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Coma - 03 - CVP

This document discusses cost-volume-profit (CVP) analysis and marginal costing. It begins by stating the objectives of CVP analysis, which include determining the breakeven point and margin of safety. It then provides equations for the CVP model and defines key terms like contribution, fixed costs, and variable costs. The document explains how marginal costing can be used for planning, control, and decision making. It also discusses how to calculate and improve the breakeven point and margin of safety. Finally, it compares absorption costing and marginal costing and lists some limitations of CVP analysis.

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Abhijeet Chandra
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162 views16 pages

Coma - 03 - CVP

This document discusses cost-volume-profit (CVP) analysis and marginal costing. It begins by stating the objectives of CVP analysis, which include determining the breakeven point and margin of safety. It then provides equations for the CVP model and defines key terms like contribution, fixed costs, and variable costs. The document explains how marginal costing can be used for planning, control, and decision making. It also discusses how to calculate and improve the breakeven point and margin of safety. Finally, it compares absorption costing and marginal costing and lists some limitations of CVP analysis.

Uploaded by

Abhijeet Chandra
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Cost-Volume-Profit Analysis

13-June-2014

Objectives
State the application areas and assumptions underlying the use
of marginal costing;
Use cost volume profit analysis to determine the breakeven
point and margin of safety;
State the effect of cost structure on decisions;
Apply cost volume profit analysis in profit planning;
Carry out sensitivity analysis of the changes in the parameters;
Present profitability statement based on absorption costing and
marginal costing;
Explain the importance of use of marginal costing for internal
reporting;
Distinguish between absorption costing and marginal costing.

CVP Equation
Total cost = fixed costs + (units sold x unit variable
cost/unit)
Profit = Sales Fixed costs Variable costs
Sales = Units sold x Selling Price
Variable costs = Units sold x Variable cost per unit
P=SF-V

Profit + Fixed costs = Sales Variable costs


P+F+SV

Contribution = Profit + Fixed costs


C=P+F

Contribution = Sales Variable costs


C=S-V

Marginal Costing: Application Areas

1. Planning
2. Control
3. Decision Making:
a.
b.
c.
d.
e.
f.
g.

Maximization of contribution
Determination of break-even point
Determination of Margin of Safety
Pricing decisions
Product substitution and discontinuance
Acceptance of offer or submission of tenders
Make or buy decisions

Break Even Point (BEP)


Break-even Point: Break even point is the level of
activity or sales where the total sales are equal to total
costs or where the contribution is equal to total fixed
costs or where the firm makes no profit or no loss.

FixedCost
SalesValue
PV Ratio

FixedCost
SalesUnit
Contribution / Unit

Improving Break Even Point


Increasing the selling price of the product;
Decreasing the variable cost of the product;
Selecting a product mix containing larger PV ratio
items of products;
Reducing the fixed costs.

Margin of Safety
Margin of safety is the excess of sales over the break even
sales which may be in terms of number of units or sales
value.
Margin of safety = Total sales units Break-even sales units,
or Total sales value Break even sales value

Improving Margin of Safety


Increasing the selling price of the product;
Decreasing the variable cost of the product;
Selecting a product mix containing larger PV ratio
items of products;
Reducing the fixed costs;
Increasing the number of units (volume of
production).

Four Conditions of Business

Low break-even point and large angle of intersection,


High break even point and large angle of intersection,
Low break-even point and small angle of intersection,
High break-even point and small angle of intersection,

Sensitivity Analysis
Cost Element

Change

PV Ratio

Break-even
Point

Margin of
Safety

Selling Price

Increase

Increase

Decrease

Increase

Decrease

Decrease

Increase

Decrease

Increase

Decrease

Increase

Decrease

Decrease

Increase

Decrease

Increase

Increase

No Change

Increase

Decrease

Decrease

No Change

Decrease

Increase

Increase

No Change

No Change

Increase

Decrease

No Change

No Change

Decrease

Variable Cost

Fixed Costs

Volume of
Output

Profit Planning

Determination of appropriate production volume, selling price and levels of


fixed costs required to earn the desired profit.

Determination of the break even point to examine the feasibility of achieving


the goal.

Which product should be selected for manufacture and in the case of multiproduct companies determination of optimal product mix is important.

Conducting sensitivity analysis to study the impact of changes in the selling


price, costs and volume on the desired profit.

Analysis of the discretionary costs with a view to exploring the possibility of


minimizing them to reduce the overall fixed costs to improve the margin of
safety.

Cost Indifferent Point and Break-even Point


Break-even Point

Cost Indifference Point

Cost indifference point is obtained by


dividing the difference in fixed costs of
the two alternatives by the difference in
the variable cost of the two alternatives.
Cost indifference point indicates the
output at which the decision maker is
indifferent in choice between the two
alternatives.
After crossing the cost indifference
point, the decision is changed from
lower fixed cost proposal to higher fixed
cost proposal.
The decision maker can accept one of
the proposals even below indifference
point.

The break even point is obtained by


dividing the total fixed costs by
contribution per unit that is selling price
minus variable cost, per unit.
The break even point is the minimum
quantity of output which is required to
be produced to meet all the costs.

After crossing the break-even point, the


company starts making profit.

The decision maker does not accept any


proposal below break-even point as it
will lead him to loss.

Marginal Costing: Assumptions

Only one variable can be changed at a time.


The company produces a single product.
Fixed costs are constant.
Contribution concept is used in determining profit.
Unit variable costs and selling prices are constant per unit.
CVP analysis applies in a relevant range.
Costs are segregated correctly in to fixed and variable.
CVP analysis is applicable in a short term horizon.
Productivity and efficiency remain constant.
Capital investment in business is not considered.

Break Even Analysis: Limitations


The presence of step cost may lead to multiple break-even
points.
The variable costs may not always be constant per unit
because of the effect of price discounts due to bulk buying
and learning curve applications on labour costs.
The selling price may not always be constant per unit
because of discounts granted to the bulk orders.
The product mix may change depending on the market
demand and consumer preferences.

Marginal Costing and Absorption Costing


Marginal Costing

Absorption Costing

1. The unit product cost represents all variable


costs.

1. The unit product costs represent production


variable and production fixed costs.

2. The cost per unit is constant and varies in


direct proportion to output.

2. The cost per unit varies in inverse ratio to


the output.

3. Contribution is obtained by deducting


variable costs from sales.

3. Profit is represented by sales minus total


costs.

4. Stocks are valued at variable production


cost.

4. Stocks are valued at production variable cost


plus production fixed cost.

5. The fixed costs stand charged off to profit


and loss account.

5. A proportionate amount of production fixed


costs enters in to the value of stocks.

6. Profit is correctly stated.

6. Profit and loss account is vitiated and the


profits are not correctly stated.

7. Fluctuations in the volume of opening and


closing stock will not lead to stock profit or
loss.

7. Fluctuations in the volume of opening and


closing stocks will lead to stock profit or loss.

Some Other Resources

CVP Analysis Online:

https://cb.hbsp.harvard.edu/cbmp/trials/37660958

Manage Customers for Profits (Not Just Sales), Harvard Business Review,

Sept.-Oct.1987.

https://hbr.org/1987/09/manage-customers-for-profits-not-just-sales

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