COST & MANAGEMENT ACCOUNTING (CMA)

Cost-Volume-Profit Analysis: Contribution Margins,

Breakeven Point, Target Operating Income, Sensitivity
Analysis and Margin of Safety
COST & MANAGEMENT ACCOUNTING:
MARGINAL COSTING
COST & MANAGEMENT ACCOUNTING:
MARGINAL COST = INCREMENTAL COST (Increase in Production Cost of 1 Unit)
MARGINAL COST is measured by the TOTAL VARIABLE COST attributable to
1 Unit.

Example:
The total cost of producing 10 units and 11 units is 10,000 and 10,500
respectively.
The MARGINAL COST for 11th unit i.e. 1 unit is 500.
MARGINAL COST is the change in the TOTAL COST due to production of
1 Unit extra.
COST & MANAGEMENT ACCOUNTING:
MARGINAL COST = INCREMENTAL COST (Increase in Production Cost of 1 Unit)
COST & MANAGEMENT ACCOUNTING:
MARGINAL COSTING:
In Marginal Costing Products and Services are valued at VARIABLE COSTS only.
Marginal Costing does not take consideration of FIXED COSTS.

MARGINAL COSTING also known as DIRECT COSTING

DIFFERENTIAL and INCREMENTAL COST:

Differential Cost is difference between the Costs of two different
Production levels.
COST & MANAGEMENT ACCOUNTING:
MARGINAL COSTING:
Characteristics

1. All Elements of Cost are classified into FIXED and VARIABLE

2. Variable Cost is the Cost of Product aka Marginal Cost
3. Prices are determined with reference to MARGINAL COSTS and
CONTRIBUTION MARGIN.
4. PROFITABILITY of departments and products is determined with reference
to their CONTRIBUTION MARGIN.
5. Cost is ascertained on the basis of the nature of cost (Behaviour)
COST & MANAGEMENT ACCOUNTING:
DETERMINATION OF COST AND PROFIT UNDER MARGINAL COSTING:

All the VARIABLE COSTS are PRODUCT- SERVICES cost

All the FIXED COSTS are charged against CONTRIBUTION margin.

Contribution is the difference between SALES REVENUE and TOTAL VARIABLE COSTS

Contribution (C) = Sales Revenue (S) – Total Variable Cost (V)

COST & MANAGEMENT ACCOUNTING:
SALES
Less PRODUCT COST
Direct Material
Direct Labour
Direct Expenses
Variable Overheads
CONTRIBUTION
Less FIXED COSTS
Fixed Operational Costs
Fixed Non-Operational Costs
PROFIT
COST & MANAGEMENT ACCOUNTING:
Example:
Variable Cost = 50,000
Fixed Cost = 20,000
Selling Price = 80,000

Contribution = (Selling Price – Variable Cost)

= 80,000 – 50,000 = 30,000

Profit = Contribution – Fixed Cost

= 30,000 – 20,000 =10,000
COST & MANAGEMENT ACCOUNTING:
Example:
Contribution = (Selling Price – Variable Cost)
= 80,000 – 50,000 = 30,000
Profit = Contribution – Fixed Cost
= 30,000 – 20,000 =10,000

Suppose the Fixed Cost is 40,000 then

Contribution – Fixed Cost = Profit or Loss
= 30,000 – 40,000 = (-)10,000
COST & MANAGEMENT ACCOUNTING:

S – VC =C
C= FC+P
MARGINAL COST EQUATION: S – VC = C=FC +P
S = Sales
VC = Variable Cost
FC = Fixed Cost
P = Profit
COST & MANAGEMENT ACCOUNTING:
Contribution Analysis

A When Contribution = 0
B When Contribution = - tive
C When Contribution = +tive = Fixed Cost
D When Contribution = +tive > Fixed Cost
E When Contribution = +tive < Fixed Cost
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

Inter- Relationship between COST – VOLUME and PROFIT

i.e. Effect of Sales Volume and Product Costs on Operating Profit of a business.

C-V-P Analysis helps in calculating the IMPACT of changes in VARIABLE COSTS,

FIXED COSTS, SELLING PRICE and the SALES MIX on the OPERATING PROFIT of
the BUSINESS.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
ABC Ltd. manufactures a product which is SOLD FOR 20 PER UNIT and has
VARIABLE COSTS OF 14 PER UNIT. FIXED COST per annum is estimated at
24,000.

