Introduction to CVP Analysis

ACT3110 – Accounting and Financial

Information
Content
Cost accounting and its importance
CVP Analysis:
Purpose and assumptions
Contribution Margin
BEP
Target profit and sales
Cost Accounting
Cost accounting is a process of recording, analyzing
and reporting all costs (both variable and fixed) of a
company related to the production of a product, to
assist a company's management in making better
financial decisions, introduce efficiencies and budget
accurately.
Cost Accounting
Objectives: Function:
 To determine cost Ascertain cost
 To control cost Control cost
 To reduce cost Aid management
 To provide decision Set selling prices
making information
Control inventory
 To determine selling
Measure efficiency
price
Disclose profitable and
non profitable activities
Cost Accounting
Advantages Disadvantages
 Ascertain cost  Lack of uniformity
 Measure & improve  Costly
efficiency  Ignores futuristic situation
 Identify unprofitable  Uses secondary data
activities  Only bring out the cost of
 Fixing price
goods
 Improve profitability
 Control inventory
 Cost control and reduction
 Identifies reasons for losses
Cost-Volume-Profit Analysis
What is:
 Analysis of the effects of different levels of activity on the
financial results of a business.
 Focus: sales volume ~ in the short-run, sales price, and the
cost of materials and labour, are usually known with a degree
of accuracy, but not sales volume.
 not usually so predictable
 profitability depends on it
Cost-Volume-Profit Analysis
Example:
Firm A trading product Z know the selling price in a particular
year is RM60 and its variable costs are approximately RM40.
 Contribution (SP – VC) per unit is RM20.
 Fixed costs of RM120,000 per annum (easily predicted)
 Qs: Will the firm make a profit in that year?
 No idea ~ do not know the sales volume for the year
 However, can predict sales volume needed to make a profit ~
CVP Analysis
CVP Analysis: Purposes
Make predictions such as:
• How many units to sell to break even?
• How much income increase if new machine is installed to
reduce labour costs?
• What is the change in income if selling prices decline and
sales volume increases?
• How will income change if we change the sales mix of our
products or services?
• What sales volume is needed to earn a target income and thus
profit?
CVP Analysis: Basic Assumptions
• Behavior of both costs and revenues is linear throughout
the relevant range of the activity index.
• All costs can be classified as either variable or fixed with
reasonable accuracy.
• Changes in activity are the only factors affecting costs.
• All units produced are sold.
• When more than one type of product is sold, the sales mix
will remain constant.
CVP Analysis: CVP Income Statement
 A statement for internal use.
 Classifies costs and expenses as fixed or variable.
 Reports contribution margin in the body of the statement.
 Contribution margin – amount of revenue remaining
after deducting variable costs.
 Reports the same net income as a traditional income
statement.

Contribution margin (CM):

Total Revenue (TR) – Total Variable Cost (TVC)
CVP Analysis: CVP Income Statement
Illustration:
D&D Electronics produces digital camcorder and a wide-
screen LCD monitor. Relevant data for the camcorders sold by
this firm in January 2021 are as follows:
 Selling price per unit of camcorder: RM500
 Variable cost per unit: RM300
 Total monthly fixed costs: RM150,000
 Units sold: 2,000

Total Cost (TC) =

Total Variable Cost (TVC) + Total Fixed Cost (TFC)
 CVP Analysis: CVP Income Statement
The CVP income statement for D&D Electronics therefore
would be reported as follows.

D&D Electronics
CVP Income Statement
For the month of January 2021
Total (RM)
Sales (2,000 camcorders @ RM500) 1,000,000
Variable costs (@ RM300) 600,000
Contribution margin 400,000
Fixed costs 150,000
Net income 250,000
CVP Analysis: CM per unit
 Contribution margin is available to cover fixed costs and to
contribute to income.
 Formula for contribution margin per unit and the
computation for D&D Electronics are:

Unit selling price – Unit variable price = CM/unit

RM500 - RM300 = RM200
 CVP Analysis: CVP Income Statement
The CVP income statement for D&D Electronics assuming a
zero net income:

D&D Electronics
CVP Income Statement
For the month of January 2021
Total (RM) Per unit
Sales (750 @ RM500) 375,000 RM500
Variable costs (@ RM300) 225,000 RM300
Contribution margin 150,000 200
Fixed costs 150,000
Net income 0
 CVP Analysis: CVP Income Statement
Assume D&D Electronics sold ONE more camcorder:

