UNIT – 2

MGT - 321

Dr. Masharique Ahmad

Associate Professor
Department of Accounting & Finance
College Of Business And Economics
Samara University, Ethiopia

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 UNIT-2

Cost Volume Profit Analysis-I

• Cost Drivers,

• Variable & Fixed Cost Behaviour,

• Difficulties in Classifying Costs.

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 Cost Volume Profit Analysis

• Cost Volume Profit Analysis is the Combination of three words: Cost + Volume + Profit

• Generally, Break Even Analysis is another name of Cost Volume Profit Analysis

• The study of Cost volume profit relationship is frequently referred to as “Break Even

Analysis”.

• Cost Volume Profit Analysis is to measure the variations of cost with the changes in the

volume of Production.

• A Break Even Analysis/Cost Volume Profit Analysis refers to the point of activity where

total revenue is equal to the total cost.

Total Revenue = Total Cost

Total Revenues - Total Costs = Zero Profit

• The relationship among Volume of Production, Cost and Profit is called Cost Volume

Profit.

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CVP: It is the study of the effects of output volume on revenue (sales),
expenses (costs), and net income (net profit).

Definitions of Break Even Point:

According to Charles T. Harngren: The Break even point is that point of
activity (Sales Volumn) where total revenues and total expenses are equal,
it is the point of zero profit and zero loss.

C= S—V Calculation of Break Even Point:

P= C- F
Fixed Cost (F)
C= F + P BEP (in units) = ---------------------------
Contribution (C)

F+P=S–V
Fixed Cost (F)
BEP (in Rs.) = --------------------------- x Sales (S)
 Cost Drivers
Cost drivers Means : Output measures of resources and activities are
called cost drivers

It is too difficult for an accountant to identifying the most appropriate cost

drivers determines how well managers understand cost behavior and how
well costs are controlled.
Production Example

Example costs: Example cost drivers:

Labor wages Labor hours
Supervisory salaries No. of people supervised
Maintenance wages No. of mechanic hours
Depreciation No. of machine hours
Energy Kilowatt hours
 Cost Driver Analysis
• It is concerned with analyzing cost behavior in a manner supportive to
strategic choices)

• Understanding cost behavior requires identifying the cost drivers present in any
given situation
• Understanding cost behavior depends on understanding the complex interplay
among the relevant cost drivers in any given situation.
Level and Behavior of Costs
Total Cost

Output Volume

Conventional Approach to Cost Driver Analysis

 Cost Behavior
Variable and Fixed costs

What is Cost Behavior?

It is how costs are related to, and affected by, the activities of an organization.

Variable cost
A variable cost is a cost that changes in direct proportion to
changes in the cost driver.

Fixed cost

A fixed cost is not immediately affected by changes in the cost driver.

 Rules of Thumb
Fixed Cost

• Think of fixed costs as a total

•Total fixed costs remain unchanged regardless of changes in cost-driver activity.

Variable Cost

•Think of variable costs on a per-unit basis.

•The per-unit variable cost remains unchanged regardless of changes in the

cost-driver activity.

Note:
•This rule of thumb holds true only within reasonable limits.
•The relevant range is the limit of cost-driver activity within which a specific relationship between
costs and the cost driver is valid.
Cost Volume Profit Analysis-II
(a) Absorption Costing and Marginal Costing
(b) Break Even Point
(c) Margin of Safety.

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 Breakeven Point

Variable Fixed Expenses

Sales – expenses = + Profit OR C

Total revenues = Total costs

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Absorption costing
• It is costing system which treats all manufacturing costs
including both the fixed and variable costs as product costs.

Marginal Costing:
• It is a costing system which treats only the variable
manufacturing costs as product costs. The fixed
manufacturing overheads are regarded as period cost
 Assumptions of CVP Analysis
• Expenses can be classified as either variable or fixed.
• CVP relationships are linear over a wide range of production and sales.
• Sales prices, unit variable cost, and total fixed expenses will not vary within the
relevant range.
• Volume is the only cost driver.
• The relevant range of volume is specified.
• Inventory levels will be unchanged.
• The sales mix remains unchanged during the period.
 Use CVP Analysis to…
• Compute the break-even point
• Study interrelationships of
– prices
– volumes
– fixed and variable costs
– contribution margins
– profits