Prepare Statements showing the total Profit/(loss) and Profit/(loss) per unit if
the Quantity sold is 3,000, 4,000 and 5,000units.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
INCOME STATEMENT
Sales Units 3,000 4,000 5,000
Selling Price/Unit 20 20 20
Sales Rev. 60,000 80,000 100,000
Variable Cost / Unit 14 14 14
Less - Variable Cost 42,000 56,000 70,000
Contribution /Unit (20-14 =6) (20-14=6) (20-14=6)
CONTRIBUTION 18,000 24,000 30,000
Fixed Cost /Unit 8 6 4.80
Less - Fixed Cost 24,000 24,000 24,000
PROFIT/LOSS (6,000) 0 6,000
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

Fixed Cost is CONSTANT in TOTAL but fluctuates on PER UNIT basis

CONTRIBUTION/Unit is CONSTANT at all SALES LEVEL.
CONTRIBUTION in TOTAL INCREASES with increase in SALES
CONTRIBUTION increases by 6,000 when SALES increases from 4,000 to 5,000
ADDITIONAL CONTRIBUTION per unit is equal to the EXTRA PROFIT per unit.
BREAK EVEN POINT = CONTRIBUTION = FIXED COST
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS
PROFIT VOLUME RATIO = P/V Ratio
= (Contribution per unit / Selling Price per unit) x 100
= 6 / 20
= .30 or
= 30%
= (Change in Contribution / Change in Sales ) x 100

What inferences can be drawn from PROFIT / VOLUME RATIO?

COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

Which is the MOST IMPORTANT factor influencing the Earning of PROFIT?

The MOST IMPORTANT factor influencing the earning of profit is the

LEVEL OF PRODUCTION.

COST VOLUME PROFIT analysis examines the relationship of COST and PROFIT
to the VOLUME of business to MAXIMIZE PROFIT
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

Where Business Activity is EXPANDING

Higher the PROFIT - VOLUME ratio the HIGHER is the rate at
which additional profits can be earned.

Where Business Activity is DECLINING

Higher PROFIT – VOLUME ratio means that the PROFITS will fall
at greater rate per unit of lost sales
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS
PROFIT – VOLUME ratio reflects
Relationship between Contribution and Sales Value.
Profitability of Business.
Percentage of gross margin to Sales.
Determination of Variable cost.
Determination of Break-even-point
Level of Output required to earn the desired profit
Deciding profitable sales mix.
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS
PROFIT – VOLUME ratio reflects
Profit Volume ratio for different activity level allows to take decision as to
continue which LINE OF ACTIVITY to generate profit .
Profit Volume ratio helps in establishing OVERALL PRODUCT MIX to have
overall profitability of the firm.
Improving Profit Volume Ratio :
By reducing the VARIABLE COST.
By increasing the SELLING PRICE.
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

A HIGHER Profit Volume ratio implies that the rate of growth of CONTRIBUTION
is faster than that of SALES.

IMPLICATION
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS

A HIGHER Profit Volume ratio implies that the rate of growth

of CONTRIBUTION is faster than that of SALES.

IMPLICATION

After Breakeven point is reached profits grows at a FASTER RATE in

comparison to a product with a lesser Contribution to Sales ratio.
COST & MANAGEMENT ACCOUNTING:
COST-VOLUME-PROFIT (CVP) ANALYSIS
Inter- Relationship between COST – VOLUME and PROFIT
CVP Analysis is extremely useful in BUDGETING and PROFIT PLANNING.

CVP Analysis helps in estimating IMPACT on PROFIT with

Changes in SELLING PRICES
Changes in VOLUME OF SALES
Changes in VARIABLE COST
Changes in FIXED COST
COST & MANAGEMENT ACCOUNTING:
BREAK EVEN ANALYSIS
CONTRIBUTION = Recovery of FIXED COSTS and the making of PROFITS.
CONTRIBUTION = FIXED COST + Desire PROFIT

By knowing how much Contribution is generated from each unit sold One can
Calculate the number of units to be sold to BREAK EVEN.

