COST VOLUME PROFIT ANALYSIS (CVP)

Topic Objectives
Describe the importance of CVP analysis as a managerial accounting technique. Classify cost by their behaviour: a.Variable cost b.Fixed cost c.Mixed cost Explain how to compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they maybe useful to managers. 2

Outline

The usage of CVP analysis

The relationships between cost volume and profit Concept of break-even point (BEP) Techniques in CVP analysis Application of CVP analysis
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CVP Analysis
Cost-volume-profit (CVP) analysis is the study of the effects of changes of costs and volume on a companys profits.

Cost-volume-profit (CVP) analysis is important in profit planning.

It also is a critical factor in management decisions.

The usage of CVP analysis

Setting the selling price.

Determining product mix.

Maximizing the use of production

facilities.

Evaluating the impact of changes in costs.

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Assumptions Underlie Each CVP Analysis

All costs can be classified either fixed or variable costs.

Changes in activity are the only factors that affect cost. All units produced are sold. When more than one type of product is sold, the sales mix will remain constant.

Relationship between fixed costs and activity

Costs

Total fixed cost

10

20

30

Activity (unit)

Relationship between variable costs and activity

Total variable cost Costs

10

20

30

Activity (unit)

Contribution Margin Concept

Contribution margin (CM) is one of the key relationships in CVP analysis and is the amount of revenue remaining after deducting variable costs.

Sales revenue

Variable Cost

Contribution Margin

Contribution Margin
Sales revenue Rs 100,000

Variable cost Contribution margin Fixed Cost

Income from operation

60,000 40,000 25,000

15,000

10

Unit Contribution Margin

Selling price per unit Rs 10.00

Variable cost per unit Contribution margin per unit

6.00 4.00

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Contribution Margin Ratio

Sales - Variable costs ----------------------------Sales
Rs 100,000 - Rs 60,000 -------------------------------Rs 100,000

X 100

= 40%

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Break-Even Point Concept(BEP)

The break-even point is the second key relationship in CVP analysis and is the level of activity at which total revenues equal total costs both fixed and variable. At break-even point, a business will have neither an income nor loss from operation.

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Illustration 1:

Syarikat PC Canggih sells each unit of product Murai at Rs 4,000. The variable cost per unit is Rs 3,250. Total fixed cost is Rs 450,000 per year.
How many units of murai must be sold in one year in order to break-even.

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1,000 units Sales (Rs 4,000 x unit) (-) Variable costs (Rs 3,250 x unit) Contribution margin (-) Fixed costs Net income / loss 4,000,000 3,250,000

500 units

600 units

2,000,000
1,625,000 375,000 450,000 (75,000)

2,400,000
1,950,000 450,000 450,000 0

750,000 450,000 300,000

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Rs000 Sales revenue

4,000
Total costs

2,400
2,000 450 Fixed costs

500 600

1000

Unit
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Techniques in CVP analysis

Contribution margin approach

Mathematical Equation approach Graphical approach

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Contribution margin approach

In units
Break-Even Point In Rs

In units Target profit In Rs 18

Calculating BEP: In Units

Contribution margin = Sales - Variable Costs Net income = Contribution margin - Total Fixed Costs BEP is when net income = 0,

Therefore, BEP is when:

Contribution margin = Total Fixed Costs

BEP In units

Total Fixed Costs ------------------------------Contribution Margin Per unit

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Calculating BEP: In Units

Illustration 2: Selling price per unit Variable costs per unit Total fixed costs 60,000 Rs 12.00 Rs 7.20 Rs 60,000

BEP (units) =

12.00 7.20
60,000 = 12,500 units

4.80
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Calculating BEP: In RM
BEP In Rs

Total Fixed Costs ------------------------------Contribution Margin Ratio

60,000

BEP (RM) =

12.00 7.20 / 12.00

60,000 = Rs 150,000

40%
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BEP Proof:
Sales revenue (12,500 units x Rs 12.00)
Total variable costs (12,500 units x Rs 7.20) Total contribution margin Total fixed costs Net income

150,000 90,000 60,000 60,000 0

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Calculating Target Income: In Units

Net income = Contribution margin - Total Fixed Costs Therefore: Net income + Total Fixed Costs = Contribution margin

Target Income In units

Total Fixed Costs + Target Income ---------------------------------------------Contribution Margin Per unit

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Calculating Target Income: In Units

Illustration 3:
Selling price per unit Variable costs per unit Total fixed costs Target income 60,000 + 15,000 12.00 7.20 = 75,000 4.80 24 = 15,625 units Rs 12.00 Rs 7.20 Rs 60,000 Rs 15,000

Target income (units)