 Calculate the level of sales necessary to achieve a target

profit
 Set sales price
 Answer “what-if” questions to influence current operations
and predict future operations
 BREAK EVEN POINT
• Breakeven analysis is also known as cost-volume profit analysis
• Breakeven analysis is the study of the relationship between
selling prices, sales volumes, fixed costs, variable costs and
profits at various levels of activity
P=S–F-V P= PROFIT
 C= S—V F= FIXED COST
V=VARIABLE COST
P=C-F C=CONTRIBUTION
S= SALES
 P= C- F
F + P= S – V
C=F+P
CVP Graph
Total Revenues

BEP Total Costs

Total
$

Profit

Activity Level
Loss
Equations
Contribution Margin (CM)
Sales Price - Variable Cost = CM per unit
Revenue - Total Variable Costs = CM in total

Contribution Margin Ratio (CM%)

Sales Price – Variable Cost
Sales Price
 Case Exercise -1
Break-Even Formula = Units

Total Fixed Costs

Sales Price (per unit) - Variable Cost (per unit)

Contribution
Margin
$100,000
12 - 4 = 12,500 units
If fixed costs are $100,000, unit sales price is $12, and
unit variable cost is $4, the break-even point is 12,500 units
Break-Even Formula - Dollars
Total Fixed Costs
Sales Price (per unit) - Variable Cost (per unit)
Sales Price (per unit)

$100,000 Contribution
Margin
12 - 4 = $150,000 Ratio
12
If fixed costs are $100,000, unit sales price is $12, and
unit variable cost is $4, the break-even point is $150,000
 Calculation of Break Even Point:

BEP in units

Fixed Cost (F) F F

BEP (in units) = ------------------------ = --------------- -=------------------

Contribution (C) S–V F+P

BEP in RS.
Fixed Cost (F)
BEP (in Rs.) = --------------------------- x Sales (S)
Contribution (C)

F
BEP (in Rs.) = -------------------- x S
S–V

S–V F
Profit Volume Ratio (PVR) = -------------------- x 100 BEP = ---------------

S
PVR
 Marginal Profit and Loss Statement
Sales ………..units @ ………. (S) : ……………..

Less: Marginal Cost

…………units@ ……………….. (V) :……………….

Contribution (C=S-V) : ………………

Less: Fixed Cost : ………………

Profit /Loss : ………………

Q.1 : if
Sales 2000 Units @ $10 Fixed Cost : $ 4400
Variable Cost : 2000units @ $6

Find:
(a) Contribution (b) Profit (b) BEP in units (c) BEP in $
 Solution:
Sales : 2000 @ $ 10 = 20, 000
Variable Cost : 2000 @ $ 06 = 12,000
Contribution ( C) = 8,000
Fixed Cost = 4,400
Profit = 3,600
F 4400
BEP =------- = --------------= 1100 units
C 10-6

F 4400
BEP =-------x s = --------- x 10= 11000 $
C 10-6
 Example
• Selling price per unit $12
• Variable cost per unit $3
• Fixed costs $45000
• Required:
– Compute the breakeven point
 Solution
Breakeven point in units = Fixed costs
Contribution per unit
= $45000
$12-$3
= 5000 units

Sales revenue at breakeven point = $12 * 5000 = $60000

 Margin of safety
• Margin of safety is a measure of amount by which the sales
may decrease before a company suffers a loss.
• This can be expressed as a number of units or a percentage
of sales

Margin of safety
= Budget sales level – breakeven sales level

Margin of safety
= Margin of safety
-----------------------------x 100
Budget sales level
 Case Exercise
• The breakeven sales level is at 5000 units. The company sets
the target profit at $18000 and the budget sales level at 7000
units
Required:
Calculate the margin of safety in units and express it as a
percentage of the budgeted sales revenue
 Case Exercise -Solution
Margin of safety
= Budget sales level – breakeven sales level
= 7000 units – 5000 units
= 2000 units

Margin of safety
= Margin of safety *100 %
Budget sales level
= 2000 *100 %
7000
= 28.6%
The margin of safety indicates that the actual sales can fall by
2000 units or 28.6% from the budgeted level before losses are
incurred.
 Case Exercise

Margin of Safety
The margin of safety is the excess of projected (or actual) sales over the
break-even sales level. This tells managers the margin between current
sales and the break-even point. In a sense, margin of safety indicates the
risk of losing money that a company faces, that is, the amount by which
sales can fall before the company is in the loss area. The margin of safety
formula is:
Sales volume - Break even sales volume = Margin of safety

