Professional Documents
Culture Documents
Cost Accounting
Cost Accounting
Cost
Volume
Profit
Analysis
SYNOPSIS
This chapter presents the cost-volume-profit (CVP) analysis model
and illustrates how managers use that model to help answer
important what-if business questions.
CVP analysis also helps management accountants alert managers to
the risks and rewards of decisions they are considering by
illustrating how the bottom-line is affected by changes in activity
levels or key pricing or cost components.
CVP analysis is based on several assumptions, one of which is that
fixed costs can be distinguished from variable costs.
However, whether a cost is variable or fixed depends on the time
period for the decision and also the range of activity (relevant
range) being considered.
We also look at a method for applying CVP analysis to companies
with multiple products and to situations where there is more than
one cost driver.
The applicability of CVP to manufacturers, service organizations,
and nonprofits is discussed.
Contribution margin is also defined and distinguished from gross
margin
Management
accounting
information
helps
managers
perform each
of these
functions
more
effectively.
Process of
Management
Strategy
Formulation
The process
of
management
involves
formulating
strategy,
planning,
control,
decision
making and
directing
operational
activities.
Planning
Directing
Control
Decision
Making
2-3
Basis of
classification :
Direct costs can be conveniently and
(CAS 1)
Nature of
expenses
Relation to
object traceability
Functions/acti
vities
Behaviour
Management
decision
making
Production
process
Time period
Basis of classification
: (CAS 1)
i)
ii)
iii)
iv)
v)
vi)
vii)
Nature of
expenses
Relation to
object traceability
Functions/acti
vities
Behaviour fixed, semivariable or
variable
Management
decision
making
Production
process
Time period
Pay-Per-View
Movies Watched
Movies
Watched
2-7
Number of HBO
Movies Watched
2-8
Introduction
Till now we allocated all manufacturing costs
to products regardless of whether they are
fixed or variable. This approach is known as
absorption costing/full costing
However, now, we will use only variable costs
which are relevant to decision-making (why?).
This is known as marginal costing/variable
costing
9
BE Analysis
Or,
CVP analysis refers to the study of the effects on
future profits of changes in fixed cost, variable cost,
sales price, quantity and mix.
The analysis provides solutions to various alternative
business plans
Cost-volume profit analysis is also known as
Breakeven analysis and is used for decision making
Therefore, Breakeven analysis is the study of the
relationship between selling prices, sales volumes,
fixed costs, variable costs and profits at various levels
of activity
Continue.
Marginal cost:
It is the additional cost of producing an additional unit of a product.
Defined as: the amount at any given volume of output by which
aggregate costs are changed if the volume of output is increased or
decreased by one unit. Thus, it is measured by the total variable cost
attributable to one unit
DL are included in marginal
cost on the assumption that
they are variable. If not, they
should be excluded
It has to be understood that
all variable costs are
generally direct costs but all
direct costs need not be
variable
In India Direct labour cost
are generally treated as
fixed, only casual labour are
treated as variable
Absorption Costing
Cost
Manufacturing cost
Direct
Materials
Direct
Labour
Finished goods
Non-manufacturing cost
Overheads
Period cost
Unsold is
added to
stock
Marginal Costing
Cost
Manufacturing cost
Direct
Materials
Direct
Labour
Finished goods
Non-manufacturing cost
Variable
Overheads
Fixed
overhead
Period cost
Unsold is
added to
stock
Features (contd):
2. Stock/Inventory Valuation : Under marginal costing, inventory/stock for
profit measurement is valued at marginal cost. It is in sharp contrast to the
total unit cost under absorption costing method.
3. Marginal Contribution: Marginal costing technique makes use of marginal
contribution for marking various decisions. Marginal contribution is the
difference between sales and marginal cost. It forms the basis for judging
the profitability of different products or departments.
4. Prices are determined on the basis of marginal cost
Advantages of marginal costing:
Simple, less confusing and less complicated
Stock valuation--Under this technique net profit is not effected by the
changes in production level or changes in stock volume; in fact profit is
directly related to sales.
