Session 2 Cost Volume Profit Analysis

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Session 2 Cost Volume Profit Analysis

• By the end of todays session(s), you should be
  able to
• Compute breakeven activity and margin of safety
  (in monetary and unit terms)
• Demonstrate an awareness of the assumptions and
  limitations of CVP analysis
• Illustrate CVP analysis and breakeven analysis,
  using a graphical approach (to including
  multi-product analysis)

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Competency Wheel
Strategic Thinking Problem Solving
Communication Managing Self
OthersLeadership IT Awareness Project
Management Change Awareness Stakeholder
Management
Financial Reporting Management Accounting
Finance Audit Assurance Tax Law Strategy
Ethics Professionalism Objectivity
Perceptiveness of own knowledge, values and
limitations
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Mapping

• This lecture maps specifically to 5.1 on the
  Competency Statement

Functional Competencies Business Competencies Core Professional Values Skills
Management Accounting Decision Making Calculations around Breakeven Analysis
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Cost Volume Profit

• Chapter Reference 9.2 (Pages 311 to 327)

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Cost Volume Profit Analysis (CVP)

• CVP is a systematic method of examining the
  relationship between changes in activity (i.e.
  volume) and changes in total revenue, expenses
  and net profit.
• The model simplifies the real world and is
  subject to a number of assumptions and
  limitations. It is a good tool for decision
  making.

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Assumptions / Limitations

• Costs can be accurately divided into their fixed
  and variable elements
• Fixed costs do not change
• All other variables remain constant
• Total costs and total revenue are linear
  functions of output
• Profits are calculated on a variable costing
  (also known as marginal costing) basis
• A single product or a constant sales mix.
• The analysis applies to the relevant range only.
• The analysis only applies to the short term.

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Contribution vs Profit

• Contribution Selling Price Variable Costs
• Profit Selling Price (Variable Costs Fixed
  Costs)
• Alternatively,
• Profit Contribution Fixed Costs
• Contribution represents an amount available to
  contribute towards fixed costs. It is normally
  expressed as a monetary amount.

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Breakeven Point

• The point at which both fixed and variable costs
  are covered by revenue and no profit is made.
• It can be expressed in terms of either sales
  units or sales revenue.

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Formulae

• Breakeven in Units
  Fixed Costs
• 
  Contribution per Unit
• Breakeven in Sales revenue
  Fixed Costs
• 
  Contribution to Sales Ratio
• OR
• Fixed Costs X Selling Price
  per Unit
• Contribution per Unit

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Contribution to Sales Ratio

• Formula
• Contribution per unit or Total
  Contribution
• Selling Price per unit Total Sales
  Revenue
• This ratio measures how much contribution is
  earned from each /1 of sales.
• It is normally expressed a as .

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Margin of Safety

• This figures indicates the level by which sales
  could fall before a loss is made.
• It can be expressed in units, as a monetary
  amount or as a .

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Formulae

• Margin of Safety (in units)
• Budgeted Sales units Breakeven Sales units
• Margin of Safety (as a of sales revenue)
• Budgeted Sales - Breakeven Sales X 100
• Budgeted Sales

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Target Profit

• Level of sales(units) required to generate the
  target profit
• Fixed Costs Required Profit
• Contribution per Unit
  
• Or
• Target Contribution
• Contribution to Sales Ratio

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Example 1 Contribution to Sales Ratio

• The following information relates to Product J
• Selling Price per unit
  40.00
• Variable Costs per unit
  24.00
• Fixed Costs
  200,000
• Requirement
• Calculate the contribution to sales ratio.

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Solution 1 Contribution to Sales Ratio

• Contribution to Sales ratio
• Selling Price 40.00
• Variable Costs (24.00)
• Contribution 16.00
• C/S Ratio 16.00 / 40.00 X 100 40

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Example 2 Breakeven Point

• The following information relates to Product
  CT33.
• Selling Price per unit
  30.00
• Variable Costs per unit
  19.50
• Fixed Costs
  280,000
• Requirement
• Calculate the breakeven point in units and in
  terms of revenue.