If U-Develop sells 8,000 prints and its break-even volume is 6,250, then its
margin of safety is;
Sales - Breakeven
8,000 - 6,250
1,750 prints
Case Study
Exercises
 [Case Study – Exercise -1, Question 1]

The Acme Company produces and sells one product. The

revenue and cost structure of the product is given below:
Particulars Amount in
S.R.
Selling Price Per Unit 10.00

Variable Cost Per Unit 6.00

Total Fixed Cost per year 1,00,000

COMPUTE THE BREAK EVEN VOLUME

IN UNITS AND RUPES
 ANSWER 1
C = S – V = 10 – 6 = 4
Fixed Expenses 1,00,000
B.E.P.in Units    25,000 units
C per unis 4

C 4
P.V .Ratio   100   100  40%
S 10
Fixed Expenses 1,00,000
B.E.P. in Amount    2,50,000
P / V Ratio 40%
 [Case Study – Exercise -2, Question 2 ]

Calculate break even point on the basis of the

following information supplied by a manufacturing
firm:
PARTICULARS AMOUNT IN
S.R.
ESTIMATED SALES 10,00,000

ESTIMATED VARIABLE COSTS 6,00,000

ESTIMATED FIXED COSTS 2,00,000

 Solution Case Exercise -2
C = S – V = 10,00,000 – 6,00,000 = 4,00,000

C 4,00,000
P.V .Ratio   100   100  40%
S 10,00,000
Fixed Expenses 2,00,000
B.E.P. in Amount    5,00,000
P / V Ratio 40%
 [Case Study – Exercise -3, Question – 3]
Following information are available about a company:
COST PER UNIT AMOUNT

RAW MATERIALS 25
LABOUR 10
VARIABLE OVERHEADS 5
SELLING PRICE 50

Fixed Overheads for the year amount to 20,000 S.R.. Sales and production was
of 10,000 units. You are to find:
i. Marginal Cost
ii. Contribution per unit
iii. Variable cost
iv. Total Contribution
v. Net Profit
 Solution Case Exercise -3

1. Marginal Cost= Mat + Labour +Variable

Overheads = 25+10+5 = 40
2. Contribution per unit = S – M.C. = 50 – 40
=10
3. Total Variable Cost = 40 x 10,000 = 4,00,000
4. Total Contribution = C x Units = 10 x 10,000
= 1,00,000
5. Net Profit = Total Contribution – Fixed
Overhead = 1,00,000 – 20,000 = 80,000
[Case Study – Exercise -4, Question – 4]
The Price structure of a cycle made by the Cycle Company Ltd. is as follows:
PARTICULARS AMOUNT

MATERIALS 60
LABOUR 20
VARIABLE 20
OVERHEADS
FIXED OVERHEADS 50
PROFIT 50
SELLING PRICE 200

This is based on the manufacture of 1,00,000 cycles per annum. This company
expects that due to competition they will have to reduce selling price4, but they
want tot keep the total profits intact. What level of production will have to be
reached, i.e. how many cycles will have to be manufactured to get the same
amount of profit, if:-
i. The selling price is reduced by 10%
ii. The selling price is reduced by 20%
 Solution Case Exercise - 4

Present Profit = 100000 x 50 = 50,00,000

Pr esent S .P. 200
90
New S .P. after 10% Re duction  200   180
100
80
New S ..P. after 20% Re duction  200  160
100

C  S  V  180  100  80
F  P 50,00,000  50,00,000 1,00,00,000
Re quired Sales to earn same amount of Pr ofit     1,25,000 cycles
C 80 80
C  S  V  160  100  60
1,00,00,000
cycles  1,66,667
60
 [Case Study – Exercise -5, Question – 5]
Given the following figures: PARTICULARS AMOUNT

FIXED COSTS 16,000

SELLING PRICE PER 8
UNIT
VARIABLE COST PER 5
UNIT

Show the impact of the following changes on break even point:

i. Fixed Cost increase by 5,000 S.R.
ii. Decrease in Fixed Costs by 4,000 S.R.
iii. 20% increase in variable cost
iv. Fixed Cost increase by 20% and variable costs decreased by 10%
 Solution Case Exercise - 5