Calculating Target Income: In RM

Target Income In Rs

Total Fixed Costs + Target Income ------------------------------Contribution Margin Ratio

60,000 + 15,000

Target income (Rs) =

12.00 7.20 / 12.00

75,000 = Rs 187,500

40%
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Target Income Proof:

Sales revenue (15,625 units x Rs 12.00)
Total variable costs (15,625 units x Rs 7.20) Total contribution margin Total fixed costs Net income

187,500 112,500 75,000 60,000 15,000

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Mathematical equation approach:

BEP in units
BEP, when net income = 0

When sales = total costs (variable & fixed)

Therefore, the equation:

Sales = Variable costs + Fixed Costs

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Mathematical equation approach:

BEP in units
Illustration 4: Selling price per unit Variable costs per unit Total fixed costs Rs 10.00 Rs 6.00 Rs 20,000

BEP (units):
Sales Rs 10 x X units = = Variable Costs Rs 6.00 x X units + Fixed Costs + Rs 20,000

Rs 4 x X units = Rs 20,000 X units = Rs 20,000 Rs 4.00

= 5,000 units
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Mathematical equation approach:

BEP in Rs

BEP (Rs): Sales = Variable Costs + Fixed Costs

X
0.4 X X

=
= =

0.6 X
Rs 20,000 Rs 20,000 0.4

+ Rs 20,000

= Rs 50,000
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BEP Proof:
Sales revenue (5,000 units x Rs 10.00)
Total variable costs (5,000 units x Rs 6.00) Total contribution margin Total fixed costs Net income

50,000 30,000 20,000 20,000 0

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Mathematical equation approach:

Target income in units

When sales = total costs (variable & fixed) + target income

Therefore, the equation:

Sales = Variable costs + Fixed Costs + Target Income

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Mathematical equation approach:

Target income in units
Illustration 5: Selling price per unit Variable costs per unit Total fixed costs Target income Rs 10.00 Rs 6.00 Rs 20,000 Rs 15,000

Target income (units):

Sales = Variable Costs + Fixed Costs + Target Income Rs 10 x X units = Rs 6.00 x X units + Rs 20,000 + Rs 15,000

Rs 4 x X units = Rs 35,000 X units = Rs 35,000 Rs 4.00

= 8,750 units
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Mathematical equation approach:

Target income in Rs

Target income (units): Sales = Variable Costs + Fixed Costs + Target Income

X
0.4 X

=
=

0.6 x X + Rs 20,000 + Rs 15,000

Rs 35,000

Rs 35,000 0.4

= Rs 87,500

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Target Income Proof:

Sales revenue (8,750 units x Rs 10.00) Total variable costs (8,750 units x Rs 6.00) Total contribution margin Total fixed costs Net income

87,500 52,500 35,000 20,000 15,000

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Application of CVP analysis

Margin of safety Changes in selling price Changes in variable costs Changes in fixed costs Profit forecasting Interdependent changes
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Margin of safety
It is the difference between actual or expected sales and sales at the break-even point.
Sales revenue Current sales revenue Total costs

Rs

MOS
BEP

Units
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Margin of safety:
In units / Rs
Margin of Safety
Illustration 6:

Current / Expected - BEP Sales

Current sales = 300,000 units BEP = 180,000 units 300,000 - 180,000 = = 120,000 units Or 40% of current sales 37

Margin of safety

Changes in selling price

Selling price increased from Rs 12.00 to Rs 15.00. Assumed that theres no changes in costs.

Selling price per unit Variable costs per unit

Contribution margin

Rs 12.00 7.20
4.80 Rs 60,000

Rs 15.00 7.20
7.80 Rs 60,000

Total fixed costs

BEP (units) BEP (RM)

12,500 Rs 150,000

7,692 Rs 115,385
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Changes in variable costs

Variable costs per unit increased from Rs 7.20 to Rs 8.00. Assumed that theres no changes selling price & fixed costs.

Selling price per unit Variable costs per unit

Contribution margin

Rs 12.00 7.20
4.80 Rs 60,000

Rs 12.00 8.00
4.00 Rs 60,000

Total fixed costs

BEP (units) BEP (Rs )

12,500 Rs 150,000

15,000 Rs 180,000
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Changes in fixed costs

Total fixed costs increased from Rs 60,000 to Rs 65,000. Assumed that theres no changes selling price & variable costs.

Selling price per unit Variable costs per unit

Contribution margin

Rs 12.00 7.20
4.80 Rs 60,000

Rs 12.00 7.20
4.80 Rs 65,000

Total fixed costs

BEP (units) BEP (Rs)

12,500 Rs 150,000

13,542 Rs 162,500
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