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Solution 2 Breakeven Point

• Selling Price
  30.00
• Variable Costs
  (19.50)
• Contribution
  10.50

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Solution 2 Breakeven Point (continued)

• Breakeven Point (Units)
• Fixed Costs / Contribution per unit
• 280,000 / 10.50 26,667 units
• Breakeven Point (Revenue)
• 26,667 units X / 30 /800,000

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• Alternative breakeven revenue formula
• Fixed Costs / Contribution to sales ratio, so we
  need to calculate the contribution to sales ratio
  first. The formula is
• Contribution per unit / Selling price per unit
• 10.50 / 30.00 0.35 or 35
• Using our alternative breakeven revenue formula
• Fixed costs / Contribution to sales ratio
• / 280,000 / 0.35 / 800,000

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Example3 Margin of Safety

• Star manufactures a product R2 to which the
  following relates
• Selling Price per unit
  35.00
• Variable Costs per unit
  21.00
• Fixed Costs
  175,000
• Budgeted Sales Volume
  16,500
• Requirement
• Calculate the margin of safety in units and as a
  percentage of budgeted sales

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Solution 3 Margin of Safety

• To Calculate the Margin of Safety you will need
  to calculate the Breakeven point in units first.
• Selling Price 35.00
• Variable Costs (21.00)
• Contribution 14.00

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Solution 3 Margin of Safety (continued)

• Breakeven Point 175,000 / 14.00 12,500 units
• Margin of Safety (Units)
• Budgeted Units Breakeven Units
• 16,500 12,500 4,000 units

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Solution 3 Margin of Safety (continued)

• Margin of Safety as of Budgeted Sales
• Budgeted Sales Breakeven Sales X 100
• Budgeted Sales
• 16,500 12,500 X 100 4,000 X 100 24.24
• 16,500 16,500

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Example 4 Target Profit

• Star manufactures a product R2 to which the
  following relates
• Selling Price per unit
  38.00
• Variable Costs per unit
  24.00
• Fixed Costs
  210,000
• Requirement
• Calculate the sales volume required to achieve a
  profit of 80,000.

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Solution 4 Target Profit

• Selling Price 38.00
• Less Variable Costs (24.00)
• Contribution 14.00

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Solution 4 Target Profit (continued)

• Fixed Costs Target Profit
• Contribution per unit
• 210,000 80,000 290,000 20,714
• 14.00 14.00

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Example 5 Comprehensive Examples

• Beta has the following information
• Selling Price per unit
  200.00
• Variable Costs per unit
  90.00
• Fixed Costs
  440,000
• Budgeted Sales
  6,500

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Example 5 (Continued)

• Requirement
• Calculate the c/s ratio
• Calculate the breakeven point in terms of units
  sold
• Calculate the breakeven point in terms of sales
  revenue
• Calculate the units sales required to achieve a
  target profit of 520,000
• Calculate the margin of safety(expressed as a
  percentage of budgeted sales)

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(a) Contribution / Sales Ratio

• Selling Price
  200.00
• Variable Costs (
  90.00)
• Contribution
  110.00
• C/S Ratio 110 / 200 X 100 55

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(b) Breakeven in Units

• Fixed Costs / Contribution per unit
• 440,000 / 110 4,000 Units

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(c) Breakeven Revenue

• Breakeven revenue
• Breakeven Units X Selling Price per unit
• 4,000 units X /200 / 800,000
• Fixed Costs / Contribution to Sales Ratio
• 440,000 / 0.55 800,000

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(d) Target Profit

• Fixed Costs Target Profit
• Contribution per unit
• 440,000 520,000 960,000 8,727 units
• 110 110

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(e) Margin of Safety

• Budgeted Sales Breakeven Sales
• Budgeted Sales
• 6,500 4,000 X 100 2,500 X 100 38.46
• 6,500 6,500

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Constant Sales Mix

• Approach to Questions
• Calculate the contribution per unit for each
  product.
• Calculate the weighted contribution
  Contribution per unit X Total Sales Units
• Calculate Breakeven Units Fixed Costs /
  Weighted Contribution

