Cvp
- 1. COSTVOLUME PROFIT ANALYSIS Dr Meena Bhatia
- 2. Chapters covered and learning outcomes achieved so far ■ Chapter One:The manager and Management accounting ■ Chapter two: An introduction to Cost terms & purposes ■ Chapter Fifteen: Allocation of support departments costs ■ Chapter five: Activity based costing LO1 Understand cost terminology and cost behavior LO2 Identify different kinds of costing systems, namely: traditional, activity based and marginal, and understand their implementation within organisations for decision making.
- 3. Situation ■ Katrina Khan a young entrepreneur recently used GMAT success a test preparation book and software package for her business school admission test. She loved the programme so much that she entered into contract with the publisher to sell it. She can purchase each package for 1200 Rs, with the privilege of returning the unsold packages at the same rate. She wants to sell these packages at an educational fair where she has to pay rent of Rs 20,000. She will not incur any other cost. Should she rent the booth, if she expects to sell these packages at 2000 Rs each?
- 4. Marginal costing statement Selling price SP XXX Per unit (Variable cost)VC XXX Per unit Contribution Margin CM XXX Per unit Contribution Margin * Quantity sold XXX Total (Fixed Cost) XXX Total Operating income XXX Total Contribution margin ratio (CMR) also PV ratio CM/SP
- 5. Equation Method Number of Packages 0 1 5 25 40 Revenue 2000per package 0 2000 10000 50000 80000 variable costs 1200per package 0 1200 6000 30000 48000 Contribution margin 800per package 0 800 4000 20000 32000 fixed costs 20000 20000 20000 20000 20000 20000 Operating Income -20000 -19200 -16000 0 12000
- 6. Breakeven point ■ Point of no profit no loss Example 1 – Fixed costs per annum £60 000 – Unit selling price £20 Unit variable cost £10 – Relevant range 4 000 - 12 000 units Break-even point Fixed costs = £60 000/£10 = 6 000 units Contribution per unit • If per-unit values are not available, the Breakeven Point may be restated in its alternate format: BE Sales = FC ÷ CMR How many units should be sold to obtain a £30 000 profit?
- 7. • With a simple adjustment, the Breakeven Point formula can be modified to become a Profit Planning tool. Profit is now reinstated to the BE formula, changing it to a simple sales volume equation Fixed costs + desired profit = £90 000/£10 = 9 000 units Contribution per unit • From time to time it is necessary to move back and forth between pre-tax profit (OI) and after-tax profit (NI), depending on the facts presented • After-tax profit can be calculated by: OI x (1-Tax Rate) = NI • NI can substitute into the profit planning equation through this form: OI = NI/(1-t)
- 10. Margin of Safety • One indicator of risk, the Margin of Safety (MOS) measures the distance between budgeted sales and breakeven sales: MOS = Budgeted Sales – BE Sales • The MOS Ratio removes the firm’s size from the output, and expresses itself in the form of a percentage: MOS Ratio = MOS ÷ Budgeted Sales
- 11. FundamentalAssumptions of CVP 1. Changes in production/sales volume are the sole cause for cost and revenue changes 2. Total costs consist of fixed costs and variable costs 3. Revenue and costs behave and can be graphed as a linear function (a straight line) 4. Selling price, variable cost per unit and fixed costs are all known and constant 5. In many cases only a single product will be analyzed. If multiple products are studied, their relative sales proportions are known and constant 6. The time value of money (interest) is ignored
- 12. Question A dry-cleaning shop takes two types of clothing. Jackets cost £6 to clean and the customer is charged £9 per garment. Coats cost £10 to clean and the customer is charged £12 per garment. The monthly fixed costs are £600 for each garment (representing the rental costs of two different types of machine). The shop expects to take in 500 jackets and 500 coats in the month. Calculate break-even point
- 13. . Jackets Coats £ £ Selling price 9 12 Variable cost 6 10 Contribution per item 3 2 Fixed costs £600 £600 Break-even point 200 units 300 units Profit for sales of 500 units £900 £400 Calculation of break-even point and of sales beyond the break-even point
- 14. Comment on calculation Although both products have the same fixed costs, the jackets have a lower break-even point because they have a higher contribution per unit. Beyond the break-even point they continue to contribute more per unit.The profits at any given level of activity are therefore higher for jackets.
- 15. Change in selling price If the selling price per unit increases and costs remain constant, then the contribution per unit will increase and the break-even volume will be lower. If the selling price of cleaning a coat rises to £15 then the contribution per unit will rise to £5.That will require only 120 coats to break even.The effect of raising the price is that customers may move elsewhere so that while it may not be difficult to exceed the break- even point at a selling price of £10 it may be extremely difficult at a selling price of £15.
- 16. Change in variable and Fixed cost Variable cost – If the variable cost increases then the contribution per unit will decrease, with the result that more items will have to be sold in order to reach the break-even point. – If it is possible to reduce variable costs then the contribution per unit will increase. The enterprise will reach the break-even point at a lower level of activity and will then be earning profits at a faster rate. Fixed Cost – If fixed costs increase then more units have to be sold in order to reach the break- even point.
- 17. SensitivityAnalysis • CVP Provides structure to answer a variety of “what-if” scenarios • “What” happens to profit “if”: 1. Selling price changes 2. Volume changes 3. Cost structure changes 4. Variable cost per unit changes 5. Fixed cost changes
- 18. Limitations of break-even analysis ■ The break-even graphs assume that cost and revenue behaviour patterns are known and change on a straight-line basis as activity levels change. ■ It may not always be feasible to split costs neatly into variable and fixed categories. Some costs show mixed behaviour. ■ The break-even graphs assume that fixed costs remain constant over the volume range under consideration. If that is not the case then the graph of total costs will have a step in it where the fixed costs are expected to increase.
- 19. Effect of sales mix on BEP Example Product X ProductY Unit contribution £12 £8 Budgeted sales mix 50% 50% Actual sales mix 25% 75% Fixed costs are £180 000 1. Budgeted BEP = £180 000 /£10 (a) = £18 000 units 2. Actual BEP = £180 000 /£9 (b) = 20 000 units ■ a (50% × £12) + (50% × £8) ■ b (25% × £12) + (75% × £8)
- 20. question Q.The total costs incurred at various output levels, for a process operation in a factory, have been measured, identify how much is fixed and variable cost Output (units) Total cost £ 11,500 1,02,476 12,000 1,04,730 12,500 1,06,263 13,000 1,08,021 13,500 1,10,727 14,000 1,13,201