CVP ANALYSIS LOOKS PRIMARILY AT THE EFFECTS OF

DIFFERING LEVELS OF ACTIVITY ON THE FINANCIAL

RESULTS OF A BUSINESS. THE REASON FOR THE
PARTICULAR FOCUS ON SALES VOLUME IS BECAUSE,
IN THE SHORT-RUN, SALES PRICE, AND THE COST OF
MATERIALS AND LABOUR, ARE USUALLY KNOWN WITH
A DEGREE OF ACCURACY.
ln any busIness, cr, Indeed, In lIfe
In general, hIndsIght Is a beautIful
thIng. lf cnly we cculd lcck Intc a
crystal ball and fInd cut exactly hcw
many custcmers were gcIng tc buy
cur prcduct, we wculd be able tc
make perfect busIness decIsIcns and
maxImIse prcfIts.
Take a reslaurahl, or exampe. l
lhe owhers khew exacly how mahy
cuslomers woud come h each evehhg
ahd lhe humber ahd lype o meas lhal
lhey woud order, lhey coud ehsure lhal
slahg eves were exacly accurale ahd
ho wasle occurred h lhe klcheh. The
realy s, o course, lhal decsohs such
as slahg ahd ood purchases have
lo be made oh lhe bass o eslmales,
wlh lhese eslmales behg based oh
pasl experehce.
Whe mahagemehl accouhlhg
hormaloh cah'l reay hep much
wlh lhe crysla ba, l cah be o use
h provdhg lhe ahswers lo queslohs
aboul lhe cohsequehces o derehl
courses o acloh. Ohe o lhe mosl
mporlahl decsohs lhal heeds lo be
made beore ahy bushess eveh slarls
s 'how much do we heed lo se h
order lo breakeveh!' By 'breakeveh'
we meah smpy coverhg a our cosls
wlhoul makhg a prol.
Ths lype o ahayss s khowh as
'coslvoumeprol ahayss' (CVF
ahayss) ahd lhe purpose o lhs arlce
s lo cover some o lhe slraghl orward
cacualohs ahd graphs requred or
lhs parl o lhe Faper F5 syabus, whe
aso cohsderhg lhe assumplohs whch
uhdere ahy such ahayss.
THE OBJECTIVE OF CVP ANALYSIS
CVF ahayss ooks prmary al lhe
eecls o derhg eves o aclvly
oh lhe hahca resuls o a bushess.
The reasoh or lhe parlcuar ocus
oh saes voume s because, h lhe
shorlruh, saes prce, ahd lhe cosl
o maleras ahd abour, are usuay
khowh wlh a degree o accuracy.
8aes voume, however, s hol usuay
so predclabe ahd lhereore, h lhe
shorlruh, prolably oleh hhges
upoh l. For exampe, Compahy A may
khow lhal lhe saes prce or producl
x h a parlcuar year s gohg lo be
h lhe regoh o S50 ahd ls varabe
cosls are approxmaley S30.
ll cah, lhereore, say wlh some
degree o cerlahly lhal lhe
cohlrbuloh per uhl (saes prce ess
varabe cosls) s S20. Compahy A may
aso have xed cosls o S200,000 per
ahhum, whch agah, are ary easy
lo predcl. However, wheh we ask lhe
quesloh: 'W lhe compahy make a
prol h lhal year!', lhe ahswer s 'We
doh'l khow'. We doh'l khow because
we doh'l khow lhe saes voume or
lhe year.
However, we cah work oul how mahy
saes lhe bushess heeds lo make h
order lo make a prol ahd lhs s where
CVF ahayss beghs.
Methods for calculating the
break-even point
The breakeveh pohl s wheh lola
revehues ahd lola cosls are equa,
lhal s, lhere s ho prol bul aso ho
oss made. There are lhree melhods or
ascerlahhg lhs breakeveh pohl:
COST-VOLUME-
PROFIT
RELEVANT TO ACCA QUALIFICATION PAPER F5
01 TECHNICAL
1 The equatIcn methcd
A lle bl o smpe malhs cah
hep us ahswer humerous derehl
coslvoumeprol queslohs.
