1.

2 INTERNATIONAL ACCOUNTING

2. “Cost – Volume Profit (CVP) analysis is well known as well as most useful analytical
tool for assessing and comparing the benefits derived by the user of the product or
service against what they are paying.” Comment.
Ans:
Cost-volume profit (CVP) analysis is a method of cost accounting that looks at the impact
that varying levels of costs and volume have on operating profit. Cost-volume profit analysis
looks to determine the break-even point for different sales volumes and cost structures, which
can be useful for managers making short-term economic decisions.
Cost-volume profit analysis makes several assumptions in order to be relevant, including that
the sales price, fixed costs and variable cost per unit are constant. Running this analysis
involves using several equations for price, cost and other variables, then plotting them out on
an economic graph.
The cost volume profit analysis, commonly referred to as CVP, is a planning process that
management uses to predict the future volume of activity, costs incurred, sales made, and
profits received. In other words, it’s a mathematical equation that computes how changes in
costs and sales will affect income in future periods.
The CVP analysis classifies all costs as either fixed or variable. Fixed costs are expenses that
don’t fluctuate directly with the volume of units produced. These costs effectively remain
constant. An example of a fixed cost is rent. It doesn’t matter how many units the assembly
line produces. The rent expense will always be the same.
Cost-Volume-Profit (CVP) Analysis is also known as Break–Even Analysis. Every business
organization works to maximize its profits. With the help of CVP analysis, the management
studies the co-relation of profit and the level of production.
CVP analysis is concerned with the level of activity where total sales equals the total cost
and it is called as the break-even point. In other words, we study the sales value, cost and
profit at different levels of production. CVP analysis highlights the relationship between the
cost, the sales value, and the profit.
Many companies and accounting professionals use cost-volume-profit analysis to make
informed decisions about the products or services they sell. In this regard, CVP analysis plays
a larger role in managerial accounting than in financing accounting. Managerial accounting
focuses on helping managers -- or those tasked with running businesses -- make smart, cost-
effective moves. Financial accounting, by contrast, focuses more on painting an economic
picture of a company so that outside parties, such as banks or investors, can determine how
financially healthy it is.
The three elements involved in CVP analysis are:
Cost, which means the expenses involved in producing or selling a product or service.
Volume, which means the number of units produced in the case of a physical product, or the
amount of service sold.
Profit, which means the difference between the selling price of a product or service minus the
cost to produce or provide it.
Investigation may involve, for instance, interviewing employees and carefully observing their
daily activities, as opposed to simply treating them as part of a statistical model.
Let us go through the assumptions for CVP analysis:
 Variable costs remain variable and fixed costs remain static at every level of production.
 Sales volume does not affect the selling price of the product. We can assume the selling
price as constant.
 At all level of sales, the volume, material, and labor costs remain constant.
 Efficiency and productivity remains unchanged at all the levels of sales volume.
 The sales-mix at all level of sales remains constant in a multi-product situation.
 The relevant factor which affects the cost and revenue is volume only.
 The volume of sales is equal to the volume of production.

