accounting need not follow standards such as GAAP, because its primary use is for internal managers, rather than outside users. Cost accounting provides information for management and Financial accounting
Cost is defined as a resource sacrificed or foregone to achieve a specific objective.Cost driver is a factor which causes the amount of cost incurred to change.Actual cost is a cost that has occurred.Budgeted Cost is a predicted cost. Costs can be classified in the following way:
Product costs are :Direct Materials, Direct Labor and Indirect Manufacturing - factory costs that are not traceable to the product. Also known as Manufacturing Overhead costs or Factory Overhead costs
Direct and Indirect costs- Direct cost is a cost that can be conveniently and economically traced to the cost object eg.Parts,Assembly line wages.Indirect Costs are costs that cannot be conveniently or economically traced to a cost object.Instead of being traced, these costs are allocated to a cost object in a rational and systematic manner.eg. Electricity,Rent,Property taxes
Fixed, Variable, Semi-variable- . Fixed Costs remain unchanged in total regardless of changes in the related level of activity or volume .eg. amortization,insurance.Variable Costs change in total in proportion to changes in the related level of activity or volume.eg.materials(parts) or fuel for a trucking company
Companies strive to control costs by doing only value added activities and by efficiently managing the use of cost drivers in those value added activities. In this paper we are going to discusss how Starbucks Corporation an international coffee and coffeehouse chain is adopting the method of Cost-Volume-Profit analysis to control costs and improve profitability.
Marginal Costing/Cost-Volume-Profit Analysis: (Leslie.G.Eldenburg,Susan Wolcott,2003,Cost Management: Measuring, Monitoring, and Motivating Performance,John Wiley & Sons Inc)
Cost-volume-profit (CVP) analysis is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to help Managers and decision makers to plan their operations. Decision makers utilize the details of the CVP analysis to decide on the following:
The products or services the company should emphasize
The volume of sales needed that would help achieve the targeted level of profit
The amount of revenue the company should generate in order to avoid losses.
To determine if the company should increase expenditure on fixed costs
To determine the amount of money the company should budget for discretionary expenditures and
to find out if fixed costs expose the organization to an unacceptable level of risk.
CVP analysis begins with the basic profit equation.
Profit = Total revenue-Total costs
Separating costs into variable and fixed categories, we express profit as:
Profit=Total revenue-Total variable costs-Total fixed costs
The contribution margin is total revenue minus total variable costs. Similarly, the contribution margin per unit is the selling price per unit minus the variable cost per unit. Both contribution margin and contribution margin per unit are valuable tools when considering the effects of volume on profit. Contribution margin per unit tells us how much revenue from each unit sold can be applied toward fixed costs. Once enough units have been sold to cover all fixed costs, then the contribution margin per unit from all remaining sales becomes profit.
If we assume that the selling price and variable cost per unit are constant, we can rewrite the profit equation in terms of the contribution margin per unit.
Profit = P*Q - V*Q -F = (P-V)*Q - F
where P = Selling price per unit
V = Variable cost per unit
(P-V) = Contribution margin per unit
Q = Quantity of products sold (units of goods or services)
F = Total fixed costs
CVP Analysis can be performed using either Units or Revenues(in dollars)
CVP Analysis in Units
Assuming that fixed costs remain constant, we solve for the expected quantity of goods or services that must be sold to achieve a target level of profit.
Profit = (P-V) * Q -F
Solving for Q = F + Profit
(P-V)
Where Q is the Quantity(units) required to obtain target profit. The denominator is (P-V) which is the contribution margin.
CVP Analysis in Revenues
The contribution margin ratio (CMR) is the percent by which the selling price (or revenue) per unit exceeds the variable cost per unit, or contribution margin as a percent of revenue. For a single product, it is
CMR = P-V
P
To analyze CVP in terms of total revenue instead of units, we substitute the contribution margin ratio for the contribution margin per unit. We rewrite the equation to solve for the total dollar amount of revenue we need to cover fixed costs and achieve our target profit as
Revenue = F + Profit
(P-V)/P
Revenue = F+ Profit
CMR
Breakeven Point
A CVP analysis can be used to determine the breakeven point, or level of operating activity at which
revenues cover all fixed and variable costs, resulting in zero profit. We can calculate the breakeven point from any of the preceding CVP formulas, setting profit to zero. Depending on which formula we use, we calculate the breakeven point in either number of units or in total revenues
Breakeven using quantity = (F+0)
(P-V)
Breakeven using Revenue= (F+0)
CMR
CVP Sensitivity Analysis
Cost-Volume-Profit Analysis examines the behaviour of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable costs or fixed costs. Sensitivity analysis helps managers in decision making and cope with uncertainity.
PROBLEM OF THE RESEARCH
(Charles.T.Horngren,Srikant.M.Datar,George Foster,2007.Cost Accounting:A Managerial Emphasis:Prentice Hall)
Cost-Volume-Profit analysis makes the following assumptions:
Changes in the number of product or service units produced and sold affects the level of revenues..