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Example 6 - Constant Sales Mix

• Acorn Ltd manufactures 2 products, AB12 and AB15.
  Sales of each product are made up as follows
• AB12 60
• AB15 40
•  
• Selling price and costs are as follows
• Product AB12
  AB15
• Selling Price 20.00
  22.00
• Material per unit 8.00
  9.00
• Labour per unit 7.50
  7.75
• Fixed costs are estimated at 1,200,000 per
  annum.
•  
• Requirement
• What are the breakeven units for each product?

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Step 1 Calculate the Contribution per Unit
Product AB12 AB15
Selling Price 20.00 22.00
Materials (8.00) (9.00)
Labour (7.50) (7.75)
Contribution 4.50 5.25
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Step 2 Calculate the Weighted Contribution
Product AB12 AB15
Contribution 4.50 5.25
of Total Sales 60 40
Weighted Contribution 2.70 2.10 4.80
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Step 3 Calculate Breakeven Point

• Breakeven Formula
• Fixed Costs / Weighted Contribution per unit
• 1,200,000 / 4.80 250,000 units
• This breakeven figure represents the total sales
  of both products at which costs will be covered
  by sales revenue generated.
• Sales units of A 250,000 X 60 150,000 units
• Sales Units of B 250,000 X 40 100,000 units

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Graphical Approach

• Need to be able to construct 3 Graphs
• Traditional Breakeven Graph
• Contribution Breakeven Graph
• Profit / Volume (P/V) Graph

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Traditional Breakeven Graph

• Lines to be shown on the Graph
• Total Sales Revenue (TSR)
• Total Costs (TC)
• Fixed Costs
• Points to identify on Graph
• Breakeven point where TSR intersects TC
• Margin of Safety Area between Budgeted Sales
  volume and Breakeven Sales Revenue

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Breakeven Graph
Total Sales
Total Costs
s
Fixed Costs
Units
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Breakeven Graph
Profit Area
s
Breakeven Point
Loss Area
Units
43
Breakeven Graph
Profit
s
MOS
Units
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Breakeven Graph

• This graph depicts
• Approximate levels of profit/loss at different
  sales levels within a relevant range
• Breakeven point (total costs total revenue)
• Margin of safety (budgeted sales breakeven
  sales)

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Contribution Breakeven Graph

• Lines to be shown on the Graph
• Total Sales Revenue (TSR)
• Total Costs (TC)
• Variable Costs (VC)
• Points to identify on Graph
• Breakeven point where TSR intersects TC

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Contribution Breakeven Graph
Total Sales
Total Costs
s
Variable Costs
Units
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Contribution Breakeven Graph
Contribution
s
Breakeven Point
Units
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Contribution Breakeven Graph

• This graph includes a variable costs line
  rather than a fixed costs line
• The graph depicts
• Approximate levels of contribution at different
  sales levels within a relevant range
• Breakeven point (total costs total revenue)

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Profit / Volume Graph

• X Axis Sales in monetary Units
• Y Axis Profit Loss
• Points to identify on the graph
• Breakeven Point Point where the profit line
  intersects the Sales Axis

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Profit Volume (P/V) Graph
Total Profit
s
Breakeven Point
Units
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Profit Volume (P/V) Graph

• This graph is a variation of the breakeven graph
  it shows the effect on profit of any changes in
  selling price, variable costs, fixed costs or
  sales demand
• The graph depicts
• Approximate levels of profit/loss at different
  sales levels within a relevant range
• Breakeven point (total costs total revenue)

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Changes in Costs Revenues

• It is possible to show the effect of changes in
  costs revenues by drawing additional lines on
  the charts
• The changes are of two types
• Fixed cost changes increases or decreases in
  fixed costs do not change the slope of the line,
  but alter the point of intersection the
  break-even point
• Variable cost and sales price changes these
  changes alter the slope of the line thus
  affecting break-even point the shape of the
  profit and loss wedges