CHAPTER 4:COST VOLUME PROFIT (CVP) ANALYSIS

CHAPTER 4:

COST VOLUME PROFIT (CVP) ANALYSIS

By sarimah ismail

THE NATURE OF CVP ANALYSIS

​COST VOLUME PROFIT ANALYSIS (CVP)

is one of the decision-making process and control tool use to examine the relationship changes in output and changes in total revenue, costs and profit. Output is one of the key factors that influences total revenue, total costs and profit.

The main aim of CVP analysis is to establish the effect on profit if there is any fluctuation in sales volume.

​

Component:

1. volume / level of activity

2. selling price

3. variable cost

4. fixed cost​

​

​The CVP analysis definition

CVP define as a systematic model defines "the relationship between changes of volume(output) with the changes of sales, expenses and profit"[ICMA]

​

CVP is a concept or tools in management accountng used by management level in order to derive the short-term decision making result.​

​The importance of CVP analysis

1. Establish the effect on profit if there is any fluctuation in sales volume

2. ​Help managers simplify the real world conditions to enable them provide information for better decision making

3. Provide useful information such as estimation on break-even point, target profit and sales.​

​The importance of CVP analysis

4. As a management tool for:

   a. planning

   b. setting prices

   c. determining the best product mix

   d. maximising the use of production facilities

   e. computing tget cost by subtracting target profit from competitive market price.

​limitations of CVP analysis

1. CVP is carried out on the assumption that variabale cost, sales price and sales mix are known and constant. In actual situation, a number of factors are beyond control such as the action of competitors, future uncertainty, technology changes & innovation and changes in the price of resources, which in turn will cause changes in variable cost, sale price and sale mix.

2. It is difficult to separate the cost as fixed and variable categories in CVP analysis, especialy for cost that has both fixed and variable cost characteristics.

3. Difficult to ensure that all the products manafactured will be sold since the forecast demand may not be accurate and competition can affect the sales volume.

4. Selling price may be reduced to achieve greater volume of sales.

refer text book, page 262

THE BREAK-EVEN POINT(BEP) APPROACH IN CVP ANALYSIS PROCESS

​THE BREAK-EVEN POINT

• Break-even point(bep) is defines as the point where total revenue equals to total costs.

• Since total revenues equal to total costs, there is zero profit or loss at break-even point.

• it can be expressed in terms​ of sales Ringgit Malaysia(RM) or sales units.

​COMPUTING BREAK-EVEN POINT

3 methods to compute break-even point:

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• Mathematical equation method;

• Contribution margin method and

• Cost-volume-profit graph method

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​MATHEMATICAL EQUATION

Total revenue - Total costs= 0

Total revenue -Total variable costs -Total fixed cost=0

(Selling price per unit x Volume)-(Variable cost per

unit x Volume) – Total fixed cost

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BE point in units

= Total fixed cost/(Selling price per unit – Variable cost per unit)

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=Total Fixed Cost/Contribution margin per unit

​CONTRIBUTION MARGIN METHOD

BE in units = Total Fixed Cost

Contribution margin per unit

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Contribution margin per unit = SP per unit - VC per unit​

​CONTRIBUTION MARGIN METHOD

BE in RM = Total Fixed Cost

Contribution margin ratio

​

Contribution margin ratio = Contribution margin per unit​

​ X 100

Selling price per unit ​

​CVP GRAPH METHOD

• CVP graph depicts relationship between cost, volume and profit by drawing the total revenueand total costs functions.

• ​CVP graph can be used to determine profit or losses at different volume of sales.

• ​The vertical distance between revenue line and total cost line is net income or net loss.

MARGIN OF SAFETY

• Margin of safety is the difference between expected sales and break-even sales.

