Break Even Analysis

FINANCIAL AND MANAGERIAL
ACCOUNTING
MBA 2014
7 Cost Volume Profit Analysis
Financial and Managerial Accounting 1

Contents
1. Introduction
2. Break even point (units and revenue)
3. Assumptions
4. Sensitivity Analysis
5. BEP and several products
6. Limitations of CVP analysis
7. Case Application (JIAO TONG HOSPITAL)

1. Introduction
Break even analysis also called Cost volume

Profit (CVP) analysis is the study of the
interrelationship between costs, volume
and profit at various levels of activities
(Units sold)
It tries to analyze the behavior of costs .i.e.
variable and fixed given different levels
of output.
1. Introduction
CVP can assist the management to

estimate profits at different levels of
activities ,the break even point (The point
at which there is no profit or no loss) and
the effect on profits given changes in
variable costs, fixed costs and production
mix (sensitivity analysis).

1. Introduction
In addition CVP analysis can assist the
management to know how much to sell in
order to make a certain level of profit. The
revenue is referred to as target revenue and
the desired profit is referred to as targeted
profit.
The next session lists the important
assumptions of CVP.

2. Assumptions
1. All the costs in the organization can be
classified into variable cost per unit and total
fixed cost. No mixed costs
2. The variable cost per unit is expected to
remain constant throughout the period
irrespective of the level of activity.
3. The total fixed cost again remains constant
and this will be maintained within the relevant
range.
2. Assumptions
4. The selling price per unit is expected to

remain constant throughout the same period.
No discounts or price reduction
5. All the units produced during the period will
be sold and there is no inventory.
6. Capacity remains the same and no
improvement or decline in productivity or
technology.

3. Break Even Point
Break Even Point. (BEP)
This is the point at which total revenue is equal to total
costs and the firm does not report any profit or loss.
BEP can be in form of units or revenue
BEP can be established using three approaches:
1. Using a mathematical formula.
2. Using a summarized income statement
3. Using a graph.

3. Break Even Point
Break Even Point. (BEP) – Using a formula
BEP (Units) – lowest number of units to be sold so that
the business does not make a loss.
BEP (units) = Fixed costs

Selling price per unit – Variable cost per unit

3. Break Even point
(Selling price – Variable cost = contribution)
BEP (Revenue) – Lowest revenue to be achieved

so that the business does not make a loss.
BEP (Revenue) = BEP (units) x Selling Price per unit
The BEP can also be established graphically …….

3. Break Even point
BEP – Using a summarized income statement
A summarized income statement is given as
follows: (Q- Quantity to sell)
Revenue (Selling Price x Q) X
Variable costs (Variable Cost x Q) (X)
Contribution (SP –VC) x Q X
Fixed Costs (X)
Net profit before tax X
3. Break Even point - graphically
Revenue
And Profit making
Costs area Total Revenue
Total Cost
BEP
BEP
Revenue
Loss
making
area
Units
BEP
Units

3. Break Even point
Under CVP analysis, if the fixed cost are
expected to remain constant then any units
sold in excess of the BEP units will lead to
profit while sales of units below the BEP units
will lead to a loss.
Meanwhile it is also important to remember
that the lower the BEP the better as the
chances of making a loss are lower.
(See Question One)
Sensitivity analysis carried out under Break
even analysis tries determine how sensitive
the BEP is to the various variables in the
BEP formulae.
Sensitivity analysis tries to answer questions
such as what is the effect of a decrease or
increase in variable costs per unit, selling
price per unit or fixed costs to the BEP?
Sensitivity analysis can be carried out in
different levels. i.e. one variable in the BEP
formulae can be adjusted while holding the
other variables constant or all the variables
can be adjusted at the same time.
The basic approach in choosing between
alternatives is to select the alternative that
leads to a reduced BEP point.

5. BEP and Several products
Break even analysis is normally considered to be
a one product model. However it can also be
used in a multiple product s by using the
following alternative approaches:
1. Assume that fixed costs can be apportioned
to the various products. There after compute
the break even point for each product using
the normal formulas.

5. BEP and Several products
2.Assume that products are sold in a certain
ratio (Product mix). Using the ratio, compute
average contribution for the whole business.
Then compute the BEP for the whole business
using the contribution. Then estimate BEP for
each product again using the ratio .
The first method is recommended because of
practical reasons.

Even though CVP is a very useful tool in decision
making, its main limitations are on the
assumptions; the assumptions can be
criticized as follows.
1. Not all costs can be classified into fixed and

variable but there are some costs that can be
semi variable or semi fixed.

2. In practice variable costs and fixed cost do not
remain constant and they actually change
from one period to the next. This is due to
such factors as changes in material cost, wage
rates and the overheads.
3. Fixed cost can only be fixed within the
relevant range; the relevant range also
changes from one period to the next.

4. Selling prices may also need to be adjusted
even within the same financial period due to
various factors such as specific customer’s
demands or changes in market prices.
5. CVP should not be applied where there are
several products unless fixed overheads can
be allocated reasonably among the products.
(See Question two on multiple products)

Break Even Analysis

Uploaded by

Copyright:

Available Formats

Break Even Analysis

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Break Even Analysis

Uploaded by

Copyright:

Available Formats

FINANCIAL AND MANAGERIAL

7 Cost Volume Profit Analysis

Financial and Managerial Accounting 1

Financial and Managerial Accounting 2

Break even analysis also called Cost volume

CVP can assist the management to

Financial and Managerial Accounting 4

Financial and Managerial Accounting 5

4. The selling price per unit is expected to

Financial and Managerial Accounting 7

Financial and Managerial Accounting 8

BEP (units) = Fixed costs

Financial and Managerial Accounting 9

BEP (Revenue) – Lowest revenue to be achieved

BEP (Revenue) = BEP (units) x Selling Price per unit

The BEP can also be established graphically …….

Financial and Managerial Accounting 10

Financial and Managerial Accounting 12

Financial and Managerial Accounting 15

Financial and Managerial Accounting 16

Financial and Managerial Accounting 17

1. Not all costs can be classified into fixed and

Financial and Managerial Accounting 18

Financial and Managerial Accounting 19

Financial and Managerial Accounting 20

You might also like