COST VOLUME AND PROFIT

ANALYSIS
Chapter 6
Management Accounting, 6th edition, Seal
 Learning Outcomes
1. Explain how changes in activity affect contribution margin and profit

2. Compute the contribution margin (CM) ratio and use it to compute changes in
contribution margin and profit

3. Show the effects of contribution margin of changes in variable costs, fixed costs, selling
price and volume

4. Compute the break-even point by both the equation and contribution margin method

5. Use the CVP formulas to determine the activity level needed to achieve a desired
target profit

6. Compute the margin of safety and explain its significance

Thandi has been running her business of selling food
for a while now

She realizes the importance of attending lectures…

Pg 3 RECAP

A management accountant

needs to make
information decisions
 A management accountant

needs information

Cost behaviour
How a cost will react or respond to changes in the level of business activity

Variable Costs Fixed Costs

A cost that changes, in total, in A cost that remains constant, in total,
direct proportion to changes in regardless of changes in the level of
level of activity. activity.
 Pg 193 -194 Selling
prices

Volume
COST- Unit or level
of
VOLUME- variable
costs Profit/loss activity
PROFIT
ANALYSIS
Total Mix of
fixed products
costs sold
 COST-VOLUME-PROFIT ANALYSIS
ASSUMPTIONS
Selling price is constant throughout the entire relevant range.

Costs are linear throughout the entire relevant range.

In multi-product companies, the sales mix is constant.

In manufacturing companies, inventories do not change

(units produced = units sold).
 Statement of Profit and Loss

Revenue Expenses PROFIT

 Contribution Statement of Profit and Loss

Variable Fixed
Revenue Costs Costs
PROFIT

Contribution
Margin
Contribution margin (CM) is the
amount remaining from sales
revenue after
variable expenses have been
deducted
 Contribution Statement of Profit and Loss

Variable Contribution Fixed

Revenue
Costs Margin Costs PROFIT
Contribution After covering fixed
margin goes costs, any remaining
to cover contribution margin
fixed contributes
expenses to profit
Pg 194
Contribution Statement of Profit and Loss
Revenue

Variable Costs

Contribution Margin

Fixed Costs

Profit/loss
Contribution Statement of Profit and Loss
Revenue
Selling price per unit x number of units sold

Variable Costs
Variable cost/unit x number of units sold

Contribution Margin
Contribution margin per unit x number of units sold

Fixed Costs

Profit/loss
 Thandi reflects on the last month…

Revenue Variable Costs Fixed Costs

R2,500 R1,500 R800

She sold 50 plates of food…

Thandi calculates the contribution margin for the period

Contribution Statement of Profit and Loss

Total
Revenue (50 plates) R2,500
Thandi has R1,000 remaining
Variable Costs R1,500 from sales revenue after
variable expenses have been
Contribution Margin R1,000 deducted.
 Contribution Margin Ratio (CM Ratio)

Contribution = Contribution Margin

Margin ratio Revenue
 Thandi wants to find out how a change in revenue will affect the
contribution margin…

Contribution margin ratio = Contribution margin

Sales
R1,000
=
R2,500
= 40%

She calculates the contribution margin ratio using figures for selling
50 plates of food.
 Change in Contribution Margin

Change in
Contribution Change in
Contribution = X
margin ratio revenue
margin
 So if revenue increases by R500, how will that affect contribution
margin?...

Change in
Contribution Change in
Contribution = X
margin ratio revenue
margin
= 40% X 500
= R20

The contribution margin will increase by R20 if revenue increases by

R500
 Thandi calculates the per unit amounts…

Contribution Statement of Profit and Loss

Total Per unit
Revenue (50 plates) R2,500 R50/plate She divides
total by sales
volume of 50
Variable Costs R1,500 R30/plate plates

Contribution Margin R1,000 R20/plate

Thandi wonders what a contribution margin per unit means…

Contribution Statement of Profit and Loss

Total Per unit
Revenue (50 plates) R2,500 R50/plate
Variable Costs R1,500 R30/plate
Contribution Margin R1,000 R20/plate

For each additional plate Thandi sells, R20 more in contribution margin
will help to cover fixed expenses and generate profit!
Thandi then calculates the total profit/loss for the period by
deducting fixed costs from contribution margin
Contribution Statement of Profit and Loss
Total
Revenue (50 plates) R2,500
Variable Costs R1,500
Contribution Margin R1,000 The R1,000 first goes to cover
fixed costs of R800
Fixed Costs R800
The remaining contribution
margin of R200 goes to profit
Profit/loss R200
 The level of sales at which profit
is zero

The point at where total

Break-even sales/revenue equals total
expenses
Point
Pg 195
The point at where total
contribution margin equals total
fixed expenses
 Pg 202 - 203 Break-even Point
Calculations

Equation method (in units)

Variable Fixed
Revenue = + + Profit
expenses costs

R0
Thandi wants to see if she can calculate the break-even point of her
business…
Equation method (per unit)
Let “Q” be the number of units required to break-even
Revenue = Variable + Fixed + Profit
expenses costs
50Q = 30Q + 800 + 0
20Q = 800
Q = 40

Thandi needs to sell 40 plates of food to break-even

 Pg 202 - 203 Break-even Point
Calculations

Equation method (in total sales)

Variable Fixed
Revenue = + + Profit
expenses costs

R0
Thandi wants to see if she can calculate the break-even point of her
business…
Equation method (rand value)
Let “X” be the total sales
Revenue = Variable + Fixed + Profit
expenses costs
X = 0.6X + 800 + 0
0.4X = 800
X = R2,000

