INDUSTRIAL UNIVERSITY OF HO CHI MINH CITY AUDITING ACCOUNTING FACULTY 1 9.COST VOLUME- PROFIT (CVP) ANALYSIS COST VOLUME- PROFIT (CVP) ANALYSIS Topic List Terms and formulae Breakeven chart Contribution chart 4 Profit/Volume chart Limitations of CVP analysis 2 1
TARGET CVP analysis enables management to predict how changes in volume (production output and sales) will impact upon costs and revenues and hence profitability. Most examination question on CVP analysis will require that you can recall the formulae included in this chapter-make sure that you learn them so that you can apply them when you need to 3 Contribution to sales ratio 4 The C/S ratio is a measure of how much contribution is earned from each $ of sales. The contribution to sales or C/S ratio can be found by two means: o Total contribution /Total sales o Contribution per unit / Selling price per unit 2
5 A product sells for $24, has total absorption costs of $18 and marginal costs of $15. What is the C/S ratio as a percentage? CVP analysis and breakeven point 6 Cost-volume-profit (CVP) analysis is the study of the interrelationships between costs, volume and profit at various levels of activity. (a) The breakeven point which is the activity level at which there is neither profit nor loss. (b) The amount by which actual sales can fall below anticipated sales, without a loss being incurred. 3
Selling price and costs per unit: 7 diagram: Break even Break even point 8 4
9 Fixed costs are $120,000; selling price per unit = $150; total absorption costs per unit = $90; marginal cost per unit = $70. What is the break-even point in units (to the nearest whole unit)? Selling price per unit = $190; total absorption costs per unit = $120; marginal cost per unit =$90. Budgeted production = 2,000 units. 10 What is the break-even point in units (to the nearest whole unit)? 5
11 Selling price per unit = $90; total absorption costs per unit = $70; marginal cost per unit = $50. Budgeted production = 2,000 units. What is the profit or loss if 1,500 units are made and sold? Margin of safety Is the difference in units between the expected sales volume and the breakeven sales voume. 12 Margin of safety in units = Actual (or Expected) sales Breakeven sales Margin of safety % = Actual (or Expected) sales Breakeven sales 100% Actual sales 6
13 A company has budgeted fixed costs of $240,000 and budgeted output of 50,000 units. Each unit makes a contribution of $8. What is the break even point and the margin of safety? 14 Selling price per unit = $60; total absorption costs per unit = $50; marginal cost per unit = $40. Budgeted production = 1,500 units What is the margin of safety? 7
Breakeven arithmetic and target profits Breakeven arithmetic: Total contribution= Fixed costs. 15 Taget profit: Target contribution = Target profit + fixed costs. Breakeven charts and profit/volume charts Draw sales line Draw fixed costs line Draw total costs line Break even point is the intersection of the sales line and the total costs line. 16 8
Variation in the use of break even charts 17 Contribution charts 18 9
The profit/volume chart 19 Decisions to change sales price or costs 20 If selling prices are lowered, sales volume is likely to increase. If new machinery is installed, fixed costs might rise but the variable cost of manufacturing might fall because the machines are more efficient. 10
21 Existing situation: selling price/unit = $50, marginal cost = $20. Expected sales = 40,000 units and fixed costs = $100,000. New situation: a new machine is introduced that makes better quality products at a lower marginal cost per unit. Selling price/unit = $55, marginal cost = $18. Fixed costs = $160,000. The same volume will be sold. What volume will have to be sold to keep profits the same? 22 Currently a product has marginal costs of $40 and a selling price of $60. Fixed costs are $120,000 and 10,000 units are sold. Inflation will increase both marginal costs and fixed costs by 10%, but competition means that the selling price can be increased by 5% only. What volume will have to be sold if the same profits are to be earned? 11
23 Currently a product has marginal costs of $45 and a selling price of $70. 200,000 units are sold and fixed costs are $3 million. If the selling price were reduced by $5, by how many units would the volume sold have to increase to earn the same profit? Where is profit on the following diagram? A. Line A B. Line B C. Line C D. Line D 24 12
Where is the margin of safety on the following diagram? A. Line A B. Line B C. Line C D. Line D 25 13