Cost-volume-profit analysis looks at different levels of volumes and costs on operating profit.
Among the tools in a business manager's decision-making arsenal, CVP analysis provides one
of the more detailed and objective ways by which a manager can assess and even predict the
course of business for the company and its employees. It makes several assumptions to be
relevant, however, which means it will only ever be an approximate calculation.
Advantage: Aids Decision-Making
CVP analysis provides managers with the advantage of being able to answer specific
pragmatic questions needed in business analysis. Questions such as what the company's
breakeven point is help managers project how future spending and production will contribute
to the success or failure of the company. For instance, when a manager knows the breakeven
point, he can tweak spending and increase production efforts to increase profitability.
Because CVP analysis is based on statistical models, decisions can be broken down into
probabilities that help with the decision-making process.
Advantage: Detailed Perspectives
Another major benefit of CVP analysis is that it provides a detailed snapshot of company
activity. This includes everything from the costs needed to produce a product to the amount
of the product produced. This helps managers determine, very specifically, what the future
will hold if variables are altered. For instance, transportation expenses and costs for materials
can change. These variable costs can affect the bottom line.
Disadvantage:  Human Error
CVP analysis allows the manager to plug in variable costs to establish an idea of future
performance, within a range of possibilities. This, however, can be a disadvantage to
managers who are not detail-oriented and precise with the data they record. Projections based
on cost estimates, rather than precise numbers, can result in inaccurate projections.
Disadvantage: Limited for Multi-Product Operations
The CVP approach to analysis is beneficial, but it is limited in the amount of information it
can provide in a multi-product operation. Much of the analysis that is done by business
managers who use this approach is done based on a single product. Multi-product businesses,
such as restaurants, can have a difficult time with CVP analysis because menu items, for
instance, are likely to have many variable cost ratios. This makes the challenge of CVP
analysis all the more difficult because it must be done for each specific product.
Disadvantage: Approximations with CVP
Even though CVP analysis is based on specific data and requires tremendous attention to
detail, the best that it can do is provide approximate answers to questions, rather than ones
that are exact. It answers hypothetical questions better than it provides actual answers for
solving problems. It leaves the business manager to decide how to act on the CVP analysis
data he has at hand.
Contribution Margin and Cost-Volume-Profit Analysis
First, take a look at the contribution margin income statement. The contribution margin is the
difference between a company's sales and its variable costs. Calculating the contribution
margin income statement shows the separation of fixed and variable costs. Simply stated, it
can fit into this simple equation:
Operating Income = Sales - Total Variable Costs - Total Fixed Costs
In order to better your understanding, this basic equation can be expanded:
Operating Income = (Price x #Units Sold) - (Variable Cost Per Unit X Number of Units
Sold) - Total Fixed Costs
Gross Margin vs Contribution Margin
It is important for a financial manager to understand that the gross profit margin and the
contribution margin are not the same. The gross profit margin is the difference between sales
and cost of goods sold. Cost of goods sold includes all costs — fixed costs and variable costs.
The contribution margin only considers variable costs. Calculating both can give the financial
manager valuable, but different, information.
Contribution Margin Ratio
Determining your contribution margin ratio is as simple as determining what percentage your
contribution margin is of your total sales. In this formula, you use the total contribution
margin, not the unit contribution margin. Calculating this ratio is important for the financial
manager as it addresses the profit potential of the firm. For example, if your contribution
margin is $40,000 and you have $100,000 in sales, your contribution margin ratio is 40
percent. This means that for every dollar increase in sales, there will be a 40 cent increase in
the contribution margin to cover fixed costs.
Calculating the Breakeven Point in Units
In analyzing CVP, a powerful function is to calculate the breakeven point in units for the
firm. You can calculate the breakeven point in dollars by multiplying the sales price for your
product by the breakeven point in units.
Breakeven point in units is the number of units the firm has to produce and sell in order to
make a profit of zero. In other words, it is the number of units where total revenue is equal to
total expenses.
If operating income equals zero, then the breakeven point in units has been reached. If the
operating income is positive, the business firm makes a profit. If the operating income is
negative, the firm takes a loss.
If you are observant, you can see that the variables in this equation resemble the variables
you have already used in the cost-volume-profit equation.
One of the focuses of CVP analysis is breakeven analysis. Specifically, CVP analysis helps
managers of firms analyze what it will take in sales for their firm to break even. There are
many issues involved; specifically, how many units do they have to sell to break even, the
impact of a change in fixed costs on the breakeven point, and the impact of an increase in
price on firm profit. CVP analysis shows how revenues, expenses, and profits change as sales
volume changes.
For this reason, the manager has to exercise extreme caution when making decisions about
changes to business operations and finance. Judgments have to be made after careful
investigation and deliberation – and not just be based solely on statistics. Investigation may
involve, for instance, interviewing employees and carefully observing their daily activities, as
opposed to simply treating them as part of a statistical model.