We khow lhal lola revehues are
ouhd by mulpyhg uhl sehg prce
(U8F) by quahlly sod (Q). Aso,
lola cosls are made up rsly o
lola xed cosls (FC) ahd secohdy
by varabe cosls (VC). Tola varabe
cosls are ouhd by mulpyhg uhl
varabe cosl (UVC) by lola quahlly
(Q). Ahy excess o lola revehue over
lola cosls w gve rse lo prol
(F). By pullhg lhs hormaloh
hlo a smpe equaloh, we come up
wlh a melhod o ahswerhg CVF
lype queslohs. Ths s dohe beow
cohlhuhg wlh lhe exampe o
Compahy A above.
Tola revehue lola varabe cosls
lola xed cosls = Frol
(U8F x Q) (UVC x Q) FC = F
(50Q) (30Q) 200,000 = F
Nole: lola xed cosls are used ralher
lhah uhl xed cosls shce uhl xed
cosls w vary depehdhg oh lhe eve
o oulpul.
Studying Paper F5?
Performance objectives 12, 13 and 14 are relevant to this exam
ANALYSIS
ll woud, lhereore, be
happroprale lo use a uhl xed
cosl shce lhs woud vary depehdhg
oh oulpul. 8aes prce ahd varabe
cosls, oh lhe olher hahd, are
assumed lo remah cohslahl or a
eves o oulpul h lhe shorlruh, ahd,
lhereore, uhl cosls are approprale.
Cohlhuhg wlh our equaloh, we
how sel F lo zero h order lo hd oul
how mahy lems we heed lo se
h order lo make ho prol, e lo
break eveh:
(50Q) (30Q) 200,000 = 0
20Q 200,000 = 0
20Q = 200,000
Q = 10,000 uhls.
The equaloh has gveh us our
ahswer. l Compahy A ses ess lhah
10,000 uhls, l w make a oss;
l ses exacly 10,000 uhls, l w
breakeveh, ahd l ses more lhah
10,000 uhls, l w make a prol.
Z The ccntrIbutIcn margIn methcd
Ths secohd approach uses a
lle bl o agebra lo rewrle our
equaloh above, cohcehlralhg
oh lhe use o lhe 'cohlrbuloh
margh'. The cohlrbuloh margh
s equa lo lola revehue ess lola
varabe cosls. Alerhalvey, lhe
uhl cohlrbuloh margh (UCM)
s lhe uhl sehg prce (U8F) ess
lhe uhl varabe cosl (UVC). Hehce,
lhe ormua rom our malhemalca
melhod above s mahpualed h
lhe oowhg way:
(U8F x Q) (UVC x Q) FC = F
(U8F UVC) x Q = FC - F
UCM x Q = FC - F
Q = FC - F
UCM
8o, F=0 (because we wahl lo hd
lhe breakeveh pohl), lheh we woud
smpy lake our xed cosls ahd
dvde lhem by our uhl cohlrbuloh
margh. We oleh see lhe uhl
cohlrbuloh margh reerred lo as lhe
'cohlrbuloh per uhl'.
Appyhg lhs approach lo
Compahy A agah:
UCM = 20, FC = 200,000 ahd F = 0.
Q = FC
UCM
Q = 200,000
20
Thereore Q = 10,000 uhls
THE CONTRIBUTION MARGIN METHOD USES A
LITTLE BIT OF ALGEBRA TO REWRITE OUR EQUATION
ABOVE, CONCENTRATING ON THE USE OF THE
CONTRIBUTION MARGIN.
STUDENT ACCOUNTANT ISSUE 14/2010
02
3 The graphIcal methcd
Wlh lhe graphca melhod, lhe lola
cosls ahd lola revehue hes are
polled oh a graph; S s showh oh
lhe y axs ahd uhls are showh oh
lhe x axs. The pohl where lhe lola
cosl ahd revehue hes hlersecl s
lhe breakeveh pohl. The amouhl
o prol or oss al derehl oulpul
eves s represehled by lhe dslahce
belweeh lhe lola cosl ahd lola
revehue hes. FIgure 1 opposle
shows a lypca breakeveh charl or
Compahy A. The gap belweeh lhe
xed cosls ahd lhe lola cosls he
represehls varabe cosls.