BREAK EVEN POINT = TOTAL FIXED COST / PV RATIO

= TOTAL FIXED COST / (Contribution/Sales) x 100
= TOTAL FIXED COST x SALES / CONTRIBUTION x 100
COST & MANAGEMENT ACCOUNTING:
BREAK EVEN POINT (CASH)
CASH BREAK-EVEN POINT is calculated only with fixed costs which are
PAYABLE IN CASH.

BREAK EVEN POINT (CASH) = CASH FIXED COST / CONTRIBUTION per Unit
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
ABC Ltd. manufacturing a single product, incurring VARIABLE COSTS of 300 per
unit and FIXED COSTS of 2,00,000 per month.
Find the BEP if the product sells for 500 per unit.
Break- Even Point (in Units) = Fixed Costs/Contribution per unit
= 2,00,000 / 200
= 1,000 units

Break- Even Points (in Value) = Total fixed cost × Sales / Contribution
Break- Even Point (in Value) = Total fixed cost / P / V Ratio
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
MNP Ltd sold 2,75,000 units at 37.50 per unit.
Variable costs are17.50 per unit (Manufacturing costs of 14 and Selling cost 3.50 per unit).
Fixed Costs are 35,00,000 (including depreciation of 15,00,000).

Calculate Break Even Sales level (QUANTITY) and

Cash Break Even Sales level (QUANTITY)
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Break Even Sales (Quantity) = Fixed Cost / Contribution per unit
= 35,00,000 / 20
= 1,75,000 units

Cash Break-Even Sales (Quantity) = Cash Fixed Cost /Contribution per unit
= 20,00,000 / 20
=1,00,000 units.
COST & MANAGEMENT ACCOUNTING:
S = VC + FC+ P
S – VC = FC + P
S – VC = C
C=F+P
By dividing both sides of the equation by Sales

C/S = (F + P) / S
S = (F + P) / C/S
COST & MANAGEMENT ACCOUNTING: CHARTS
COST & MANAGEMENT ACCOUNTING: CHARTS
COST & MANAGEMENT ACCOUNTING: CHARTS
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Fixed Cost is 50,000
Variable Cost per unit is 20
Selling Price per unit is 30
Sales is 8,000 units.

Calculate the Sales Revenue and Sales Units at which the Company will:
(a) A Break-Even Point
(b) Earn a Profit of 20,000
(c) Incur a Loss of 10,000
COST & MANAGEMENT ACCOUNTING:
Sales at B/E = FC / P/V ratio
Contribution =Sales – Variable Cost = 30 - 20=10
Fixed Cost = 50,000 P/V Ratio= 10/30 x 100 =33.3%
Break Even = 50,000/33.3%
= Rs.150,150
Break Even Sale = Fixed Cost / Contribution per unit
= 50,000/ 10
= 5,000 units
Sales to earn Profit of 20,000: S = F + P / P/V Ratio
S = (50,000 + 20,000) /33.3% = 210,021
COST & MANAGEMENT ACCOUNTING:
Sales Units at 20,000 Profit
Q = (F + P)/Contribution per unit
Q = (50,000 + 20,000) / 10 = 7,000 units
Sales at 10,000 Loss
S = (F + P)/ P/V Ratio
S = (50,000 – 10,000) / 33.3% = 20,000
Sales Units at 10,000 Loss
Q = (F + P)/Contribution per unit
Q = (50,000 – 10,000) / 10 = 4,000 units
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Given the following particulars
i. Fixed Cost 1,50,000
ii. Variable Cost 15 per unit
iii. Selling Price is 30 per unit

CALCULATE:
(a) Break-Even Point 10,000 units
(b) Sales to Earn a profit of 20,000 3,40,000
COST & MANAGEMENT ACCOUNTING:
MARGIN OF SAFETY:
Represents difference between TOTAL SALES and SALES at BEP.
Expressed as % of Sales or Value
Margin of safety reflects BUSINESS STRENGTH.

MARGIN OF SAFETY = PROFIT / P-V Ratio

Small Margin of Safety

Large Margin of Safety
COST & MANAGEMENT ACCOUNTING:
MARGIN OF SAFETY:
COST & MANAGEMENT ACCOUNTING:
MARGIN OF SAFETY:

Small Margin of Safety means Firm is having

High Fixed Expenses.
Slight variation in sales will have SIGNIFICANT IMPACT on profitability.

