Management Accounting

FINC001
Break–Even Analysis and Cost-
Volume-Profit Analysis
Unit 11
Learning Objectives
• What is the break-even point (BEP) and why is it
important?
• How is the BEP determined and what methods are used
to determine BEP?
• What is cost-volume-profit (CVP) analysis and how do
companies use CVP information in decision making?
• How will margin of safety concepts used in business?
• How to analyze the techniques in management planning?
Absorption & Marginal Costing
Absorption costing also known a traditional costing
is the method in which the cost of the product is
determined by considering both fixed and variable
cost and therefore it is also known as full cost
method.

Whereas Marginal costing is a technique which

considers only the variable costs while computing
the cost of a product.
Cost-Volume-Profit Analysis
Cost-Volume Profit (CVP) analysis is the analysis of three
variable viz. cost, volume and profit. Cost-Volume Profit
(CVP) Analysis is examination of relationship between total
cost, total revenue, total volume and operating income
with a parallel change in the number of unit sold.
CVP analysis is a model to examine the behavior of net
profit in response to the change in total cost, total revenue
or both.
Cost-Volume-Profit Analysis
Applies to: Relationship of:
• Manufacturers • Revenue
• Wholesalers • Costs
Retailers • Volume changes
• Service industries • Profits
Variable Costing and CVP
• Variable Cost is the cost that varies with the
change in the level of activity and direct labour or
direct material are two examples of variable cost

• Variable costing
• Separates costs into fixed and variable components
• Shows fixed costs in lump-sum amounts, not on a per-
unit basis
• Does not allow for release of fixed costs from inventory
when production and sales volumes differ
Use CVP Analysis to…
• Calculate the level of sales • Compute the BEP
necessary to achieve a
• Study interrelationships of
target profit
• Prices
• Set sales price
• Volumes
• Answer “what-if” questions • Fixed and variable costs
to influence current
• Contribution margins
operations and predict
future operations • Profits
CVP Assumptions
a)Changes in the level of revenues and costs arise only because of changes in
the number of product (or service) units sold.

b)Total costs can be separated only into two components- Fixed and Variable.

c)The selling price, variable cost per unit, and fixed costs are known and
constant.

d)When represented graphically, the behavior of total revenues and total costs
are linear in relation to units sold within a relevant range and time period.

e)Either the product sold or the product mix remains constant, although the
volume changes.
Important Equations
Break-even point :
Total Revenues = Total Costs
Total Revenues – Total Costs = Zero Profit

Contribution Margin (CM) :

Sales Price – Variable Cost per unit = CM per unit
Revenue – Total Variable Costs = CM in total

Contribution Margin Ratio (CM%) or P/V Ratio =

Sales Price – Variable Cost
Sales Price
 Break-Even Formula—Units
Total Fixed Costs
Sales Price (per unit) – Variable Cost (per unit)
Contribution
Margin

Rs.100,000
Rs.12 – Rs.4 = 12,500 units

If fixed costs are Rs.100,000, unit sales price is Rs.12, and

unit variable cost is Rs. 4, the BEP is 12,500 units.
 Break-Even Formula—Rupees
Total Fixed Costs
Sales Price (per unit) – Variable Cost (per unit)
Sales Price (per unit)

Rs.100,000 Contribution
Margin
Rs.12 – Rs.4 = Rs.150,000 Ratio
Rs.12

If fixed costs are Rs.100,000, unit sales price is Rs.12, and

unit variable cost is Rs.4, the BEP is Rs.150,000.
Income Statement Proof
Sales Rs. 150,000 (12,500 * 12)
Less Total variable costs (50,000) (12,500 * 4)
Contribution Margin Rs. 100,000
Less Total fixed costs (100,000)
Profit before taxes
-0-

If fixed costs are Rs.100,000, unit sales price is Rs.12, and

unit variable cost is Rs.4, the BEP is 12,500 units.
Using CVP Analysis
 Setting a target profit
𝑓 ⅈ 𝑥 ⅇⅆ cos 𝑡+𝑃𝑟 𝑜 𝑓 ⅈ 𝑡
 Enter before-tax profit in numerator
𝑐𝑜𝑛tr ⅈ 𝑏𝑢𝑡𝑖 𝑜𝑛𝑟𝑎𝑡𝑖𝑜