Alerhalvey, a cohlrbuloh graph
coud be drawh. Whe lhs s hol
speccay covered by lhe Faper F5
syabus, l s sl useu lo see l.
Ths s very smar lo a breakeveh
charl, lhe ohy derehce behg lhal
hslead o showhg a xed cosl he,
a varabe cosl he s showh hslead.
Hehce, l s lhe derehce belweeh
lhe varabe cosl he ahd lhe lola
cosl he lhal represehls xed cosls.
The advahlage o lhs s lhal l
emphasses cohlrbuloh as l s
represehled by lhe gap belweeh lhe
lola revehue ahd lhe varabe cosl
hes. Ths s showh or Compahy A h
FIgure Z opposle.
Fhay, a prolvoume graph
coud be drawh, whch emphasses
lhe mpacl o voume chahges oh
prol (FIgure 3 oh page 7). Ths
s key lo lhe Faper F5 syabus ahd
s dscussed h more dela aler h
lhs arlce.
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000
UnIts scld
S
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
Tola cosls
FIGURE 1: COMPANY A: BREAK-EVEN CHART
Fxed cosls
Breakeveh pohl
Tola revehue
03 TECHNICAL
ASCERTAINING THE SALES
VOLUME REQUIRED TO ACHIEVE A
TARGET PROFIT
As we as ascerlahhg lhe breakeveh
pohl, lhere are olher roulhe cacualohs
lhal l s |usl as mporlahl lo uhderslahd.
For exampe, a bushess may wahl lo
khow how mahy lems l musl se h
order lo allah a largel prol.
Example 1
Compahy A wahls lo acheve a largel
prol o S300,000. The saes voume
hecessary h order lo acheve lhs
prol cah be ascerlahed ushg ahy o
lhe lhree melhods oulhed above. l
lhe equaloh melhod s used, lhe prol
o S300,000 s pul hlo lhe equaloh
ralher lhah lhe prol o S0:
(50Q) (30Q) 200,000 = 300,000
20Q 200,000 = 300,000
20Q = 500,000
Q = 25,000 uhls.
Alerhalvey, lhe cohlrbuloh melhod
cah be used:
UCM = 20, FC = 200,000 ahd F =
300,000.
Q = FC - F
UCM
Q = 200,000 - 300,000
20
Thereore Q = 25,000 uhls.
Fhay, lhe ahswer cah be read rom lhe
graph, alhough lhs melhod becomes
cumser lhah lhe prevous lwo. The prol
w be S300,000 where lhe gap belweeh
lhe lola revehue ahd lola cosl he s
S300,000, shce lhe gap represehls
prol (aler lhe breakeveh pohl) or oss
(beore lhe breakeveh pohl.)
0 5,000 10,000 15,000 20,000 25,000
UnIts scld
S
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0
Tola cosls
FIGURE 2: COMPANY A: CONTRIBUTION GRAPH
Breakeveh pohl
Tola revehue
Varabe cosls
C
o
h
l
r

b
u
l

o
h
A CONTRIBUTION GRAPH SHOWS THE DIFFERENCE
BETWEEN THE VARIABLE COST LINE AND THE TOTAL
COST LINE THAT REPRESENTS FIXED COSTS.
AN ADVANTAGE OF THIS IS THAT IT EMPHASISES
CONTRIBUTION AS IT IS REPRESENTED BY THE GAP
BETWEEN THE TOTAL REVENUE AND VARIABLE
COST LINES.
STUDENT ACCOUNTANT ISSUE 14/2010
04
Ths s hol a quck ehough
melhod lo use h ah exam so l s
hol recommehded.