Large Margin of Safety means Firm is having

Reasonable level of Fixed Expenses.
Variation in Sales will have NO SIGNIFICANT IMPACT on profitability.
COST & MANAGEMENT ACCOUNTING:
MEASURES FOR IMPROVING MARGIN OF SAFETY:

Reduction in Fixed Costs.

Increase in Selling Price where demand is Inelastic.
Reduction in Variable Costs
Increase in Sales Volume where capacity exists.
COST & MANAGEMENT ACCOUNTING:

BEP
FIXED COST
CONTRIBUTION
MARGIN OF SAFETY
FINACIAL CONDITION
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
KK Ltd. has Sales of 600,000 (40,000 @ 15 per unit.
The Variable Cost per unit is 10 and the Fixed Costs are 150,000.

Calculate the Margin of Safety expressed in terms of:

Sales (Units)
Sales Value
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Contribution per unit: (SP – VC) = 15 - 10 = 5
BE Sales (Units) = Fixed Cost / Contribution per unit
BE Sales (Units) = 150,000 / 5 = 30,000 units
Break-Even Sales (Value) = 30,000 x 15 = 450,000
The Margin of Safety = Total Sales – BE Sales
Margin of Safety (Units) = 40,000 units – 30,000 units = 10,000 units
Margin of Safety (Value) = Total Sales – Break Even Sales
= 600,000 – 4,50,000
= 150,000.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
A Company earned a profit of 30,000 during the year.
If the Marginal Cost and Selling Price of the product are 8 and 10 per unit
FIND Margin of Safety.

Contribution = SP – VC = 10 – 8 = 2
Margin of Safety = Profit / P-V ratio
P-V ratio = (C/S)x 100 = (2/10)x100 = 20%
Margin Of Safety = 30,000 / 20% = 1,50,000
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
A Ltd. Maintains Margin of Safety of 37.5% with an overall Profit Volume ratio
of 40%. Its Fixed Costs amount to 5,00,000.

CALCULATE the following:

Break-Even Sales
Total sales
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Profit Volume ratio = 40%
BES = Fixed Cost / P-V ratio
= 5,00,000/40%
= 12,50,000
Total Sales = BES + Margin of Safety
=12,50,000 + 37.5% of Total Sales
Total Sale – 37.5% of Total Sales = 12,50,000
1S – .375S = 12,50,000
.625S = 12,50,000 or S= 20,00,000
COST & MANAGEMENT ACCOUNTING:
IMPORTANT FORMULAS:
COST & MANAGEMENT ACCOUNTING:
IMPORTANT FORMULAS:
COST & MANAGEMENT ACCOUNTING:
IMPORTANT FORMULAS:
COST & MANAGEMENT ACCOUNTING:
EXAMPLE: Comment “P/V will INCREASE or P/V will DECREASE or P/V will NOT CHANGE”
fort he following independent situations:
(i) An increase in the Sales Volume
(ii) An increase in the Fixed Cost
(iii) A decrease in the Variable Cost per unit
(iv) A decrease in the Contribution Margin
(v) An increase in Selling Price per unit
(vi) A decrease in the Fixed Cost
(vii) A 10% increase in both Selling Price and Variable cost per unit
(viii) A 10% increase in the Selling Price per unit and 10% decrease in the Sales
volume
COST & MANAGEMENT ACCOUNTING:
COST & MANAGEMENT ACCOUNTING: Angle of Incidence shows the
ANGLE OF INCIDENCE: RATE AT WHICH PROFIT IS
EARNED once the BREAK EVEN
POINT is reached.

The WIDER the angle the greater

is the rate of earning
profits.

A large angle of incidence with a

high margin of safety indicates
extremely favourable position.
COST & MANAGEMENT ACCOUNTING:
ANGLE OF INCIDENCE:
The angle of incidence is a measure of the PERCENTAGE INCREASE IN SALES
needed to offset a given PERCENTAGE DECREASE IN CONTRIBUTION MARGIN.

It helps assess the IMPACT OF COST AND PRICE CHANGES on PROFITABILITY.

