Course Name Cost Accounting

Lecturer Name Dr. Mohamed Ahmed Saleh

 Chapter 2

Cost-Volume-Profit
Analysis

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 Cost-Volume-Profit (CVP) Analysis

Cost- Volume- Profit Analysis

Foundational Assumptions in (CVP):
• Changes in production/sales volume are the sole cause for cost and
revenue changes
• Total costs consist of fixed costs and variable costs
• Revenue and costs behave and can be graphed as a linear function (a
straight line)
• Selling price, variable cost per unit and fixed costs are all known and
constant
• In many cases only a single product will be analyzed. If multiple
products are studied, their relative sales proportions are known and
constant 3
• The time value of money (interest) is ignored.
Cost- Volume- Profit Analysis
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Basic Formulas
 Cost-Volume-Profit (CVP) Analysis

Cost- Volume- Profit Analysis

Managers trying to evaluate the effects of changes in volume of goods or
services produced might be interested in upward changes such as increased
sales expected from increases in promotion or advertising.

AND
Managers might be interested in downward changes such as decreased sales
expected due to a new competitor entering the market or due to a decline in
economic conditions.
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 Cost- Volume- Profit Analysis
Cost-Volume-Profit Graph

$150,000 A
Net Income
138,000 C
Sales
120,000
Net Income Area
Dollars

D
90,000
Variable
Total Break-Even Point Expenses
60,000 Expenses
Net Loss 60,000 units
30,000 or $90,000
B
Area
18,000
Fixed
0 10 20 30 40 50 60 70 80 90 100 Expenses
Units (thousands)
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 Cost- Volume- Profit Analysis
Key Terminology: Breakeven Analysis
Break even point: The point at which a company makes neither a
profit or a loss.

OR The level of sales at which revenue equals expenses and net

income is zero.

Sales
- Variable expenses
- Fixed expenses
Zero net income (break-even point) 7
 The Break-even point
occurs where total

Cost- Volume- Profit Analysis

Break-Even Chart revenue equals total
costs – the firm, in this
example would have to
Costs/Revenue TR TC sell Q1 to generate
sufficient revenue
(income) to cover its
total costs.
VC

BEP

FC

Q1 Output/Sales 8
Breakeven Formula

Cost- Volume- Profit Analysis

Contribution Per Unit. The sales price minus the variable cost per unit. It measures
the contribution made by each item of output to the fixed costs and profit of the 9
organisation
 Cost- Volume- Profit Analysis
Contribution Margin, continued
• Contribution Margin also equals contribution margin per unit
multiplied by the number of units sold (Q)
CM = CMu x Q

• Contribution Margin Ratio (percentage) equals contribution margin

per unit divided by Selling Price
CMR = CMu ÷ SP
= (s.p/u – v.c/ u) ÷ s.p/u

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Basic Formula Derivations
The Basic Formula may be further rearranged and decomposed as
follows:
Sales – VC – FC = Operating Income (OI)
Where:

(SPu x Q) – (VCu x Q) – FC = OI
Q (SPu – VCu) – FC = OI
Q (CMu) – FC = OI

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Break Even formula
• Recall the last equation in an earlier slide:
Q (CMu) – FC = OI
• A simple manipulation of this formula, and setting OI to zero will
result in the Breakeven Point (quantity):
BEQ = FC ÷ CMu
• At this point, a firm has no profit or loss at the given sales level
• If per-unit values are not available, the Breakeven Point may be
restated in its alternate format: 12
BE Sales = FC ÷ CMR
 Margin of Safety

Cost- Volume- Profit Analysis

• The difference between budgeted or actual sales and
the breakeven point.

• The margin of safety may be expressed in units or

revenue terms.

• Shows the amount by which sales can drop before a

loss will be incurred. 13
 Cost- Volume- Profit Analysis
Example (1):

Using the following data, calculate the breakeven point

and margin of safety in units:
Selling Price = €50

Variable Cost = €40

Fixed Cost = €70,000

Budgeted Sales = 7,500 units 14

 Cost- Volume- Profit Analysis
Solution:

Contribution margin (u) = €50 - €40 = €10 per unit

Breakeven point = €70,000/€10 = 7,000 units

Breakeven point in value= 7,000 units * s.p/u 50 = € 350000

Margin of safety = 7500 – 7000 = 500 units

Magin of safety in value= (7500 * 50) – 350000 =

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 Profit Planning

Cost- Volume- Profit Analysis

• What if a firm doesn’t just want to breakeven – it
requires a target profit

• Contribution per unit will need to cover profit as well

as fixed costs

• Required profit is treated as an addition to Fixed Costs

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 Profit Planning

Cost- Volume- Profit Analysis

Example (2):

Using the following data, calculate the level of sales

required to generate a profit of €10,000:
Selling Price = €35
Variable Cost = €20

Fixed Costs = €50,000 17

 Profit Planning

Cost- Volume- Profit Analysis

Solution:

• Contribution = €35 – €20 = €15

• Level of sales required to generate profit of €10,000:

€50,000 + €10,000

€15
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=4000 units
Break even analysis rules
•

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 Break even analysis rules
•

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