  ​

• Can be expressed in units or RM

Margin of Safety in units = Actual Sales in units - Break-even sales in units

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Margin of Safety in RM = Actual Sales in RM - Break-even sales in RM

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Margin of safety (%) = ​Actual Sales - Break-even sales x 100

Actual sales​

• Useful to assess the risk of not achieving a profitable performance

  ​

• Indicates the amount by which sales could be lowered before profits reach the break-even point

Example MOS

A product that sells for RM30 per unit has the following cost details:

​

Unit variable cost RM15

Total fixed costs RM45,000

expected sales volume for the next month is 4,800 units. What is the Margin of safety?

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​answer:

​i. CM= MOS(unit)= MOS(%)=

​

ii. BEP ​(unit)= MOS(RM)=

​EXTENDING BREAK-EVEN POINT

Quantity of sales to achieve the targeted profit​

​

= (Fixed Costs + Targeted Profit)

Contribution Margin per unit

The changes in​ variable costs will affect the decisions made by the managers. As the variable costs increase, the profit will decrease. Sales volume will have to be increased to maintain the targeted net profit

CHANGES IN VARIABLE AND SALES VOLUME

Changes in fixed cost will cause changes in the break-even point

CHANGES IN FIXED COSTS AND SALES VOLUME

EFFECTS OF CHANGES IN VARIABLE AND FIXED COSTS, SALES VOLUME AND SELLING PRICE ON COST-VOLUME-PROFIT

CHANGES IN FIXED COSTS, SELLING PRICE AND SALES VOLUME

Changes in fixed cost, revenue and volume of sales will can cause an increase or decrease in net profit. Sales volume will have to be increased when costs increase in order to maintain the target profit.

CHANGES IN VARIABLE, FIXED COST AND SALES VOLUME

Changes in variable and fixed cost can cause the sales volume to increase or decrease. All the changes will finally affect the net income and the management's decision.

​Exercise 1

Purle phone Sdn. Bhd produce Red Phone for local market. The product price is RM200 per unit. The details of cost involved presented below:

Fixed cost RM800,000​

Variable Cost RM120​

During the year, Purple Phone Sdn. Bhd sold 15,000 unis of Red Phone.

Calculate:

a) Break -even point in unit and RM

b) Margin of safety (MOS)​

c) Graphical Method ​

​

​

Exercise 2

Papa Sdn Bhd makes and sells product MIM at a price of RM50 per unit. The variable cost is RM40 per unit and the budgeted fixed cost is RM60,000. Budgeted sales are 8,000 unit.

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Calculate the:

​

i. The break-even point in unit and RM

ii. Margin of safety (MOS) in unit and RM​

iii. MOS in term of percentage​

Exercise 3

A company produce a type of product and sell it with price RM10 per unit. Variable cost per unit is RM6 and fixed cost was RM60,000 a year.

​

Calculate:

i. Contribution margin per unit

ii. BEP in unit

iii. BEP in RM

iv. units to be sold to get profit RM20,000 per year

v. Profits for 20,000 unit sold per year

vi. Variable cost increased to RM6.50 per unit and fixed cost increased to RM70,000. If selling price constant, how many unit have to be sold to keep annual profit RM20,000.​

Exercise 4

The super Watch company manufactures high quality watches. For the current year, sales are 5,200 watches at RM350 each. Information on manufacturing and selling and administrative expenses are as follows:

Manufacturing costs:

direct material RM120 each

direct labor RM75 each

variable overhead RM10 each

fixed overheads RM100,000 per annum

Selling and administrative expenses:​

variable RM5 each

fixed RM100,060 per annum​

​

Required:

i. compute the contribution margin

ii. calculate the contribution percentage

iii. calculate the break-even point in units and RM

iv. The margin of safety in units​

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Exercise 5

The budgeted costs and sale at 14,000 units has been prepared by the cost accountant of JAYA Limited:

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Sales Label(Unit) 14,000

Direct material RM39,200

Direct labor RM42,000

Variable overhead RM1.50 per unit

Fixed overheads RM5,400 per annum

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Sales price is RM12.00 per unit

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Required:

i. .calculate the break-even point in units and RM

ii. The net profit if sales for the next year reach 20,000 units.

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