Meaningful reporting--Reports based on this technique provide
information based on sales rather than production conveying real estate of
efficiency.
So
What is Marginal cost ?
The cost of producing one more unit
Or
the cost which could be avoided by
not producing a unit
What is Marginal costing ?
An approach in which only variable costs are
included in cost of sales
fixed costs are treated as period costs
and are written off as incurred
Contribution Margin
Profit (Net Margin) = Gross margin fixed cost
Gross margin is also known as the contribution margin
Contribution margin is the portion of sales revenue
available to cover fixed costs and provide a profit.
Sales revenue
Variable costs
Contribution margin
Fixed costs
Profit
Contribution
Is the difference between the sales value and the marginal or
variable cost of sales
Contribution may be defined as the profit before the recovery of
fixed costs
contribution goes toward the recovery of fixed cost and profit, and
is equal to fixed cost plus profit (C = F + P).
In case a firm neither makes profit nor suffers loss, contribution
will be just equal to fixed cost (C = F).
This is known as break even point.
Sales revenue
Less variable costs
Contribution margin
Less fixed costs
Profit
Total
Rs1,000,000
400,000
Rs 600,000
350,000
Rs 250,000
Per Unit
Rs2,000
800
Rs1,200
Ratio
100%
40%
60%
PROFIT ?
Therefore
S-V = F+P
If any 3 factors in the equation are known
The 4th could be found out
P=S-V-F
P=C-F
F=C-P
S=F+P+V
V=S-C.
SALES?
F COST?
V Cost?
C=S-V
=12,000-7000=5000
P=C-F
=5,000-4000
=Rs 1,000
S=C+V
=5,000+7,000
=Rs 12,000
F=C-P
=5,000-1,000
=Rs 4,000
V=S-C
=12,000-5000
=Rs 7,000
Sales
$ 250,000
Less: variable expenses 150,000
Contribution margin
100,000
Less: fixed expenses
100,000
Net income
$
7-29
Graphic
Method
Profit way
At the output level when total revenue
equal to total cost.
(Selling price X number of units)
(variable cost per unit x number of units)
fixed cost = operating profit
At Break even level operating income is
zero
Break even quantity = Fixed cost /
(selling price variable cost)
CP 1-2-3
Which of the following is not a factor in cost-volume-profit analysis?
a. Units sold
b. Selling price
c. Total variable costs
d. Fixed costs of a product
Which of the following is not an assumption of cost-volume-profit analysis?
a. The time value of money is incorporated in the analysis.
b. Costs can be classified into variable and fixed components.
c. The behavior of revenues and expenses is accurately portrayed as linear over
the relevant range.
d. The number of output units is the only driver.
Contribution margin is calculated as
a. total revenue total fixed costs.
b. total revenue total manufacturing costs (CGS).
c. total revenue total variable costs.
d. operating income + total variable costs.
Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit
Unit
Sales
sales volume
price
in units
(Rs500 X)
Unit
Sales
variable volume
expense in units
(Rs300 X)
Rs80,000 = Rs0
X = 400 units
Expenses can be separated in variable and fixed
expenses. At the break-even point, income is
Rs0.
7-33
Contribution-Margin Approach
Consider the following information developed by the accountant at Curl,
Inc.:
Curl, Inc. manufactures surf boards.
Each surf board sells for $500 and
has variable costs of $300.
Total
$250,000
150,000
$100,000
80,000
$ 20,000
Per Unit
$
500
300
$
200
Percent
100%
60%
40%
7-34
Contribution-Margin Approach
Fixed expenses
Unit contribution margin
Therefore, the contribution margin per unit
is $200. When enough surf boards are sold
so that the total contribution margin is
$80,000, Curl Inc. will break even for the
period.
$80,000
$200
= Break-even point
(in units)
To compute the break-even volume of surf
boards, divide the total fixed expenses by the
unit contribution margin. For Curl, Inc.,
$80,000 is divided by $200, which is 400 surf
boards. That means that the break-even
point is 400 surf boards.
