CVP analysis- Cost accounting

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CVP analysis- Cost accounting

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ANALYSIS

IIM LUCKNOW

COST-VOLUME-PROFIT ANALYSIS

behaviour of costs and helps analyse its impact on

profit planning;

on profit;

Sales Price

Cost (Fixed and Variable component)

Volume of Sales

Sales-mix (proportion of different products in the total sales of

the company)

BEHAVIOR OF COSTS

The behavior can be explained with a mathematical

expression describing how costs change with changes in

the level of an activity.

Based on behaviour, the costs can be classified as:

Fixed Costs

Variable Costs

Mixed Costs

&

BREAK-EVEN ANALYSIS

output at which the company recovers all its costs (fixed

as well as variable costs);

Point (BEP); also referred to as Break-Even-SalesRevenue (BESR) when expressed in terms of sales value

(rupees).

to a situation wherein firm has no profit/ no loss.

COST-VOLUME-PROFIT GRAPH

DETERMINATION OF BREAK-EVEN-POINT (BEP)

RELEVANT RANGE

10,000

Total revenues

(TR)

Financial

Break-even

Point

8,000

Break-even

Point

6,000

Operating

profit

4,000

2,000

Interest

Total

Operating

Fixed Cost

Operating

loss

0

0

10

20

30

Units Sold

40

50

(SINGLE PRODUCT FIRM)

on their behaviour with volume of activity; i.e., Fixed and

Variable Costs;

AN EXAMPLE

SOLUTION

= 15000/10= 1500 units

Operating Break even Po int( BEP)

CMPU

= Sales Value (per unit)- Variable Cost (per unit)

Break even Sales Re venue ( BESR )

C / V Ratio

C/V ratio= Contribution/ Sales Value

Financial BEP

CMPU

Cash Break even Po int

CMPU

IMPORTANT TERMS

ratio;

Sales Value;

BREAK EVEN ANALYSIS

Margin of Safety;

variable cost, change in fixed costs, change in sales price,

etc.];

capacity utilization)

provided that the firm breaks even;

= (Actual Sales Break-even Sales) / Actual Sales;

For example,

Actual Sales = 15000 units; Break-even Sales= 10000

units;

Margin of Safety= (15000-10000)/ 15000 = 33.33%.

AN EXAMPLE

(i) Determine BEP (in units) and BESR.

(ii) Suppose that a plant expansion will add Rs. 60,000 to the fixed costs per quarter. How many

buckets are now needed to break-even?

(iii) After expansion, at what level of sales revenue the profitability of company will remain intact?

(iv) The co. feels that it should earn at least Rs. 36000 PBT on new expansion. Determine the

desired sales volume?

(v) Determine the Cash Break-even, given that Depreciation is Rs. 20,000.

SOLUTION

Total fixed Cost= 120000; Sales Price (per bucket)= Rs. 30; Variable

cost (per bucket) = 360000/20000 = Rs. 18;

CMPU = 30-18= Rs. 12 per bucket.

C/V ratio = 12/30 = Rs. 0.40 per rupee of sales;

BESR = 120000/0.4= Rs. 3,00,000

(2) Expansion;

New BEP = (Existing Fixed Costs + Fixed Cost of Expansion)/

CMPU

= (120000+60000)/12 = 15000 bucket.

(3) Current Profitability (based on sales) = 1,20,000/6,00,000 = 20%;

Desired Sales Volume (X units)

= [{12*(X-15,000) }]/30*X = 20%

= 30,000 units or Rs. 9,00,000

SOLUTION

(4) Desired Sales Volume to support additional PBT of Rs.

36,000;

DSV = (120000+60000+120000+36000)/ 12 = 28000

Buckets;

(5) Cash Break-even Point= Cash Operating Fixed Costs/

CMPU;

= (120000-20000)/12 = 10,000 BUCKETS

BREAK-EVEN ANALYSIS

FOR

MULTI-PRODUCT FIRM

The following data relates to a co. ABC. The co. manufactures two products,

viz., A & B. The following table contains data collected at the end of first quarter

of 2013.

Particulars

SALES

VARIABLE COST

CONTRIBUTION

FIXED COSTS

NET INCOME

P/V OR C/V RATIO

BREAK-EVEN SALES

SALES-MIX (%)

Products

A

2,00,000

1,20,000

80,000

B

1,20,000

80,000

40,000

0.625

0.375

Total

3,20,000

2,00,000

1,20,000

75,000

45,000

0.375

200000

How many units of each product A and B need to be sold in order to achieve

the Break-even, given the selling price of 25 and 15, respectively?

sold in order to achieve the Break-even, given the

selling price of Rs. 10, 15 and 5 respectively?