F 16,000
Pr esent B. E. P. inUnits    5,333 units
C 3
Effect of increase in Fixed Costs by 5,000,
Now Total Fixed Expenses =
16,000+5,000 = 21,000
F 21,000
New B. E. P. inUnits    7,000 units
C 3

Effect of decrease in Fixed Cost by 4,000 ,

Now Fixed Expenses =16,000 - 4,000 =
F 12,000
New B. E. P. inUnits    4,000 units
12,000 C 3
 Contd. Solution Case
Exercise -5
Effect of increase in variable cost by 20%
V.C. = 5 + 1 = 6 , New C will be 8 – 6 = 2

F 16,000
New B. E. P. inUnits    8,000 units
C 2
[Case Study – Exercise -6, Question – 6]
The total cost and profits during two period were as follows:
PARTICULARS PERIOD –I PERIOD – II

AMOUNT AMOUNT

TOTAL COST 4,00,000 6,50,000

PROFIT 50,000 1,00,000

Calculate:
i. P/V Ratio
ii. Break Even Sales
iii. Sales required to earn a profit of 1,25,000 S.R.
iv. Profit earned when sales are 3,50,000 S.R.
 Solution Case Exercise - 6

Change in Pr ofit 50000

P / V Ratio   100   100  20%
Change in Sales 250000

Fixed Expenses  Sales  P / V Ratio  Pr ofit  5,00,000  20%  50000  50,000

F 50000
B.E.P.Sale    2,50,000
P / V Ratio 20%

Fixed Expenses  Desired Pr ofit 50,000  1,25,000

Sales to earn a Pr ofit 1,25,000    8,75,000
P / V Ratio 20%

Pr ofit when Sales are 3,50,000 

Pr ofit  ( Sales P / VRatio )  Fixed Cost  3,50,000  20%  50,000  20,000
[Case Study – Exercise -7, Question – 7]

XY Co. Sold in two successive years 7,000

and 9,000 units and incurred a loss of
10,000 S.R. and earned 10,000 as profit
respectively. The selling price per unit is
100 S.R.

Calculate (a) the amount of fixed costs, (b)

the number of units to break even, and (c)
the number of units to earn a profit of
50,000 S.R.
 Solution Case Exercise -
7
Change in Pr ofit 20,000
P / V Ratio   100   100  10%
Change in Sales 2,00,000
The amount of Fixed Cost:
Contribution of First Year 10% of 7,00,000 = 70,000 + Loss during the
year 10,000 = 80,000

Fixed Cost 80,000

B.E.P.    8,00,000
P / V Ratio 10%

Total Sales 8,00,000

B.E.P. in Units    8,000 units
S .P. per unit 100
 Contd.
Fixed Cost  Desired Pr ofit 80,000  50,000
Re quired Sales    13,00,000
P / V Ratio 10%

Total Sales 13,00,000

B.E.P. in Units    13,000 units
S .P. per unit 100
[Case Study – Exercise -8, Question – 8]

Fixed Expenses = 20,000, Variable Cost per

unit 10, Selling Price Unit = 20, Calculate
profit when sales will be 2,00,000.
Solution Case Exercise -8
C 10
P / V Ratio   100   100  50%
S 20
50
Pr ofit  ( Sales  P / VRatio )  Fixed Expenses  2,00,000   20,000  80,000
100
 [Case Study – Exercise -9, Question 9]

Given:
P/V Ratio = 30%, Total Turnover = 50,000
S.R.
Find out Contribution

Solution Case Exercise 30

-9
Contributi on  Sales  P / V Ratio  50,000   15,000
100
Case Study – Exercise -10, Question10

Fixed Expenses = 20,000, Variable Cost

per unit 10, Selling Price Unit = 20,
Calculate the required sales if profit target
of Rs. 60,000 has been budgeted.
Solution Case Exercise - Answer 10

C  S  V  20  10  10
F  P 20,000  60,00,000
Re quired Sales to earn 60,000 amount of Pr ofit   
C 10
80,000
 8000 units
10

C  S  V  20  10  10
P / V Ratio  C / S X 100  10 / 20 X 100  50%
FP 20,000  60,00,000
Re quired Sales to earn 60000 amount of Pr ofit   
P / V Ratio 50%
80,000
X 100  1,60,000
50

Dr Masharique Ahmad