ANGLE OF INCIDENCE = (Percentage Decrease in Contribution Margin) /

(Percentage Increase in Sales) x 100
COST & MANAGEMENT ACCOUNTING:
ANGLE OF INCIDENCE:
Example: If a company faces a 20% decrease in contribution margin, and it
wants to know how much sales must increase to offset this, the angle of
incidence is calculated as follows:

Angle of Incidence = (20% / X%) x 100 =

COST & MANAGEMENT ACCOUNTING:
Representation of Break Even Point , Margin of Safety and Angle of
Incidence under different Conditions:

Fixed Cost are…

Rate of Profit Earning is …
Margin of Safety is ….
Business is financially ….
COST & MANAGEMENT ACCOUNTING:
Representation of Break Even Point , Margin of Safety and Angle of
Incidence under different Conditions:

Fixed Cost are…

Rate of Profit Earning is …
Margin of Safety is ….
Business is financially ….
COST & MANAGEMENT ACCOUNTING:
Conclusion from Break Even Charts :

BEP location specifies MAGNITUDE of Fixed Cost.

BEP location specifies MARGIN OF SAFETY.
Magnitude of Angle of Incidence depends on magnitude of variable cost
hence variable cost must be controlled to maintain the profit earning rate.
Location of BEP and Angle of Incidence specifies stability of Business.
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Direct Materials 2,05,000
Direct Labour 75,000
Fixed Overheads 60,000
Variable Overheads 1,00,000
Sales 5,00,000
Calculate BEP? What will be the effect on BEP if Fixed Costs and Variable Costs increases
by 10%?
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
Calculate BEP? What will be the effect on BEP if Fixed Costs and Variable Costs increases
by 10%? Period I Period II
Sales 45,000 50,000
Total Cost 40,000 43,000
Find P/V ratio, Fixed Expenses , BE Sales and Margin of Safety
COST & MANAGEMENT ACCOUNTING:
Period I Period II
Sales 45,000 50,000 5,000
Total Cost 40,000 43,000 3,000
Profit 5,000 7,000 2,000
P / V ratio = Change in Profit / Change in Sales x 100
= 2,000 / 5,000 x 100 = 40%
Total Sales = Period I + Period II
= 45,000 + 50,000= = 95,000
P / V ratio = Contribution / Sales x 100
Contribution = Sales x P/V ratio
= 95,000 x 40% = 38,000
COST & MANAGEMENT ACCOUNTING:
Contribution = Sales x P/V ratio
= 95,000 x 40% = 38,000
Sales – Variable Cost = Contribution = Fixed Costs + Profit
Contribution = Fixed Cost + Profit
38,000 = Fixed Cost + 12,000

Fixed Cost = 38,000 – 12,000 = = 26,000

Break Even Sales = Fixed Cost / P/V ratio
= 26,000 / 40% = 65,000
Margin of Safety = Total Sales – Sale at BEP
= 95,000 – 65,000 = 30,000
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
The Profit Volume ratio of a Firm is 40% and its Margin of Safety is 50%.
Find out the Profit and Break Even point if Sales volume is Rs.8,00,000?
COST & MANAGEMENT ACCOUNTING:
EXAMPLE:
The Profit Volume ratio of a Firm is 40% and its Margin of Safety is 50%.
Find out the Profit and Break Even point if Sales volume is Rs.8,00,000?
Sales (Given) 8,00,000
Less Margin of Safety i.e. 50% given 4,00,000
Break Even Sales 4,00,000
BEP = Fixed Cost / P/V ratio or
Fixed Cost = BEP x P/V ratio
= 4,00,000 X 40% ( given )
= 1,60,000
COST & MANAGEMENT ACCOUNTING:

P/V ratio = Contribution / Sales x 100

Contribution = 8,00,000 x40%
= 3,20,000
Contribution at BEP = 4,00,000 x 40%
= 1,60,000
At BEP Contribution is = Fixed Cost 1,60,000
Profit at Sales of = 8,00,000 1,60,000
COST & MANAGEMENT ACCOUNTING:
EXAMPLE: (Validating the Answer))
Sales 8,00,000
Less Variable Cost ( balancing figure ) 4,80,000
Contribution 3,20,000
Less Fixed Cost 1,60,000
Profit 1,60,000
Profit Volume ratio= 3,20,000 x 100 / 8,00,000 = 40 % - given
Margin of Safety = 8,00,000 – 4,00,000 = 50% - given
COST & MANAGEMENT ACCOUNTING (CMA)