CVP Analysis in Management Accounting

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C V P Analysis

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Understand how cost behaviorand cost-volume-profit analysis

are used by managers.

CVP Analysis

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Cost-Profit-Volume Analysis

What is cost-volume-profit analysis?

It is the study of the effects of outputvolume on revenue (sales), expenses(costs), and net income (net profit).

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Questions Addressed by CVP Analysis

How much must I sell to earn my desired income?

How will income be affected if I reduce selling prices to increase sales volume?

What will happen to profitability if I expand capacity?

Variable Costs

Fixed Costs

Mixed Costs

Cost Estimation Methods

Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include:

1. Account Analysis2. Scattergraph3. High-Low Method4. Regression5. Relevant Range

Scattergraph

High-Low Method

Example: Let total costs at 500 units of output be $150,000 and at 3,000 units of output be $400,000. Calculate variable and fixed costs, respectively.

High-Low Method

Solution: High Low Change

Costs: $400,000 $150,000 $250,000

Units: 3,000 500 2,500

Calculate Variable Cost Per Unit:

$250,000/2,500 = $100

Calculate Total Fixed Costs:

$400,000 – (3,000 x 100) = $100,000

High-Low Method

Regression Analysis

Relevant Range

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How Is Cost Behavior Used By Managers ?

Understanding cost behavior is vital tothe manager’s decision-making role,because one of the main goals ofmanagement accounting iscontrolling costs.

Cost-Volume-Profit Analysis

1. The Profit Equation

2. Breakeven Point

3. Margin of Safety

4. Contribution Margin

5. Contribution Margin Ratio

6. What-if Analysis

The Profit Equation

Profit = SP(x) –VC(x) – TFC

X = Quantity of units produced and sold

SP = Selling price per unit

VC = Variable cost per unit

TFC = Total fixed cost

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Break-Even Point

The break-even point is the level of sales at which revenue equals expenses and net income is zero.

Break-Even Point

Break-Even Point

TFC/CM(per unit) = Break-Even (units)

X = Quantity of units produced and sold

SP = Selling price per unit

VC = Variable cost per unit

CM = Contribution margin

TFC = Total fixed cost

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Contribution Margin and Gross Margin

Gross margin (which is also called gross profit)is the excess of sales over the cost of goods sold.

Contribution margin is the excess of sales overall variable costs.

Contribution Margin

SP(u) – VC(u) = CM (u)

SP = Selling price per unit

VC = Variable cost per unit

CM = Contribution margin

u = per unit

Contribution Margin Ratio

(SP – VC) / SP = CM%

SP = Selling Price per unit

VC = Variable Cost per unit

CM = Contribution Margin

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Per Unit PercentageSelling price $5 100Variable cost 4 80Difference $1 20

CVP Scenario

Total monthly fixed expenses = $8,000Rent $2,000Labor $5,500Other $ 500

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Equation Technique

$5N – $4N – $8,000 = 0$1N = $8,000N = $8,000 ÷ $1N = 8,000 Units

Let N = number of units to be sold to break even

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Equation Technique

S – 0.80S – $8,000 = 0.20S = $8,000S = $8,000 ÷ .20S = $40,000

Let S = sales in dollars needed to break even

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Margin of Safety

The margin of safety shows how far sales can fall below the planned level before losses occur.

Actual sales –

Break-even sales=

Margin of safety

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Target Net Profit

Managers can also use CVPanalysis to determine thetotal sales, in units anddollars, needed toreach a targetnet profit.

Managers can also use CVPanalysis to determine thetotal sales, in units anddollars, needed toreach a targetnet profit.

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Target Net Income and Income Taxes

Revenues (2,535 × $90) $228,150Variable costs (2,535 × $32) 81,120Contribution margin: $147,030Fixed costs: 96,000Operating income: $ 51,030Income taxes: ($51,030 × .30) 15,309Net income $ 35,721

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Target Net Profit

Contribution Margin Technique

Target sales volume in units =Fixed expenses + Target net incomeContribution margin per unit