ACCOUNTING A CCOUNTING COST-VOLUME-PROFIT ANA A NAL L YSIS NOTES AND A ND QUESTIONS
CONTENTS TOPIC
PAGE
SECTION ONE INTRODUCTION TO CVP ANALYSIS ANALYSIS ............... 2
Purpose Of Cost-Volume-Profit Analysis ...................................................................... 2 CVP Elements ............................................................................................................... 2 Variable Costs C osts ........................................................... ............................. ........................................................... .............................................................. ................................. 2 Fixed Costs .......................................................... ............................ ........................................................... ................................................................... ...................................... 2 Relevant Range ...................................................................................................................... 3 Mixed Costs Or Semi-Variable Costs ..................................................................................... 4 Total Costs .......................................................... ............................. ........................................................... .................................................................... ...................................... 4 Total Revenue Re venue ........................................................... ............................. ........................................................... .............................................................. ................................. 4 Contribution Margin ......................................................... ........................... ............................................................ ........................................................ .......................... 4 Profit.......................................................... ............................ ........................................................... ........................................................... ................................................. ................... 5 Break-Even Point ..................................................... ............................................................... .............................. ................................. 5 Margin Of Safety ................................................. ........................................................... ............................. ....................................... ......... 5 Exercise 1.1 ............................................................................................................................ 6 Exercise 1.2 ............................................................................................................................ 6 SECTION TWO CALCULATING BREAK-EVEN AND A TARGET LEVEL OF PROFIT........................ ............ ......................... .......................... .......................... ................... ...... 7
Contribution Margin Technique ..................................................................................... 7 Calculate The Number Of Units At Break-Even Point ........................................................ .......................... ................................... ..... 7 Calculate The Sales Dollars At Break-Even Point .......................................... ............. ..................................................... ........................ 7 Calculate The Number Of Units To Achieve A Target Level Of Profit........................... Profit..................................... .......... 8 Calculate The Sales Dollars To Achieve A Target Level Le vel Of Profit .......................................... 8
Equation Approach ....................................................................................................... 9 Calculate The Number Of Units At Break-Even Point ........................................................ .......................... ................................... ..... 9 Calculate The Sales Dollars At Break-Even Point .......................................... ............. ..................................................... ........................ 9 Calculate The Number Of Units To Achieve A Target Level Of Profit........................... Profit................................... ........ 10 Calculate The Sales Dollars To Achieve A Target Level Le vel Of Profit ........................................ 10 Exercise 2.1 .......................................................................................................................... 11 Exercise 2.2 .......................................................................................................................... 12 Exercise 2.3 .......................................................................................................................... 12 Exercise 2.4 .......................................................................................................................... 13 Exercise 2.5 .......................................................................................................................... 14 Exercise 2.6 .......................................................................................................................... 15 Exercise 2.7 .......................................................................................................................... 17 GOALS CHECKLIST - ARE YOU ABLE TO DO THE FOLLOWING? ........................... .............. ........................... ........................... ........................... .................... ...... 18
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SECTION ONE INTRODUCTION TO CVP ANALYSIS
PURPOSE OF COST-VOLUME-PROFIT ANALYSIS
This analysis is a technique used in order to make decisions in decisions in the business. It is part of management accounting. It examines how changes changes in costs and volume volume affect affect a business’s revenue and profit.
CVP ELEMENTS Costs are normally defined by how they will change in relation to changes in volume and sales e.g. Variable or fixed costs. VARIABLE COSTS
These costs will will change as the volume of production production and sales changes. changes.
E.g.
Materials, wages of factory staff
I.e. As a manufacturer’s garden tables and chairs production and sales increases, the cost of materials (e.g. wood for the table and chairs) will increase. Formula: VC = VC per unit x number of units produced
FIXED COSTS Max capacity (0-25)
These costs costs will stay the same (constant) (constant) as the volume of production and sales changes. E.g. Salaries of office staff, rent of factory I.e. As the manufacturer’s garden tables and chairs production and sales increases, the cost of the factory rent or the manager’s salary will stay constant (fixed).
