CHAPTER 10 Cost–volume–profit analysis 44510.9 Analyse an outsourcing decision.
Whether it is for cost savings or other factors, an entity may decide to outsource a product or
business activity to an external provider. To assess such a decision, the entity would need to com-
pare the in-house costs with those of the external provider. Costs that will be incurred regardless
of the decision taken are unavoidable and therefore irrelevant.10.10 Analyse a special order decision.
An entity may be requested by a new or existing customer to provide a modified product or pro-
vide an existing product at a lower cost. The motivation could be driven by a need for cash flow
or a strategic move to develop relationships with new customers. In such a decision the entity
would need to compare the incremental income with the incremental cost. An opportunity cost
should be considered if there is no idle capacity.Key terms
Available capacity (idle capacity) Difference between maximum capacity and current operating
capacity.
Avoidable costs Costs avoided if an outsourcing decision is accepted.
Break-even analysis Calculation of the necessary levels of activity required in order to break even in a
given period.
Contribution margin Calculated by deducting total variable costs from the total revenue.
Contribution margin per limiting factor Contribution margin per a limited resource.
Contribution margin per unit Selling price per unit less variable cost per unit.
Contribution margin ratio Contribution margin per unit divided by the selling price per unit.
Cost–volume–profit analysis Investigation of change in profits in response to changes in sales
volume, costs and prices.
Fixed costs Costs that remain the same in total (within a given range of activity and timeframe)
irrespective of the level of activity.
Incremental costs Additional costs incurred for each additional unit.
Incremental income Additional income gained for each additional unit.
Margin of safety Excess of revenue (or units of sales) above the break-even point.
Mixed costs Costs that possess fixed and variable characteristics.
Operating leverage Mix between fixed and variable costs in the cost structure of an entity.
Opportunity cost Cost of forgoing benefits that would be available if the resources had been used for
the next best alternative.
Outsourcing Purchase of goods or services from an external party.
Outsourcing decision Decision on whether to make or buy a product or service, or to outsource the
production of that product or service.
Relevant costs Costs that will be different under alternative courses of action.
Relevant income Income that will be different under alternative courses of action.
Relevant range Activity range over which the fixed costs remain constant.
Sales mix Number of units of each product/service sold relative to the total number of units sold.
Special order One-off customer order that is different from the orders usually received by the
entity.
Unavoidable costs Costs incurred regardless of the decision taken regarding outsourcing a product or
service.
Variable costs Costs that change in total as the level of activity changes.
Weighted average contribution margin (WACM) Sum of the contribution margin of each product
weighted by the relative sales mix.