D&D Electronics
CVP Income Statement
For the month of January 2021
Total (RM) Per unit
Sales (751 @ RM500) 375,500 RM500
Variable costs (@ RM300) 225,300 RM300
Contribution margin 150,200 200
Fixed costs 150,000
Net income 200
CVP Analysis: Break-even Analysis
Process of finding the break-even point level of activity
at which total revenues equal total costs (both fixed and
variable).
BEP point @ TS = TC TC = TVC + TFC Net income = 0
 Can be computed or derived
 from a mathematical equation,
 by using contribution margin, or
 from a cost-volume profit (CVP) graph.
 Expressed either in sales units or in sales dollars.
CVP Analysis: Break-even Analysis
BEP using Mathematical Equation
 Total Sales (TS) = Total Cost (TC)
CVP Analysis: Break-even Analysis
BEP using Contribution Margin (CM)
 Contribution margin = Total Fixed Cost
BEP Analysis: Contribution Margin
When the BEP in units is desired, contribution margin per
unit [CM(unit)] is used in the following formula which
shows the computation for D&D Electronics.

D&D Electronics:
SP: RM500; VC: RM300; TFC: RM150,000
BEP Analysis: Contribution Margin
When the BEP in dollars is desired, contribution margin
ratio [CM(%)] is used in the following formula which
shows the computation for D&D Electronics.
 CVP Analysis: Break-even Analysis
BEP using Graph
Because this graph also
shows costs, volume,
and profits, it is referred
to as a cost-volume-
profit (CVP) graph.
BEP Analysis: Graphic Presentation
BEP Analysis: Exercise
Lombardi Company has a unit selling price of $400, variable costs
per unit of $240, and fixed costs of $180,000. Compute the break-
even point in units using (a) a mathematical equation and (b)
contribution margin per unit.
CVP Analysis: Target Net Income (Profit)
 To determine level of sales necessary to achieve a specified
income.
 Can be determined from each of the approaches used to
determine break-even sales/units:
► from a mathematical equation,
► by using contribution margin, or
► from a cost-volume profit (CVP) graph.
 Expressed either in sales units or in sales dollars.
CVP Analysis: Target Net Income (Profit)
TNI using Mathematical Equation
TS – TVC – TFC = NI
Required Sales – TVC – TFC = Target NI
Required Sales – TVC = TFC + Target NI
D&D Electronics:
SP: RM500; VC: RM300; TFC: RM150,000; Target NI:
RM120,000
CVP Analysis: Target Net Income (Profit)
TNI using Contribution Margin
BEP (Q) = TFC / CM(u)

Required Sales = [TFC + Target NI] / CM(u)

D&D Electronics:
SP: RM500; VC: RM300; TFC: RM150,000; Target NI:
RM120,000
CVP Analysis: Target Net Income (Profit)
TNI using Contribution Margin Ratio
BEP (Q) = TFC / CM(u)

Required Sales = [TFC + Target NI] / CM(u)

D&D Electronics:
SP: RM500; VC: RM300; TFC: RM150,000; Target NI:
RM120,000
Target Net Income: Exercise
Zootsuit Inc. makes travel bags that sell for $56 each. For the
coming year, management expects fixed costs to total $320,000
and variable costs to be $42 per unit. Compute the following:

(a) break-even point in dollars using the contribution margin

(CM) ratio; and

(b) the sales dollars required to earn net income of $410,000.

 Comprehensive
Target Net Income: Exercise
Mabo Company makes calculators that sell for $20 each. For the
coming year, management expects fixed costs to total $220,000 and
variable costs to be $9 per unit. Compute:
a) Break-even point in units using the mathematical equation.
b) Break-even point in dollars using the contribution margin
(CM) ratio.
c) Sales required in dollars to earn net income of $165,000.
 Comprehensive
CVP Analysis: Limitation
• Limited for Multi-Product Operations
Based on single product, difficult to apply to multiple products.

• Limited to assumptions
Does not reflects the reality in business.

• Limited to short-run analysis

Data can be approximate only for the short-run, things changes in
longer run.

• Approximation
Requires tremendous attention to detail but approximation at best.