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Variable cost $
$
Fixed cost
Q
Q
(Max capacit ) (0-25)
RELEVANT RANGE Be ond/over—FC The relevant range is the range of production over which costs are being measured.
E.g. to produce 0 - 100,000 manufacturer’s garden tables and and chairs the fixed costs are $50,000.
Most fixed costs can only be constant for a certain period i.e. period i.e. a relevant range.
Thereafter that cost goes onto a higher level.
E.g.
Factory Rent
I.e. As production increases the factory rent will stay constant. At a certain stage, however, to produce more than more than the relevant range you will need to rent another factory. So from that point onwards, the cost of rent will increased. Thus rent will will stay fixed (constant) (constant) only over over a relevant period.
Fixed over 3 relevant ranges 3000 $ (rent) 2000 1000 100
200 Q (unit (unit s)
300
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MIXED COSTS OR SEMI-VARIABLE COSTS
These are costs that have both a fixed cost fixed cost portion and a variable cost variable cost portion. Refer to the following examples:
A salesman salesman who is paid a basic salary as well as a commission commission on sales. The basic salary is the fixed cost while the commission is the variable cost. The cost cost of a land-line telephone. The rental rental is fixed and includes making calls calls in the local calling area but making toll calls (calls outside the local calling area) are charged for so these are variable costs.
VC (commission) VC (commission)
$ FC (basic FC (basic salary) Q TOTAL COSTS
All costs of production Formula: TC = FC + (VC per Unit x Units)
TOTAL REVENUE
Total dollar amount earned from sales Formula: TR = Selling Price x Units Sold
CONTRIBUTION MARGIN The difference between the total revenue and the variable cost is called the contribution margin. This is because this is the amount that contributes towards covering the fixed f ixed costs and any profit that the business will make. It is also known as the variable the variable profit .
Contribution Margin = Selling Price – Variable Cost
=$100-$70 =$30
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FC+VC
PROFIT =TR-TC
Formula:
Profit = Total Revenue minus Total Costs = SP(x) – (FC + VC(x))
Formula:
Profit = (Quantity x Contribution Margin) – Fixed Costs
BREAK -EVEN POINT POINT =TR=TC(no P/L)
TR – TC = 0 i.e. no profit. A business business will want want to find out out the point, which shows where total revenue is equal to equal to total total costs. costs . Any sales quantity less than this point would indicate a loss is made. Any sales quantity more than this point will indicate a profit is profit is made. This point point is called break-even break-even point and indicates where the profit is zero/nil (0).
MARGIN OF SAFETY
a) Units
The aim is to produce produce and sell more than the break-even quantity, so as to include a safety margin (i.e. if production and sales drop, one would still be at a point above the break-even point). The margin of safety can be be calculated calculated in units or as a percentage: =
Actual (or expected) Sales – Breakeven Sales
b) Percentage or Ratio =
Actual (or expected) Sales – Breakeven Sales Actual (or expected) Sales
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X 100
EXERCISE 1.1 Classify the following expenses as either fixed, variable or mixed (semi-variable). Expenses
Type
Salaries Raw Materials Rent Wages Interest Insurance Accountants’ Fees Delivery Costs Electricity Telephone Expense Depreciation (Straight Line or Diminishing Dimi nishing Value) EXERCISE 1.2 Dotty West makes widgets. She has provided you with the following details for last year: Selling price per widget
$25
Salaries
$60,000
Raw Materials per widget
$10
Labour per unit
$5
Rent
$12,000
Total units sold
30,000
Break-even quantity
25,000
Calculate the following: WORKINGS Total Revenue Total Variable Costs Total Contribution Margin Total Fixed Costs Profit Margin of Safety (%)
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ANSWER
SECTION TWO CALCULATING BREAK-EVEN AND A TARGET LEVEL OF PROFIT
CONTRIBUTION MARGIN TECHNIQUE CALCULATE CALCUL ATE THE NUMBER OF UNITS AT BREAK -EVEN POINT POINT
(1) =
Fixed Costs Contribution Margin per unit level of sales (units to break-even)
Contribution margin/unit = Selling Price per unit – Variable Cost per unit CALCULATE THE SALES DOLLARS AT BREAK-EVEN POINT
(2).Level of sales (units) to break-even x selling price
= level of sales ($) ($)
Example 1: A product has a selling price of $15.50, $15.50, a variable cost of $8.00 and a fixed cost cost of $1,050.00. What is the break-even quantity? What is the break-even in sales dollars?