Variable expenses as a
percentage of sales

Thandi needs to sell R2,000 worth of food to break-even

 Pg 202 - 203 Break-even Point
Calculations

Contribution margin method (in units)

Break-even point (units) = Fixed costs + Profit

Contribution margin/unit
R0
Break-even point (units) = Fixed costs
Contribution margin/unit
Thandi wants to see if she can calculate the break-even point of her
business…
Contribution margin method (units)

Break-even point (units) = Fixed costs

Contribution margin/unit
R800
=
(R50 – R30)
R800
=
R20/unit
= 40 units

Thandi needs to sell 40 plates of food to break-even

 Pg 202 - 203 Break-even Point
Calculations

Contribution margin method (in total sales)

Break-even point (units) = Fixed costs + Profit

Contribution margin ratio
R0
Break-even point (units) = Fixed costs
Contribution margin ratio
Thandi wants to see if she can calculate the break-even point of her
business…
Contribution margin method (total sales)

Break-even point (units) = Fixed costs

Contribution margin ratio
R800
=
0.4
= R2,000

Thandi needs to sell R2,000 worth of food to break-even

 Target Using CVP formulas to determine
Profit the sales volume needed to
achieve a target profit
Analysis
Pg 205
 Pg 205 Target Profit Analysis
Calculations

Equation method (in total sales)

Variable Fixed
Revenue = + + Profit
expenses costs

The
profit
desired
Thandi wants to calculate how many plates she needs to sell in order
to generate profit of R1,000
Equation method (per unit)

Let “Q” be the number of units required to reach target profit

Revenue = Variable + Fixed + Profit
expenses costs
50Q = 30Q + 800 + 1,000
20Q = 1,800
Q = 90

Thandi needs to sell 90 plates of food to reach a target profit of R1,000

 Pg 205 Target Profit Analysis
Calculations

Contribution margin method (in total sales)

Break-even point (units) = Fixed costs + Target profit

Contribution margin ratio
Thandi wants to calculate how many plates she needs to sell in order
to generate profit of R1,000
Contribution margin method (per unit)

Number of units to = Fixed expenses + Target profit

reach target profit Contribution margin ratio
R800 + R1,000
=
R20/unit
= 90 units

Thandi needs to sell 90 plates of food to reach a target profit of R1,000

Margin Of The excess of budgeted (or
actual) sales over the break-even
Safety volume of sales

Pg 206
Pg 206 Margin Of Safety
Calculation

Margin of Break-even
= Revenue -
safety revenue
Thandi wants to find out by how much can her sales decrease before
she starts incurring losses…
Margin of safety

Margin of safety = Revenue - Break-even revenue

= 2,500 - 2,000
= R500

Thandi’s margin of safety is R500 or 10 plates of food

Pg 206 Margin Of Safety percentage
Calculation

Margin of =Margin of safety

safety % Revenue
Thandi wants to find out by how much can her sales decrease before
she starts incurring losses…
Margin of safety (% of sales)

Margin of safety % = Margin of safety

Revenue
R500
=
R2,500
= 20%

Thandi’s margin of safety is 20% of sales

Explaining how changes in
activity affect contribution
margin and profit
Thandi wonders what revenue she needs to generate to break-even…

Contribution Statement of Profit and Loss

Total Per unit
Revenue (50 plates) R2,500 R50/plate
Variable Costs R1,500 R30/plate
Contribution Margin R1,000 R20/plate
Fixed Costs R800
Profit/loss R200

Each month Thandi must generate at least R800 in contribution margin

to break even.
What would happen if Thandi only sold 40 plates?...

Contribution Statement of Profit and Loss

Total Per unit
Revenue (40 plates) R2,000 R50/plate
Variable Costs R1,200 R30/plate
Contribution Margin R800 R20/plate
Fixed Costs R800
Profit/loss R0

If Thandi sells 40 units in a month, it will be operating at the break-even

point (the level of sales at which profit is zero)
 Thandi notices a few things…

Contribution Statement of Profit and Loss

Total Per unit
Revenue (40 plates) R2,000 R50/plate
Variable Costs R1,200 R30/plate
Contribution Margin R800 R20/plate
Fixed Costs R800 Variable costs per unit
Profit/loss R0 remained unchanged

Total Fixed costs Total Variable costs changed

remained unchanged according to number of plates sold
 What if she sells 41 plates…?

Contribution Statement of Profit and Loss

Total Per unit
Revenue (41 plates) R2,050 R50/plate
Variable Costs R1,230 R30/plate
Contribution Margin R820 R20/plate
Fixed Costs R800
Profit/loss R20

Profit will increase by R20

 A social media influencer costs R100 per month. Thandi is considering
engaging an influencer to advertise her business. Thandi hopes that this
will increase her sales to 54 plates.
Contribution Statement of Profit and Loss
Current Future
(50 plates) (54 plates)
Change
Revenue R2,500 R2,700 R200
Variable Costs R1,500 R1,620 R120
Contribution Margin R1,000 R1,080 R80
Fixed Costs R800 R900 R100
Profit/loss R200 R180 R20

Although this would increase revenue by R200, it decreases profit by R20.

Some customers have asked Thandi to use basmati rice instead. They say if
she does this, they will bring 5 extra customers. Use of basmati rice
increase her variable costs by R2.
Contribution Statement of Profit and Loss
Current Future
(50 plates) (55plates)
Change
Revenue R2,500 R2,750 R250
Variable Costs R1,500 R1,760 R260
Contribution Margin R1,000 R990 R10
Fixed Costs R800 R800 R0
Profit/loss R200 R190 R10

Although this would increase revenue by R250, it decreases profit by R10.

The end