Management Accounting - Cost Volume Profit Analysis

Tuesday, 22 May 2012

Classification by Cost Behaviour • How cost change with respect to changes in activity levels • Cost associated with an activity are those caused by the activity. One of the factor causing this is known as cost driver • Underlying cost behaviours are assumed to be in a liner relationship, that is, total cost will change at a constant rate • Fixed Cost: ○ Total cost that is constant as level of cost driver varies ○ When illustrating on a graph, fixed cost appears as a straight horizontal line along the graph • Variable Cost: ○ Total cost that vary in proportion to changes is the cost driver ○ Total Variable Cost = Variable Cost per unit x Number of units ○ Illustrating this graphically, the line will continue to increase as the number of units increases • Mixed Cost: ○ Cost that has both a fixed and variable component ○ Example: Utilities Bill (Electricity, water etc.) ○ Total Cost = FC + VC*x Issues Addressed by Cost-Volume-Profit Analysis • CVP Analysis focus on price, revenue, volume, cost, profit and sales mix • Questions on these areas can be answered through CVP analysis • Profit Before Tax = Sales Revenues - Variable Expenses - Fixed Expenses • Before answering questions, these assumptions must be applied: ○ Behaviour of cost and revenue linear over relevant range ○ Selling price are constant ○ Changes in activity levels affect cost ○ All units are sold ○ Sales mix remains constant for multi-product firms • Other than assumptions, CVP concepts must be applied too: ○ Contribution Margin = Total Revenue - Total Variable Cost ○ Contribution Margin per unit = Unit Selling Price - Unit Variable Cost ○ Contribution Margin Ratio = Contribution Margin per unit/Unit Selling Price • An important CVP concept is the break-even analysis ○ This is the level of activity where TR = TC, that is, zero profit. This is known as the break-even point ○ At break-even point, the equation is 0 = S.x - V.x - F. Therefore, x = F/(S - V) ○ Graphically, the break even point is the intersection of total revenue and total cost. All points to the right is profit and all points to the left is loss • To verify the accuracy of the analysis, profit and loss statement can be used (Sales - Variable Cost = Contribution Margin - Fixed Cost)
Week 12 Page 1

VR/S • R = FC + PBT/Contribution Margin Ratio Week 12 Page 2 . set S as the percentage (decimal) • To solve a question that requires profit after tax.tax rate)PBT CVP Analysis for Multi-Product Firm • For the break-even point for a multi product firm.V)X .(Variable cost per unit x number of units) .Fixed Cost) CVP Analysis: Units-Sold Approach • Measures sales activity and answers questions in terms of units sold • This approach is used to identify the number of units sold to reach the break-even point (set profit as 0) • It can also identify the number units sold to reach a targeted profit (set profit as target) • PBT = (Selling Price per unit x Number of units) . variable cost is defined as a percentage of revenue • Variable Cost Ratio = Variable/Sales • P = R(SX) . this equation is used: PAT = (1 .F .used (Sales .Variable Cost = Contribution Margin .F X = (P + F)/(S .Fixed Cost • P = (S . the weighted average contribution margin per unit is needed CVP Analysis: Sales-Revenue Approach • Measures sales activity and answer questions in terms of revenue generated • Useful when units are difficult to identify in the information given • Sales Activity are defined as sales revenue.V = Contribution Margin per unit • To solve a question that requires a profit that is a percentage of sales revenue: ○ As sales revenue is SX.V) • S .

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