Break-even quantity: $15.50 - $8.00 = $7.50 = contribution margin/unit $1,050.00 $7.50
=
140 140 unit s E.g:pens
Break-even Break-even in sales doll ars: 140 units x $15.50
=
$2,170.00
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CALCUL ATE THE NUMBER OF UNITS TO TO ACHIEVE A TARGET LEVEL OF PROFIT (3).CALCULATE Fixed Cost Cost s + Prof Prof it Contribution Margin per unit = level level o f sales (units to reach the target target level of pr ofit) CALCULATE CALCUL ATE THE SALES DOLLARS DOLL ARS TO ACHIEVE A TARGET LEVEL OF PROFIT PROFIT
(4).Level of sales (units) x selling price
= level of sales ($)
Example 2: A product has a selling price of $15.50, $15.50, a variable cost of $8.00 and a fixed cost cost of $1,050.00. How many units need to be sold to reach a target profit of $3,000.00? What will be the sales dollars to achieve a profit of $3,000.00? Quantity Quantity t o reach target target level of prof it: $15.50 - $8.00 = $7.50 = contribution margin/unit $1,050.00 + $3,000.00 $7.50
=
540 units
Break-even Break-even in sales doll ars: 540 units x $15.50
=
$8,370
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EQUATION APPROACH CALCULATE CALCUL ATE THE NUMBER OF UNITS AT BREAK -EVEN POINT POINT Use the formula to find x. TR = TC
[Total Revenue = Total Costs]
SP(x) = FC + VC(x) Selling price x quantity = Fixed Costs + (Variable costs x quantity)
CALCULATE THE SALES DOLLARS AT BREAK-EVEN POINT Level of sales (units) to break-even x selling price = level of sales ($) ($) Example Exampl e 1: 1: A product has a selling price of $15.50, $15.50, a variable cost of $8.00 and a fixed cost cost of $1,050.00. What is the break-even quantity? What is the break-even in sales dollars? Break-even quantity: $15.50(x) = $1,050.00 + $8.00(x) $15.50(x) – $8.00(x) = $1,050.00 $7.50(x) = $1,050.00 Break-even = 140 140 units Break-even Break-even in sales doll ars: 140 units x $15.50 = $2,170
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CALCULATE CALCUL ATE THE NUMBER OF UNITS TO TO ACHIEVE A TARGET LEVEL OF PROFIT
SP(x) = FC + VC(x) + Profit
CALCULATE CALCUL ATE THE SALES DOLLARS DOLL ARS TO ACHIEVE A TARGET LEVEL OF PROFIT PROFIT Level of sales (units) x selling price = level of sales ($) Example 2: A product has a selling price of $15.50, $15.50, a variable cost of $8.00 and a fixed cost cost of $1,050.00. How many units need to be sold to reach a target profit of $3,000? What will be the sales dollars to achieve a profit of $3,000.00? Quantity Quantity t o reach target target level of prof it: $15.50(x) = $1,050.00 + $8.00(x) + $3,000.00 $15.50(x) - $8.00(x) = $4,050.00 $7.50(x) = $4,050.00 Break-even = 540 540 units Break-even Break-even in sales doll ars: 540 units x $15.50 = $8,370
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EXERCISE 2.1 Coveny Manufacturers Ltd produces and sells a single product. The following information is provided. Selling price Variable Cost Total Fixed Cost