3. “Preparation of cash budget is helpful to resolve many systematic questions of an

organization, however in very few occasions the cash budget is failed to detect uneven
cash flows.” why and how?– Discuss.
Ans:
The cash budget is management’s approximation of cash on hand at the beginning of a
budget period and the estimated cash inflows and outflows. The cash inflows may include
those that result from cash sales, the sale of assets, the collection of accounts receivable,
borrowing cash or stock issuance. The cash outflows may include disbursements for material
purchases, debt repayment, asset acquisition, taxes, manufacturing costs and dividends. The
cash budget highlights a company’s probable income or deficit for a period, the latter of
which the company must address by increasing sales or decreasing expenditures. The
importance of the cash budget lies in its ability to identify a company’s future financing
needs, highlight the need for corrective actions and evaluate a company’s performance.
By creating a cash budget, a company can anticipate when a cash deficit might exist and the
extent of that shortfall. In turn, the budget indicates when a difference between budgeted and
actual values might need to be made up by borrowing. Short-term financing might be
required to acquire inventory, promote products or pay monthly expenses. By predicting cash
requirements, a company can also evaluate future business opportunities in part based on an
opportunity’s probable financing needs and costs. For instance, financing costs will influence
the profitability of a merger and product development. This process allows a company to
select only those organizational goals that are financially feasible.
A cash budget is a way to determine if a company has the cash necessary to meet upcoming
obligations and to trigger corrective actions if a company’s actual figures don’t match the
budget estimates. For example, a company experiencing cash-flow problems may need to
borrow money in the short term for emergency equipment repairs, the payment of taxes or a
monthly payroll. In addition, the company may need to borrow money in the long term for
the introduction of a new product to the market or the replacement of equipment. The
company might also need respond to a sharp decline in market sales by adjusting spending or
prices or negotiating more favorable terms with lenders.
A cash budget is used to illustrate a company’s financial position to internal and external
stakeholders – individuals with an interest in the company – including investors, suppliers
and company leadership. For example, increasing cash flow may indicate strong demand for
the company’s products and opportunities for company expansion, which are positive signals
to current and potential investors. In contrast, if company expenses are significantly more
than the company’s cash inflow, the investment risk is high and may deter additional
investment in the company. Declining cash flow may also make it more difficult for a
company to obtain additional vendor credit or pay its existing debt, which might force the
company into bankruptcy.
Features of Cash Budget
1. The cash-budget period is broken down into periods, mainly in months.
2. The cash-budget is always in columnar form i.e. column showing each month.
3. Payments and receipts of cash are identified in different heading and showing total for each
month.
4. The surplus of total cash payment over receipts or of receipts over payment for each month
is shown.
5. The running balances of cash, which would be determined by taken the balance at the end
of the previous month and adjusting it for either deficit or surplus of receipts over payments
for current month, is identified.
Importance of Cash Budget
Cash budget is an important tool in the hands of financial management for the planning and
control of the working capital to ensure the solvency of the firm.  The importance of cash
budget may be summarised as follow:
1. Helpful in Planning: Cash budget helps planning for the most efficient use of cash. It
points out cash surplus or deficiency at selected point of time and enables the management to
arrange for the deficiency before time or to plan for investing the surplus money as profitable
as possible without any threat to the liquidity. 
2. Forecasting the Future needs: Cash budget forecasts the future needs of funds, its time
and the amount well in advance. It, thus, helps planning for raising the funds through the
most profitable sources at reasonable terms and costs. 
3. Maintenance of Ample cash Balance: Cash is the basis of liquidity of the enterprise.
Cash budget helps in maintaining the liquidity. It suggests adequate cash balance for expected
requirements and a fair margin for the contingencies. 
4. Controlling Cash Expenditure: Cash budget acts as a controlling device. The expenses of
various departments in the firm can best be controlled so as not to exceed the budgeted limit. 
5. Evaluation of Performance: Cash budget acts as a standard for evaluating the financial
performance. 
6. Testing the Influence of proposed Expansion Programme: Cash budget forecasts the
inflows from a proposed expansion or investment programme and testify its impact on cash
position.
7. Sound Dividend Policy: Cash budget plans for cash dividend to shareholders, consistent
with the liquid position of the firm. It helps in following a sound consistent dividend policy. 
8. Basis of Long-term Planning and Co-ordination: Cash budget helps in co-coordinating
the various finance functions, such as sales, credit, investment, working capital etc. it is an
important basis of long term financial planning and helpful in the study of long term
financing with respect to probable amount, timing, forms of security and methods of
repayment.

