COST VOLUME PROFIT ANALYSIS CVP 1 Topic Objectives

COST VOLUME PROFIT ANALYSIS (CVP) 1

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 3

CVP Analysis Cost-volume-profit (CVP) analysis is the study of the effects of changes of costs and volume on a company’s profits. Cost-volume-profit (CVP) analysis is important in profit planning. It also is a critical factor in management decisions. 4

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. 5

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. 6

Relationship between fixed costs and activity Costs Total fixed cost 0 10 20 30 Activity (unit) 7

Relationship between variable costs and activity Total variable cost Costs 0 10 20 30 Activity (unit) 8

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 9

Contribution Margin Sales revenue RM 100, 000 Variable cost 60, 000 Contribution margin 40, 000 Fixed Cost 25, 000 Income from operation 15, 000 10

Unit Contribution Margin Selling price per unit RM 10. 00 Variable cost per unit 6. 00 Contribution margin per unit 4. 00 11

Contribution Margin Ratio Sales - Variable costs --------------Sales RM 100, 000 - RM 60, 000 ----------------RM 100, 000 X 100 = 40% 12

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. 13

Illustration 1: Syarikat PC Canggih sells each unit of product “Murai” at RM 4, 000. The variable cost per unit is RM 3, 250. Total fixed cost is RM 450, 000 per year. How many units of “murai” must be sold in one year in order to break-even. 14

1, 000 units 500 units 600 units Sales (RM 4, 000 x unit) 4, 000, 000 2, 400, 000 (-) Variable costs (RM 3, 250 x unit) 3, 250, 000 1, 625, 000 1, 950, 000 Contribution margin 750, 000 375, 000 450, 000 (-) Fixed costs 450, 000 300, 000 (75, 000) Net income / loss 450, 000 0 15

RM’ 000 Sales revenue 4, 000 Total costs 2, 400 2, 000 450 Fixed costs 0 500 600 1000 Unit 16

Techniques in CVP analysis Contribution margin approach Mathematical Equation approach Graphical approach 17

Contribution margin approach In units Break-Even Point In RM In units Target profit In RM 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 19

Calculating BEP: In Units Illustration 2: Selling price per unit RM 12. 00 Variable costs per unit RM 7. 20 Total fixed costs BEP (units) = = RM 60, 000 12. 00 – 7. 20 60, 000 = 12, 500 units 4. 80 20

Calculating BEP: In RM BEP In RM = BEP (RM) = = Total Fixed Costs ---------------Contribution Margin Ratio 60, 000 12. 00 – 7. 20 / 12. 00 60, 000 = RM 150, 000 40% 21

BEP Proof: Sales revenue (12, 500 units x RM 12. 00) 150, 000 Total variable costs (12, 500 units x RM 7. 20) 90, 000 Total contribution margin 60, 000 Total fixed costs Net income 0 22

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 23

Calculating Target Income: In Units Illustration 3: Target income (units) Selling price per unit Variable costs per unit Total fixed costs Target income = RM 12. 00 RM 7. 20 RM 60, 000 RM 15, 000 60, 000 + 15, 000 12. 00 – 7. 20 = 75, 000 = 15, 625 units 4. 80 24

Calculating Target Income: In RM Target Income In RM Target income (RM) = = = Total Fixed Costs + Target Income ---------------Contribution Margin Ratio 60, 000 + 15, 000 12. 00 – 7. 20 / 12. 00 75, 000 = RM 187, 500 40% 25

Target Income Proof: Sales revenue (15, 625 units x RM 12. 00) 187, 500 Total variable costs (15, 625 units x RM 7. 20) 112, 500 Total contribution margin 75, 000 60, 000 Total fixed costs Net income 15, 000 26

Application of CVP analysis Margin of safety Changes in selling price Changes in variable costs Changes in fixed costs Profit forecasting Interdependent changes 27

Margin of safety It is the difference between actual or expected sales and sales at the break-even point. Sales revenue RM Current sales revenue Total costs MOS BEP 0 Units 28

Margin of safety: In units / RM Margin of Safety Illustration 6: Margin of safety = 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 29

Changes in selling price Selling price increased from RM 12. 00 to RM 15. 00. Assumed that there’s no changes in costs. Selling price per unit Variable costs per unit Contribution margin Total fixed costs BEP (units) BEP (RM) RM 12. 00 RM 15. 00 7. 20 4. 80 7. 80 RM 60, 000 12, 500 RM 150, 000 7, 692 RM 115, 385 30

Changes in variable costs Variable costs per unit increased from RM 7. 20 to RM 8. 00. Assumed that there’s no changes selling price & fixed costs. Selling price per unit Variable costs per unit Contribution margin Total fixed costs BEP (units) BEP (RM) RM 12. 00 7. 20 8. 00 4. 80 4. 00 RM 60, 000 12, 500 RM 150, 000 15, 000 RM 180, 000 31

Changes in fixed costs Total fixed costs increased from RM 60, 000 to RM 65, 000. Assumed that there’s no changes selling price & variable costs. Selling price per unit Variable costs per unit Contribution margin Total fixed costs BEP (units) BEP (RM) RM 12. 00 7. 20 4. 80 RM 60, 000 RM 65, 000 12, 500 RM 150, 000 13, 542 RM 162, 500 32

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