Total costs can be divided into a fixed and a variable component with respect to the level of output
The analysis either covers a single product or assumes that the sales mix when multiple
products are sold will remain constant as the level of total units sold changes.
The unit selling price, unit variable costs, and fixed costs are known and constant.
.Revenues and costs can be added and compared without taking into account the time
value of money.
(Robert Kee,2007, Cost-volume-profit analysis incorporating the cost of capital.: Journal of Managerial Issues)
Cost Volume Profit Analysis is used widely, but faces criticism for its use of following assumptions
CVP assumes deterministic and linear cost and revenue functions.
CVP focuses on a single product and its single-period analysis.Firms across a variety of industries have found the simple CVP model to be helpful in both strategic and long-run planning decisions. However,in situations where revenue and cost are not adequately represented by the simplifying assumption of CVP analysis, managers should consider more sophisticated approaches to financial analysis. (Charles.T.Horngren, George Foster, and Srikant M. Datar.1994.Cost Accounting:
A Managerial Emphasis:Prentice-Hall.)
An implicit assumption, and one that is frequently overlooked in evaluating the use of CVP analysis, involves its treatment of the cost of capital. CVP analysis, like other managerial accounting techniques and models, uses accounting profitability as the primary decision criterion for evaluating resource allocation decisions. CVP analysis, like other managerial accounting techniques, ignores the cost of capital and treats it as if it were zero. However, the opportunity cost of the funds invested in the assets used to manufacture a product is a cost the same as the cost of operating resources, such as direct material, labor, and overhead. The failure of CVP analysis to incorporate the cost of capital into a product's cost function can lead to underestimating a product's cost, while overstating its profitability. For products that require a significant investment of capital, ignoring the opportunity cost of invested funds may lead to accepting products whose rate of return is less than the firm's cost of capital. In effect, traditional CVP analysis encourages managers to select products that destroy, rather than create, economic value for the firm. Finally, using an accounting measure of profitability creates a bias to employ capital relative to operating resources because the cost of capital is not reflected in a product's cost like those of operational resources. Therefore, product designers and developers may employ investment funds beyond the point where the marginal benefit of the last dollar of capital used is equal to its marginal cost.
IMPORTANCE AND OBJECTIVES OF THE RESEARCH:
(Flora Guidry, James O.Horrigan,Cathy Craycraft,1998.CVP analysis:a new look:Journal of Managerial Issues)
Cost Volume Profit analysis (CVP) is used widely and is one of the simplest, analytical tools in management accounting. CVP allows managers to examine wide range of strategic decisions such as pricing policies,product mixes,market expansions or contractions,outsourcing contracts and other planning decisions.Critics of CVP argue that it is too simplistic.The real world and the world of managerial affairs is complicated. , CVP analysis does not consider the impact of strategic decisions on the wealth of firms, nor does it consider the effect of those decisions on firms' asset structures and risk levels. Those considerations are important because virtually all CVP analysis deal with decisions that alter the asset and cost structures of firms, which means that the risk levels and costs of capital of those firms will also change because of those decisions. These missing elements in CVP analysis can be filled in with a small number of additional variables. The wealth effects can be included by analyzing the cost of capital of the assets necessary to carry out a decision. The risk level imposed by a decision can be incorporated by considering the degree of operating risk or the systematic risk level as reflected by an accounting beta risk variable. The cost of capital itself can be estimated through an analysis of the revenue patterns and the asset structures involved in a decision. In general, through the use of information that would usually be available in a CVP analysis, the full impact of a strategic decision can be assessed.
LITERATURE REVIEW
BACKGROUND
This section should contain a rationale for my research. i will ask some questions like why I AM undertaking the project? Why is the research needed? I need to show how my work will build on and add to the existing knowledge.
CASE STUDY
(www.starbucks.com)
Starbucks Corporation is an international coffee and coffeehouse chain which was founded in 1971 and is based in Seattle, Washington. Starbucks Coffee Company is the leading retailer, roaster and brand of specialty coffee in the world, with more than 16,000 retail locations in North America, Latin America, Europe, the Middle East and the Pacific Rim - wherever there is a demand for great coffee.
Starbucks operates in Kuwait, KSA, UAE, Egypt, Lebanon, Jordan, Qatar, Bahrain & Oman in the Middle East region. Starbucks stores have been operating in the Middle East since 1999 through a licensing agreement with trading partner and licensee MH Alshaya WLL, a private Kuwait family business.
Starbucks has three reportable operating segments, United states segment
constituted 73%,International segment constituted 19% and Global Consumer Products Group constituted 8% of total net revenues for fiscal year 2009. The Company's primary competitors for coffee beverage sales are quick-service restaurants and specialty coffee shops. The Company employed approximately 142,000 people worldwide as of September 27, 2009. The company believes that factors such as customers trading their products to lower priced products,unfavorable economic conditions,decline in the Starbucks brand name could negatively impact sales,net revenues,operating income,operating margins and earnings per share.
DATA ANALYSIS AND RESEARCH (www.forbes.com)
STARBUCKS CORP (NASDAQ: SBUX) | Income Statement
RECOMMENDATION
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CONCLUSION
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