END3972 – Cost & Management Accounting

Week 4 – 20/3/2023

Assist. Prof. Mert Edalı

medali@yildiz.edu.tr

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 Outline
 Cost – Volume – Profit Analysis

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 Chapter 3
Cost – Volume – Profit Analysis

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 Cost – Volume – Profit Analysis
 In Chapter 2, we discussed total revenues, total costs, and income.
 Cost-volume-profit (CVP) analysis
 studies the behavior and relationship among these elements as changes occur in the units
sold, the selling price, the variable cost per unit, or the fixed costs of a product.
 Example:
Emma Frost is considering selling GMAT Success, a test prep book and software
package for the business school admission test, at a college fair in Chicago.
 purchase this package from a wholesaler at $120 per package
 return all unsold packages and receive a full $120 refund per package
 must pay $2,000 for the booth rental at the fair
 Emma must decide whether she should rent a booth

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 Cost – Volume – Profit Analysis
 Emma predicts that she can charge a price of $200 for GMAT Success.
 At that price she is reasonably confident that she will be able to sell at least 30
packages and possibly as many as 60.
 All the predictions are based on experience
 Boston fair (4 months ago)
 Emma uses the CVP analysis that follows, and decides to rent the booth at the
Chicago fair.
 First step: identify which costs are fixed and which costs are variable and then calculate
contribution margin.

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 Cost – Volume – Profit Analysis
 The booth-rental cost of $2,000 is a fixed cost.
 does not change no matter how many packages are sold
 The cost of the package is a variable cost.
 increases in proportion to the number of packages sold

 The only numbers changing with respect to the number of packages sold are
 total revenues
 total variable costs

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 Cost – Volume – Profit Analysis
 Contribution margin
 indicates how operating income changes as the number of units sold changes.
 Contribution margin;
 5 packages sold → 5 x $200 – 5 x $120 = $400
 40 packages sold → 40 x $200 – 40 x $120 = $3,200
 Other definitions;

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 Cost – Volume – Profit Analysis
 Emma incurs $2,000 in fixed costs (booth rental price).
 Emma will recover $80 for each package that she sells.
 If she sells enough packages, she can recover the booth rental cost.
 Beyond that point, she then start making a profit.
 contribution margins for different quantities of packages sold
 contribution income statement

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 Cost – Volume – Profit Analysis
 Different formulations to express CVP relationships;
 First formulation:

 Second formulation:

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 Cost – Volume – Profit Analysis
 Main assumptions of CVP Analysis:
1. Changes in production/sales volume are the sole cause for cost and revenue changes.
2. Total costs consist of fixed costs and variable costs.
3. Revenue and costs behave and can be graphed as a linear function (a straight line).
4. Selling price, variable cost per unit, and fixed costs are all known and constant.
5. In many cases only a single product will be analyzed. If multiple products are studied,
their relative sales proportions are known and constant.
6. The time value of money (interest) is ignored.

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 Cost – Volume – Profit Analysis
 The third method is the graph method.
 We represent total costs and total revenues graphically.
 x axis → units sold
 y axis → monetary value ($, TL, etc.)
 We draw to different lines;
 total revenues line (with respect to units sold)
 total costs line (with respect to units sold)
 The total costs line is the sum of fixed costs and variable costs (with respect to
units sold).
 To draw each line, we need (at least) two points.

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 Cost – Volume – Profit Analysis
 Let us first consider the total revenues line;
 First natural point to consider is “$0 revenues at 0 units sold”.
 We can pick another convenient point. At 40 units sold, total revenues are $8,000
($200 per unit x 40 units)

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 Cost – Volume – Profit Analysis
 Now consider the total costs line;
 at 0 units sold, the total cost is $2,000! → fixed cost (first point)
 40 units sold → total cost = 40 x $120 + $2,000 = $6,800

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 Cost – Volume – Profit Analysis

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 Cost – Volume – Profit Analysis
 The breakeven point (BEP)
 quantity of output sold at which total revenues equal total costs
 i.e., the quantity of output sold that results in $0 of operating income

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 Cost – Volume – Profit Analysis
 If Emma sells fewer than 25 units, she will incur a loss.
 If she sells 25 units, she will break even.
 If she sells more than 25 units, she will make a profit.

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 Cost – Volume – Profit Analysis
 Target operating income;
 “How many units should I sell to reach a target operating income?”
 e.g., How many units must Emma sell to earn an operating income of $1,200?

 Revisit the data;

 purchase this package from a wholesaler at $120 per package
 return all unsold packages and receive a full $120 refund per package
 must pay $2,000 for the booth rental at the fair

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 Cost – Volume – Profit Analysis

 Not very useful for calculating the quantity

required to reach a target operating
income.

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 Cost – Volume – Profit Analysis
 Instead, we can use a profit-volume (PV) graph.
 A PV graph shows how changes in the quantity of units sold affect operating
income.
 Recall;
 fixed costs, $2,000; selling price, $200; and variable cost per unit, $120
 The PV line can be drawn using two points.
 the operating loss at 0 units sold, which is equal to the fixed costs of $2,000
(0, -$2,000)
 A second convenient point is the breakeven point, which is 25 units in our example
(25, $0)

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 Cost – Volume – Profit Analysis

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