List of the Disadvantages of a Cash Budget

1. It creates a danger of theft.
You must have plenty of documentation that tracks your cash movements to protect yourself
against theft. Cash is the easiest asset to steal, partially because it is not very easy to trace.
Although you don’t need to list every serial number of every bill you send outside of your
home or business, it is helpful to sign-out specific amounts when the cash must travel to a
new location. That will give you a paper trail that can be used to potentially make an
insurance claim should something happen.
2. It limits your spending power.
Many businesses today have stopped accepting cash for certain activities. You may find it to
be impossible to rent a car without having at least a debit card available to access your cash
resources. Some hotels will not accept a reservation without a debit or credit card number. If
you switch to a cash-only budget, you may find it difficult to access some of the services your
home or business may require. That, in turn, limits your overall productivity.
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3. It limits where you spend your money.
If you show up at a store to purchase something in cash, most will accept the transaction
without a second thought. If you want to make that purchase online, however, cash is not
going to be a suitable option. Most, but not all, geographic locations have eliminated the cash
on-delivery (COD) process, requiring payment up-front for products or services. Trying to
process a cash payment on an e-commerce website is almost impossible to do.
4. It can be easy to lose.
If you carry cash on you, there is a chance you could inadvertently misplace it. That means
you no longer have access to it until it is found. That is why having some level of card
protection, even if it is a debit card, offers a small advantage. If you lose your debit card, you
can call your bank and have the number frozen until the card is found, or the institution sends
you a new one. Lose your cash and you’ve lost your money.
5. It limits your ability to build a credit profile.
Cash budgets may limit the amount of debt that you create for yourself. That is advantageous
in saving money. It also means that your ability to purchase big ticket items will be restricted.
You’ll need to save up enough money to purchase a vehicle instead of financing the
transaction. You’d be forced to save up the cash to purchase a property or home outright
instead of being able to use a mortgage. In the long run, you pay less with cash because you
avoid interest. In the short-term, however, you are limiting your options.
6. It eliminates rewards.
Credit card rewards might seem like a trap to some. When used wisely, they can extend the
power of your finances. Imagine if your credit card gives you a 3% cash back reward on
purchases you already make. Pay with the credit card, earn the cash back, then pay off the
balance each month with the cash you’d have spent anyway. Just like that, you’ve increased
your spending power by 3%. If you use a cash-only budget, this benefit is not accessible.
7. It is not always a reflection of profit.
Within a cash budget, it is easy to mistake an inflow of cash as profit. That is not always the
case. Inflows might occur because of a security deposit being paid. The sale of a capital asset
creates a cash inflow as well. One-off activities and non-sustainable events create cash
inflows as well. If these are mistakenly classified as profits, then the estimates being made on
actual profits are flawed and may create unpleasant surprises down the road.
8. It relies on estimates to meet future needs.
When using a cash budget, the inflows and outflows from the previous year are used to
allocate cash for line items in the next year. That means each annual budget is an estimate,
based on the previous results generated. There is no guarantee that cash flows will be similar
year-by-year for any budget. At the same time, non-financial issues may influence your cash
flow, which may negate certain values that may generate cash in the future.
9. It forces cost to be the primary factor in making decisions.
Let’s say there is a product priced at $2.50 and you like to purchase it at this store across
town because the customer service is better. You could purchase it for $2 at a closer store, but
the service there is terrible. Using a cash budget, you’re forced to go with the latter because
that is where you save money. Cost becomes a primary factor in making each decision.