ACC1100D ACCOUNTING KEY CONCEPTS / THEORY

Topic 11 Cost Volume Profit (CVP) Analysis

COST BEHAVIOUR AND COST – VOLUME – PROFIT ANALYSIS

What is a ‘fixed cost’?

A fixed cost does not respond to changes in the level of activity / output.

A fixed cost remains fixed in total ……….. Yet as output increases the fixed cost
per unit decreases.

What is a ‘variable cost’?

A variable cost changes in response to changes in the level of activity / output.

A variable cost will change (increase/decrease) in direct proportion to changes

(increase/decrease) in the level of activity / output. However, the variable cost
per unit of output remains constant (approximately).

What is the relevant range of activity?

This refers to levels of activity / output that the firm has experienced in the past.
For example, a firm may have output ranging between 25,000 → 30,000 units over
the past 10 years.

It is assumed that the relationship between output and costs within this range are
predictable as they have been experienced previously. However, predictions
outside this range may result in a different relationship between costs and output.

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What is the meaning of cost-volume-profit analysis?

CVP analysis relates to the study of the relationships between cost, volume and
profits.

CVP analysis is concerned with the change in profits in response to changes in

sales volumes, costs and prices

Helps answer the following questions:-

 How many units need to be sold, or services performed, to break even

(for example, earn zero profit)?

 What is the impact on profit of a change in the mix between fixed,

variable and mixed costs?

 How many units need to be sold, or services performed, to achieve a

particular level of profit?

 What is the impact on profit with an increase or decrease in costs?

What is ‘Break – Even’ point?

This is the point at which the total revenue earned is exactly equal to the total
expenses (variable and fixed) incurred ………… there is NO profit or loss.

What is the ‘contribution margin’?

The contribution margin, in total, is the total sales revenue minus the total variable
costs ……………….. TR - TVC

The contribution margin, per unit, is the unit selling price minus the unit variable
cost ……………….. SP - VC

EXAMPLE: Selling Price = $80 Variable Cost per Unit = $30

Total Fixed Costs = $50,000

Each unit sold delivers a Contribution Margin (C.M.) = $50 per unit ……….

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i.e. The Contribution Margin MUST firstly cover the FC, and after that Profit.

Therefore, if the entity sells 1,000 units x $50 (C.M.) = $50,000 = TFC

Meaning Break-Even point has been achieved at 1,000 units of output ……….

When they sell 1,001 units ………. Profit = $50

When they sell 1,002 units ………. Profit = $100 (i.e 2 x $50)

When they sell 1,100 units ………. Profit = $5,000

When they sell 2,000 units ………. Profit = $50,000 etc., etc.

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