Overall Contribution = (20000+18000+16000)= 54000;

= (100000+60000+40000) = Rs. 200000;

Overall C/V ratio = 54000/200000 = 0.27 per rupee of sales

*The firm will be able to break-even only if the required total revenue comes from the three products

in the ratio 5:3:2. If we change the mix of products (sales mix), the break-even point will also

change. Therefore, it is borne out from the above that another assumption needed in the case of

multi-product firms for determining BEP is that the sales mix is assumed to be constant.

Revenue to be generated from Product X = 100000*.5= Rs. 50000

Likewise, the revenue to be generated from the other two products will be Rs. 30000 and

20000 respectively. Based on the sales price per unit, we can determine the no. of units of each

product required to break the even.

Product X =50000/10 = 5000 units

Y = 30000/15 = 2000 units

Z = 20000/5 = 4000 units

Given their current product mix, the company needs to sell 5000, 2000 and 4000 units of

products X, Y and Z respectively to achieve the Break-even.

RESOURCES

RESOURCES

Required:

(1) Assume that Raw material is a constrained resource, max. availability of which is 16000 Kgs.

Besides, maximum sales potential of each product is 5000 units. Advise the optimal product

mix to maximize profit given fixed costs of Rs. 300000.

(2)

In question no. 2, suppose that total sale potential of the firm is limited to 6000 units (both

products taken together) instead of the individual sales potential of the products (earlier fixed

at 5000 each). Determine the optimal product mix.

SOLUTION

potential or production (due to constrained availability of

key inputs) or sometimes both, contribution per unit of

limiting factor/ constrained resource becomes criteria for

choosing product mix to maximize profits to the firm.

SOLUTION

(1) Max. Material available= 16000 Kg.

Max. Sales Potential of each product = 5000 units;

Since material is a constrained resource, the criteria

need to be used will be contribution per kg of material

(in general, contr. Per unit of constrained resource).

(of each product) that can be sold.

of that product which has higher contribution per Kg. of

material. And, in case there is still some material left that

will be used to produce other product.

Product X=110/2 = Rs. 55/ Kg.

Product Y= 138/3 = Rs. 46/ Kg.

Therefore, we will produce maximum units of product A (but

not more than 5000 to satisfy the other constraint), given its

higher contribution of per unit of constrained resource.

Raw material. It becomes a feasible solution given total material

available, i.e., 16000 Kg.

6000/ 3 = 2000 units.

Therefore, the optimal mix that will maximize the profit will be 5000

units of Product X and 2000 units of Product Y; given these

constraints.

= Rs. 5,26,000

solution which may or may not be optimal. TEHREFORE, IT IS

RECOMMENDED TO GO WITH LINEAR PROGRAMMING

METHOD TO DETRMINE THE OPTIMAL PRODUCT MIX.

Max (Profit)=110*X +138*Y 3,00,000

X= Units of Product X;

Y=Units of Product Y

Subject to

X+Y<=6000

2X+3Y<=16000

optimal product mix.

GRAPHICAL SOLUTION

7000

6000

OPTIMAL SOLUTION

IT CAN BE ACHIEVED BY SOLVING THE TWO

CONTRAINTS, VIZ.,

2*X+3*Y = 16000

X+Y = 6000

PRODUCT Y

5000

4000

3000

2000

1000

0

0

1000

2000

3000

4000

5000

PRODUCT X

6000

SALES CONSTRAINT

7000

8000

9000

SOLUTION

solution area to get optimal results and you will get:

you higher profit.

FLEXIBLE BUDGETING

FLEXIBLE BUDGETING

remains unaffected by the level of activity actually achieved. Such

budgets are rarely used in practice.

invariably prepared in practice) are prepared for relevant range,

say, 50% - 90% of installed capacity.

levels of activities; say, at 50, 70, 90 per cent level of capacity

utilization.

Formula and Expense Control Budget.

FLEXIBLE BUDGET

in nature and cant be seen as static one.

activity and its impact on costs (and, therefore, on

profits).

activity, say, 15000-20000;

actually it slips to 16000 units; the manager can use

flexible budget at 16000 (level of activity) to measure the

performance more appropriately.

classify them as Variable, Fixed and Mixed.

normally production units are chosen;

each level of activity is associated with the

corresponding costs.

EXAMPLE

Solution

SOLUTION

CASE DISCUSSION

THROUGHPUT ACCOUNTING

Contribution used in marginal/ variable costing.

relating to product mix and control measures on Throughput instead

of Contribution.

Throughput doesnt accumulate by just producing Inventories.

determined:

Inventory

Operating Expenses: All the expenses, except material, required to make

the input a saleable output.

THROUGHPUT ACCOUNTING

setting managerial tasks in terms of throughput. For

example, a manager is required to generate throughput of,

say, Rs. 1000000 in a month.

simple producing doesnt generate throughput.

which have a high demand in the market. As generating

inventory is not going to benefit them in short-run.

ROI.

THROUGHPUT ACCOUNTING

A short-term approach;

piled up during production to cope up with the demand

for the rest of the period.

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