cvp analysis(2)
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Chapter 22
Cost-Volume-Profit Analysis
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Analysis
CVP analysis is a technique for studying the relationship betweencost, volume and profits. Examines the behavior of totalrevenues, total costs, and operating income as changes occur inthe output level, selling price, variable costs or fixed cost
It can be used to answer the questions like:
a. How much sales should be made to avoid the losses?
b. How much should be the sales to earn a desired profit?
c. What will be the effect of change in prices, costs and volume onprofits
d. Which product or product mix is most profitable?
e. Should we manufacture or buy some product or component?
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Assumptions of CVP
Analysis Expenses can be classified as either variable or fixed. CVP relationships are linear over a wide range of production and
sales. Sales prices, unit variable cost, and total fixed expenses will not vary
within the relevant range.
Volume is the only cost driver. The relevant range of volume is specified. Inventory levels will be unchanged. The sales mix remains unchanged during the period. revenues change in relation to production and sales
costs and prices are known if more than one product exists, the sales mix is constant we can ignore the time value of money
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Objectives Identify how changes in volume affect costs.
Use CVP analysis to compute breakeven point.
Use CVP analysis for profit planning and graph the
cost-volume-profit relations Use CVP method to perform sensitivity analysis.
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Contribution Margin Contribution margin is equal to the difference between total revenue and total
variable costs
Contribution margin per unit
= Selling price - Variable cost per unit
Contribution margin percentage= Contribution margin per unit / selling price per unit
Pages 68 - 69
Revenue 200400 100%
Variable costs 120240 60%
Contribution margin 80160 40%
Total for Per Unit 2 units %
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Contribution Margin
Income StatementSales
- Variable Costs
Contribution Margin
- Fixed CostsOperating Income
Sales (20,000 x 85) 1,700,000
Variable costs
(20,000 x 70) (1,400,000)Contribution margin 300,000
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Contribution Margin
Income Statement
Packages Sold
0 12 2540
Revenue 0200 4005,0008,000
Variable costs 0120 2403,0004,800
Contribution margin 080 1602,0003,200
Fixed costs 2,0002,0002,000 2,0002,000
Operating income (2,000)(1,920)(1,840) 01,200
Income statement that groups line items by cost behavior to highlight the contribution margin
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The unique sales level at which a
company earns neither a profit norincurs a loss.
Sales – Variable Costs – Fixed Costs = 0
Computing Break-Even
Point
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Breakeven Point Quantity of output where total revenues equal total costs
Point where operating income equals zero
Breakeven point in units
= Fixed costs / Contribution margin per unit
= 2,000 / 80
= 25 units
Breakeven point in Rupees
= Fixed costs / contribution margin %
= 2,000 / 40%
= 5,000 RS.
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Margin Of Safety Excess of actual or budgeted sales over
the break – even sales is known as MOS
MOS = Total Sales - sales at BEP
It can be improved by taking the followingsteps:
1. By increasing the level of production orselling price
2. By reducing fixed or variable cost.
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Angle of Incidence Is the angle between the sales line and the
total cost line formed at the break even point
where the sales line and the total cost lineintersects each other. It indicates the profit
earning capacity of a business.
A Large angle of incidence indicate a high
rate of profit and a small angle of incidence
indicates a low rate of profit
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Variable
Fixed
Mixed
Types of
Costs
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Minutes Talked
Total L
ongDista
nc
e
Tele
phone
Bill
Total variable costs changewhen activity changes.
Your total long distance
telephone bill is based
on how many minutes
you talk.
Total Variable Cost
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Minutes Talked
PerMinute
Telep h
oneCharg e
Variable costs per unit do not changeas activity increases.
The cost per longdistance
minute talked is
constant.
For example, 2 Rs. per minute.
Variable Cost Per Unit
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Number of Local Calls
MonthlyBa
sic
Telep
honeBill
Total fixed costs remain unchanged
when activity changes. Total Fixed Cost
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Variable Costs
Example
0 1 2 3 4 5
24 –
18 – 12 –
6 – ––––
Volume
(Thousands of passengers)
TotalVa
ria
(th
ousan
ds)
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Mixed Costs
Contain fixed portion that is incurredeven when facility is unused & variable
portion that increases with usage. Example: monthly electric utility
charge Fixed service fee
Variable charge per kilowatt hour used
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T o t a l
m i x e
d c o s
tVariable
Utility Charge
Activity (Kilowatt Hours)
Total
UtilityCos
t
Fixed Monthly
Utility Charge
Mixed Costs
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Volume in Units
Costs
and
Revenue
inDo
llars Total fixed costs
Plot total fixed costs on the vertical axis.
Preparing a CVP Chart
Total costs
Draw the total cost line with a slopeequal to the unit variable cost.
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Volume in Units
Costs
and
Revenue
inDo
llars Total fixed costs
Preparing a CVP Chart
Total costs
SalesStarting at the origin, draw the sales line
with a slope equal to the unit sales price.
Break-evenPoint
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Various Sales Levels
Example What operating income is expected when
sales are 80,000 units?
Selling price (20/unit) 16,00,000
Less: Variable exp (10/unit) 8,00,000
Contribution 8,00,000
Less: Fixed cost 4,00,000
Operating profit 4,00,000
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Computing MultiproductBreak-Even Point
Unit contribution margin is replacedwith contribution margin for a
composite unit. A composite unit is composed of
specific numbers of each product inproportion to the product sales mix.
Sales mix is the ratio of the volumesof the various products.
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The resulting break-even formulafor composite unit sales is:
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Computing MultiproductBreak-Even Point
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Break-even pointin composite units
Fixed costsContribution margin
per composite unit
=
Break-even point
in composite units
900,000
450 per composite
unit
=
Step 2: Compute break-even point in
composite units.
Computing MultiproductBreak-Even Point
Break-even point
in composite units
= 2,000 composite units
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Window Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution 75$ 150$
Sales Mix Ratio 4 1
Computing MultiproductBreak-Even Point
A company sells windows and doors. They sell 4 windows for every door.
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Sales Composite
Product Mix Units Units
Window 4 × 2,000 = 8,000Door 1 × 2,000 = 2,000
Step 3: Determine the number of windows and
doors that must be sold to break even.
Computing MultiproductBreak-Even Point
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Windows Doors CombinedSelling Price $200 $500
Variable Cost 125.00 350.00
Unit Contribution 75.00$ 150.00$
Sales Volume × 8,000 × 2,000 Tota l Contribution 600,000$ 300,000$ 900,000$
Fixed Costs 900,000
Income $ 0
Step 4: Verify the results.
Multiproduct Break-EvenIncome Statement