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Chapter 8 Updated Notes - CVP Analysis

Cost-volume-profit (CVP) analysis examines the relationships between costs, volume, and profit at different activity levels. It is used to determine the break-even point and profit or loss at various production volumes. The summary outlines key CVP concepts like contribution margin, contribution ratio, fixed costs, and how to calculate break-even point and margin of safety using relevant information.

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40 views

Chapter 8 Updated Notes - CVP Analysis

Cost-volume-profit (CVP) analysis examines the relationships between costs, volume, and profit at different activity levels. It is used to determine the break-even point and profit or loss at various production volumes. The summary outlines key CVP concepts like contribution margin, contribution ratio, fixed costs, and how to calculate break-even point and margin of safety using relevant information.

Uploaded by

kundiarshdeep
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 8: Cost-Volume-Profit (CVP) Analysis

Cost volume profit (CVP)/breakeven analysis is the study of the interrelationships between
costs, volume and profit at various levels of activity.

The management of an organisation usually wishes to know the profit likely to be made if the
aimed-for production and sales for the year are achieved. Management may also be interested to
know the following:
 The breakeven point, which is the activity level at which there is neither profit nor loss.
 The amount by which actual sales can fall below anticipated sales, without a loss being
incurred.

Breakeven Analysis Concepts and Formulae:


1. Contribution per unit = Selling price per unit – variable cost per unit.
NB: VC = MC

2. Profit, P = (Sales volume * Contribution per unit) – Fixed costs


P = (Cont. per unit) X – F
NB: X = Sales volume, and F = Fixed costs
(Cont. per unit) X = total contribution

3. Break – even point (in units) i.e. BEP (X) = Fixed costs/Contribution per unit
BEP (X) = F/Cont. per unit.
At the breakeven point, sales revenue = total costs and there is no profit. At the breakeven
point, total contribution = fixed costs.
4. Contribution/Sales ratio i.e. C/S ratio = Contribution/sales * 100%
The C/S ratio is a measure of how much contribution is earned from each $1 of sales.

5. Margin of safety (in units) = Budgeted sales or expected sales – BEP (X).
The margin of safety is a measure of how much budgeted sales can fall by before the break-
even point is reached. It is usually expressed as the percentage fall from budgeted production
that can be tolerated before falling in a loss.
Margin of safety (as a %) = Budgeted sales – BEP (X) * 100%
Budgeted sales
Illustration 1
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)?
Solution
BEP(X) = F/Cont. per unit = 120,000/(150 – 70) = 1,500 units
Illustration 2
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?
Solution
P = (Cont. per unit)X – F
= (90 - 50)1,500 – (20*2,000) = $20,000

NB: F = fixed cost per unit * budgeted production = 20*2,000u = 40,000

Illustration 3
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?
Solution
BEP(X) = F/Cont. per unit = 240,000/8 = 30,000u

MoS = Budgeted output or sales – BEP(X) = 50,000 – 30,000 = 20,000u

Break-even Charts and P/V Charts.


These charts display revenue, costs, profits and contribution in various formats.
The breakeven point can also be determined graphically using a breakeven chart or a
contribution breakeven chart. This is a chart which shows approximate levels of profit or loss
at different sales volume levels within a limited range.

The profit/volume (PV) chart is a variation of the breakeven chart which illustrates the
relationship of profits to sales.

A breakeven chart has the following axes:


 A horizontal axis showing the sales/output (in value or units)
 A vertical axis showing $ for sales revenues and costs

The basic break-even chart:


The budgeted profit is the difference between revenue and total costs at the budgeted volume of
sales.
To the left of the breakeven point, total costs exceed total revenue so a loss is made.
The margin of safety (in units) is the distance between the budgeted volume and the break-even
volume.

Contribution break-even chart:


You can see that at the break-even point, the contribution (revenue less variable costs) is equal to
the fixed costs.

The profit volume graph:

This graph allows you to immediately see the profit at any level of sales. It is not very helpful in
identifying the break-even point (which you would calculate before drawing the graph).

Illustration 4
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?
Solution:
C/S ratio = Cont. per unit/Selling price per unit = (24 – 15)/24 = 0.375 = 37.5%

Illustration 5

Solution
BEP(X) = F/Cont. per unit = 30,000/(15 - 5) = 3,000u

Illustration 6

a) What is the company’s break-even point to the nearest whole unit?


b) How many units must be sold if K Limited wants to achieve a profit of $11,000 for the year?
Solution
a)
BEP(X) = F/Cont. per unit
F = (4 + 0.8)10,000 = 48,000
Cont. per unit = SP – VC = 6 – (1.20+0.40) = 4.40
BEP(X) = 48,000/4.40 = 10,909 units

b)
P = (Cont. per unit)X – F
11,000 = 4.4X – 48,000
59,000 = 4.4X
X = 13,409u

Illustration 7

Solution
Variable cost per unit = 38,640/6,000 = 6.44
Selling price per unit = 84,000/6,000 = 14
P = (Cont. per unit)X – F
12,000 = (14 – 6.44)X – 39,975
12,000 = 7.56X – 39,975
X = 6,875 units

Sales revenue = selling price per unit * X


= 14 * 6,875 = $96,250

Illustration 8

Solution
MoS = Actual sales units – BEP(X)
Actual sales units = 140,000/10 = 14,000u
BEP(X) = F/Cont. per unit
NB: C/S ratio = Cont. per unit/Selling price per unit
0.4 = Cont. per unit/10
Cont. per unit = 0.4 * 10 = 4
BEP(X) = F/Cont. per unit = 48,000/4 = 12,000u
MoS = Actual sales units – BEP(X)
= 14,000 – 12,000 = 2,000u

Illustration 9

Solution
BEP(X) = F/Cont. per unit
6,000 = F/(90 - 40)
F = 6,000 * 50 = $300,000

Illustration 10

Solution
C/S ratio = Cont. per unit/Selling price per unit
Cont. per unit = Selling price per unit – Variable costs per unit
= 60 – (14+12+19) = 15
C/S ratio = 15/60 = 0.25 = 25%

Illustration 11

a) What sales revenue is required to earn a profit of $65,000?


b) How many sales units are required to earn a profit of $52,000?
Solution
a)
selling price per unit = 640,000/128,000 = 5
variable cost per unit = 384,000/128,000 = 3
P = (Cont. per unit)X – F
65,000 = (5 - 3)X – 210,000
65,000 = 2X – 210,000
275,000 = 2X
X = 137,500u
Sales revenue = selling price per unit * X = 5 * 137,500 = $687,500

b)
P = (Cont. per unit)X – F
52,000 = (5 - 3)X – 210,000
52,000 = 2X – 210,000
2X = 262,000
X = 131,000u

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