MARGIN OF SAFETY
The margh o saely hdcales by how
much saes cah decrease beore a oss
occurs, e l s lhe excess o budgeled
revehues over breakeveh revehues.
Ushg Compahy A as ah exampe, el's
assume lhal budgeled saes are 20,000
uhls. The margh o saely cah be
ouhd, h uhls, as oows:
Budgeled saes breakeveh saes =
20,000 10,000 = 10,000 uhls.
Alerhalvey, as s oleh lhe case, l
may be cacualed as a percehlage:
Budgeled saes breakeveh saes/
budgeled saes.
lh Compahy A's case, l w be
10,000/20,000 x 100 = 50.
Fhay, l coud be cacualed h lerms
o S saes revehue as oows:
Budgeled saes breakeveh saes
x sehg prce = 10,000 x S50 =
S500,000.
CONTRIBUTION TO SALES RATIO
ll s oleh useu h shge producl
slualohs, ahd essehla h
mulproducl slualohs, lo ascerlah
how much each S sod acluay
cohlrbules lowards lhe xed cosls. Ths
cacualoh s khowh as lhe cohlrbuloh
lo saes or C/8 ralo. ll s ouhd h
shge producl slualohs by elher
smpy dvdhg lhe lola cohlrbuloh by
lhe lola saes revehue, or by dvdhg
lhe uhl cohlrbuloh margh (olherwse
khowh as cohlrbuloh per uhl) by lhe
sehg prce:
For Compahy A: S20/S50 = 0.4
lh mulproducl slualohs, a weghled
average C/8 ralo s cacualed by ushg
lhe ormua:
Tola cohlrbuloh/lola saes revehue
Ths weghled average C/8 ralo cah
lheh be used lo hd CVF hormaloh
such as breakeveh pohl, margh o
saely elc.
Example 2
As we as produchg producl x
descrbed above, Compahy A aso
beghs produchg producl y. The
oowhg hormaloh s avaabe or
bolh producls:
Prcduct x Prcduct y
8aes prce S50 S60
Varabe cosl S30 S45
Cohlrbuloh per uhl S20 S15
Budgeled saes
(uhls) 20,000 10,000
The weghled average C/8 ralo cah be
ohce agah cacualed by dvdhg lhe
lola expecled cohlrbuloh by lhe lola
expecled saes:
(20,000 x S20) - (10,000 x S15) /
(20,000 x S50) - (10,000 x S60) =
34.375
The C/8 ralo s useu h ls owh rghl
as l les us whal percehlage each S o
saes revehue cohlrbules lowards xed
cosls; l s aso hvauabe h hephg
us lo qucky cacuale lhe breakeveh
pohl h S saes revehue, or lhe saes
revehue requred lo geherale a largel
prol. The breakeveh pohl cah how be
cacualed lhs way or Compahy A:
Fxed cosls / cohlrbuloh lo saes ralo
= S200,000/0.34375 = S581,819 o
saes revehue.
To acheve a largel prol o S300,000:
Fxed cosls - requred prol /
cohlrbuloh lo saes ralo = S200,000
- S300,000/0.34375 = S1,454,546.
O course, such cacualohs provde
ohy eslmaled hormaloh because
lhey assume lhal producls x ahd y are
sod h a cohslahl mx o 2x lo 1y. lh
realy, lhs cohslahl mx s uhkey
lo exsl ahd, al lmes, more y may be
sod lhah x. 8uch chahges h lhe mx
lhroughoul a perod, eveh lhe overa
mx or lhe perod s 2:1, w ead lo lhe
aclua breakeveh pohl behg derehl
lhah ahlcpaled. Ths pohl s louched
upoh agah aler h lhs arlce.
CONTRIBUTION TO SALES RATIO IS OFTEN USEFUL
IN SINGLE PRODUCT SITUATIONS, AND ESSENTIAL
IN MULTI-PRODUCT SITUATIONS, TO ASCERTAIN
HOW MUCH EACH $ SOLD ACTUALLY CONTRIBUTES
TOWARDS THE FIXED COSTS.
05 TECHNICAL