Breakeven analysis, Cost of capital

Reviews the book "Control and Management of Capital Projects," by John W. Hackney.

Capital Budgeting, Breakeven analysis

Reviews the book `Creative and Innovative Approaches to the Science of Management,' by Yuji Ijiri.

A major limitation of traditional sales and profit variance analysis is that it neglects price-quantity relationships for firms not operating under conditions of perfect competition. This paper shows how data from sales and gross profit reports can be used to estimate price elasticities and cross elasticities of demand. Finally, the relationship of price elasticity to profit maximization is developed for a simple case.

This exercise examines the possibility of using shadow prices to calculate transfer prices between divisions of the multi-division or conglomerate firm and of basing divisional profit statements on transfer prices derived in this way. In order to demonstrate the proposal, a well known Harvard Buisiness School case is modified in two ways so that two different linear programming solutions can be derived. Divisional income statements are then computed which indeed do exactly distribute the total profit of the firm each time, but these statements are found to have several unsatisfactory features for purposes of income determination. The exercise concludes by suggesting extensions for study and problem solving for the student.

The article reports on a seminar on budget mix variances. After having attended to his instructor patiently for several quarters and after a review of the literature, Peter Griffin, second-year management student, overcame his own natural reticence and the spring lethargy spreading over the campus and questioned the general applicability of budget mix variances in gross profit analysis. His challenge invigorated discussion for almost a whole period. Whether he is right or not, this communique claims to take no position. Instead here is a scenario of the exchange he maneuvered, and it will be left to the reader to judge for himself the merit of Griffin's position. The point of computing a budget mix variance is that net income or contribution margin will differ from expectations as the quantity increases if the mix changes. The one occasion for which it seems reasonable to compute mix for budgets or sales is when production planning is pretty well locked in or fixed at some level and when later on deliberate substitution between products takes place at that level. Then there has to be a decision to change the mix and there should be a variance to measure the effect of that decision.

The article presents a comment on the article related to matrix theory and cost allocation by professor Neil Churchill that appeared in the October 1964 issue of the journal "The Accounting Review." Churchill's article provided an expanded version of the cost allocation model and then suggested other applications of linear algebra to cost accounting analysis. This comment will be directed at the Williams-Griffin model. As the article explained, the techniques of linear analysis with a helping hand from computers make the solution of reciprocally related systems quite simple in theory. This phrase, in theory, suggests two lines of thought, neither of which is to be construed as a basic criticism of the Williams-Griffin-Churchill material. The first, very briefly, is that what is in theory so simple still presents problems in practice. A different Net Services model predicates its approach on the assumption that service departments exist only to fulfill needs of operating departments and that their costs to these operating departments can only be determined after they have been charged by other services and credited for work done for other services.

The article informs that few sectors of governmental endeavor have grown at the explosive rate in the U.S. and that has marked highway construction since 1956, date of a new and expanded Federal Aid Highway Act. Today the construction of Interstate highways constitutes the largest public works program in the history of the world. Despite this claim on public attention in general and on the interest of accountants in particular, there are several reasons why this work receives relatively little publicity, its budget is dwarfed by defense, space and agricultural subsidy outlays, the cost of highway construction is not recorded in any single total amount, being divided as it is, between Federal and State agencies. The extent of autonomy which has been left to each State for the fulfillment of its share of a national system must be gratifying even to the most ardent states rights advocate. And in fact, as could be expected, the individual States have gone forward with the job at widely variant rates of speed and with quite different degrees of efficiency, enthusiasm and integrity, some exceeding all plans for progress and others lagging far behind.

This article focuses on a study which illustrated the application of a matrix algebra formulation and solution to the problem of calculating standard prime cost variances. If the total material and labor price, mix, and quantity variances for all components are desired, these may be obtained by accumulating the relevant variances for all individual components. If there are a larger number of individual components involved in the manufacture of a single product, certain efficiencies in the computation of these variances may be achieved by setting up the basic data in matrix form and using simple matrix operations to perform the arithmetic. There are several advantages to be gained from the expression of accounting procedures, such as the calculation of standard cost variances, in mathematical form. In the first place, the explicit statement of the variables to be used in the analysis and the mathematical derivation of the formulas involved make it possible for the cost accountant to see clearly what the key elements in the analysis are and how the computational rules which an accountant later follows automatically were arrived at.