Rs.100,000 + Rs. 30,000

12 – 4 = Rs.195,000
12
If fixed costs are Rs.100,000, unit sales price is Rs.12,
unit variable cost is Rs.4, and the desired before-tax
profit is Rs.30,000, the required sales are Rs.195,000.
Using CVP Analysis
 Setting a target profit
 Convert after-tax profit to before-tax profit

Before-tax profit = After-tax profit

1 – tax rate

Rs.60,000 Rs.48,000
= 1 – 20%

At a 20% tax rate, an after-tax profit of Rs.48,000

equals a before-tax profit of Rs.60,000.
Using CVP Analysis
• Setting a target profit
• Convert after-tax profit to before-tax profit
• Enter before-tax profit in numerator

Rs.100,000 + Rs.60,000
Rs.12 – Rs.4 = Rs. 240,000
Rs.12

If fixed costs are Rs.100,000, unit sales price is Rs.12,

unit variable cost is Rs.4, and the desired after-tax
profit is Rs.48,000, the required sales are Rs.240,000.
Income Statement Proof
Sales Rs. 240,000 (20,000 * 12)
Less Total variable costs (80,000) (20,000 * 4)
Contribution Margin Rs. 160,000
Less Total fixed costs (100,000)
Profit before taxes Rs. 60,000
Income taxes (12,000) (60,000 * 20%)
Profit after taxes Rs. 48,000

If fixed costs are Rs.100,000, unit sales price is Rs.12,

unit variable cost is Rs.4, and the desired after-tax
profit is Rs.48,000, the required sales are Rs.240,000.
Using CVP Analysis
Set profit per unit

X = FC/(CMu - PuBT)

Profit
per Unit
Sales Before Tax
Volume Total Contribution
Fixed Margin per unit
Cost
Graphical Approach to Break-even

• Break-even chart illustrates

relationships among
• Revenue
• Volume
• Costs
 Traditional CVP Graph
Total Costs
Total Costs
Total Total
Variable Costs
Rs. Rs.
Fixed Costs

Activity Level Activity Level

Total Revenues Total Revenues

Total Costs Loss Total Costs

Total
Total
Rs.
Rs. Profit

Activity Level Activity Level

 Profit-Volume Graph
Rs.

BEP

Activity Level

Fixed Costs

Loss Profit
Income Statement Approach
B/E Target Profit
Sales Rs. 150,000 Rs. 240,000
LessTotal variable costs (50,000) (80,000)
Contribution Margin Rs. 100,000 Rs. 160,000
LessTotal fixed costs (100,000) (100,000)
Profit before taxes -0- 60,000
Income taxes (24,000)
Profit after taxes Rs. 36,000

Proof of CVP and/or

graph solutions
Profit Planning
• For any organization their ultimate goal is to earn profit.
• Profit planning is possible only when the manager has full idea of
different type of cost and the estimated selling price and its
units.
• Some of the common factors effecting profit are us under –
1. Sales Volume
2. Selling price
3. Fixed and variable cost
4. Sales mix
• BEP increases when
• Fixed costs increase
• Sales price decreases
• Variable costs increase
CVP Analysis- A Tool for
Profit Planning
CVP analysis may help profit maximization in following
ways:
1. It helps in forecasting the profit.
2. It is important for budget preparation.
3. It helps in performance evaluation.
4. It assists in finding the overhead cost at different
level of operations
5. It helps in coming up with optimum pricing of a
product.
Important Equations
Margin of Safety

In break-even analysis, the term margin of safety

indicates the amount of sales that are above the break-
even point. In other words, the margin of safety
indicates the amount by which a company's sales could
decrease before the company will have no profit.
 Margin of Safety
• How far the company is operating from its BEP.
• Budgeted (or actual) sales after the BEP.
• The amount that sales can drop before reaching the BEP.
• Measure of the amount of “cushion” against losses.
• Indication of risk.
• The lower the margin of safety, the more carefully
management must watch sales and control costs.
Margin of Safety- Formula
• Units:
Actual units — break-even units
• Rupees:
Actual sales rupees — break-even sales rupees
• Percentage:
Margin of Safety in units or Rupees
Actual unit sales or Rupee sales
Break-even Sales and Margin
of Safety
Actual sales 200,000 units
Break-even sales 90,000 units
Contribution margin Rs. 408,000
Profit before tax Rs. 224,400

Margin of Safety % = Actual sales – Break-even sales

Actual sales

= 200,000 – 90,000 = 55%

200,000