Total
$250,000
150,000
$100,000
80,000
$ 20,000
Per Unit
$
500
300
$
200
Percent
100%
60%
40%
Contribution-Margin Approach
The break-even point of 400 units can be proven by first calculating total sales:
multiply $500 x 400 units for $200,000 in total sales. The variable expenses are
$300 per unit x 400 units which is $120,000. Total sales less total variable
expenses is total contribution margin of $80,000. When fixed expenses 0f
$80,000 are deducted from the total contribution margin, that leaves $0 in net
income.
Total
$200,000
120,000
$ 80,000
80,000
$
-
Per Unit
$
500
300
$
200
Percent
100%
60%
40%
For Curl, Inc., the fixed costs of $80,000 are divided by the
contribution margin ratio of 40% to determine the breakeven sales of $200,000.
$80,000
40%
Total
$200,000
120,000
$ 80,000
80,000
$
-
Per Unit
$
500
300
$
200
Percent
100%
60%
40%
$200,000 sales
7-37
Contribution margin
Sales
AND
Fixed expense
CM Ratio
= CM Ratio
Break-even point
(in sales dollars)
7-38
Therefore
CostVolumeProfit Analysis
Fixed
Cost
BEP (Units) = --------------Contribution PU
Equation
METHOD
= F
S-V
Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution
Fixed Cost
Fixed Cost
BEP (Rs) = ------------------ = -----------------P/V Ratio
C/S
When P/V is calculated using unit contribution and unit
selling prices . We can write
Total fixed costs
BEP = ---------------------x Unit selling prices
Unit contribution
And if P/V is calculated at given level of activity
Total fixed costs
BEP = ------------------------ x total sales
total contribution
$80,000 + $100,000
$200
Equation Approach
The equation approach also can be used to find the units of sales required to earn a target net
profit. Recall that in the profit equation, profit is equal to revenues minus variable and fixed
expenses. Recall that profit was set to zero to determine the break-even point. When
management has determined a target net profit greater than zero, that number becomes
profit variable in the equation
($500 X)
($300 X)
$80,000 = $100,000
($200X) = $180,000
X = 900 surf boards
7-42
Before-tax
=
net income
7-44
5.How
FC
Q1
Output/Sales
Break-Even Analysis
TR
TR
TC
VC
FC
Q1
Output/Sales
The Break-even point occurs where total revenue equals total costs the firm, in this example would have to
sell Q1 to generate sufficient revenue to cover its costs.
Break-Even Analysis
Costs/Revenue
TR
TR
TC
VC
FC
Q2
Q1
Output/Sales
Break-Even Analysis
TR)
Costs/Revenue
TR
TC
VC
If the firm chose to set
prices lower it would
need to sell more units
before covering its
costs
FC
Q1
Q3
Output/Sales
Break-Even Analysis
TR
Costs/Revenue
TC
Profit
VC
Loss
FC
Q1
Output/Sales
Angle of Incidence
Break-Even Analysis
Costs/Revenue
TR
TR
Assume
current
sales at Q2
TC
VC
Margin of Safety
FC
Q3
Q1
Q2
Output/Sales
Applying BE
Safety Margin
The
difference
between
budgeted
sales
revenue
and breakeven sales
revenue.
Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income
Break-even
sales
400 units
$ 200,000
120,000
80,000
80,000
$
-
Actual sales
500 units
$ 250,000
150,000
100,000
80,000
$
20,000
The
amount
by
which
sales
can
drop
before
losses
begin
to be
incurre
d.
7-53
Costs/Revenue
TR
TR
Angle of
Incidence:
The angle
between
Margin of Safety
sales and
total cost
FC
line. This
angle is an
indicator of
Q1
Q3
Q2
Output/Sales
profit earning
capacity over A large angle of incidence with high MS indicates monopoly conditions
the BEP.