$30 per unit $18 per unit $300,000 per year
1. Calculate the the break-even break-even point point in units
2. Calculate the the break-even break-even point in sales dollars
3. Calculate the units the company company need to sell to make make $60,000 profit.
4. Calculate the profit if 60,000 units are sold sold (use an equation).
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EXERCISE 2.2 Borich Limited is a manufacturing company. They provide you with the following information: Manufacturing capacity – 3,000 units Fixed overhead costs are $12,000 per month Variables costs are Direct materials $8, Direct labour $3 and Variable overhead costs $1 (per unit) 1. How many units would would the company need to sell each each month to break-even break-even if these units were sold for $20 each?
2. How many units would would the firm need to sell to make a profit of $10,000 per month?
EXERCISE 2.3 Burners Ltd manufactures stoves. They supply the following information: Revenue and costs per unit ($): Price 150 Material cost 50 Labour cost 25 Other variable costs 10 Fixed costs ($) 96,200 Maximum Capacity of the firm 4,000 stoves 1. Calculate the break-even break-even quantity quantity for Burners.
2. If the firm operates operates at 50% capacity what level of profit will be earned? earned?
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EXERCISE 2.4 Cee Dee Ltd distributes CDs and has supplied you with the following information: Royalty payments to musicians Raw materials Labour
$ per CD 5 4 5
Rent & rates Manager’s salary
$ annually 50,000 60,000
Selling price per CD
$30
1. Calculate the break-even quantity for Cee Dee Dee Ltd
2. Calculate the profit/loss made if 6,000 CDs are sold?
3. How many CDs would need to be sold to earn a profit of $20,000? __________________________ _______________________________________ ___________________________ ____________________________ _________________ ___
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EXERCISE 2.5 Smith Ltd is a manufacturing firm that produces a single product. The details following relate to that product: Selling Price $20 per unit Variable Cost $14 per unit Total Fixed Costs $120,000 Relevant Range 0 => 30,000 units 1. Calculate the breakeven breakeven units units and sales.
2. Calculate the volume of sales (in units and dollars) to give a profit of $24,000.
3. Calculate the profit if the sales are $600,000.
4. The profit for the period at the current level of of sales is expected expected to be $24,000. $24,000. Smith Ltd has been asked to accept an order for a further 10,000 units at a price of $16. The manager does not want to accept the order because the price is less than the average cost per unit. Make a recommendation as to whether he should accept the order or not. Justify your suggestion.
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EXERCISE 2.6 Ace-Kool Ice Cream Ltd operates a chain chain of stores selling ice cream products. products. The company is considering opening a new store in a new location. The following data is collected: Av erag e sel li ng pr ic e per li tr e of ic e cr eam $ 2.56 Variable cost per litre Ice cream Cups, cones, toppings Total Variable Cost (per uni t)
$ 1.34 0.58 $ 1.92 1.92
Fixed costs per month: Rent Other sundry items Wages of employees Manager’s base salary Other fixed costs Total Fixed Cost
$ 400 120 1,330 400 150 $2,400 $2,400
Required: To develop the basis for a decision, consider each of the following. (Do all the following questions as follow through i.e. through i.e. any changes are carried through to all questions): 1. What is the monthly monthly break-even point, point, expressed both both in litres of ice cream cream and in dollars of sales?
2. If the rent were increased increased to $1,200 per per month, what would the new break-even break-even point in dollars and litres be?
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3. If the cost of ice cream cream increased to $1.66, what would the the new break-even point in dollars and litres be?
4. If the manager were to be paid a commission commission of 2 cents cents per litre for each litre sold beyond the break-even point, what profit would the store earn at a volume of 15,000 litres?
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EXERCISE 2.7 NZIC students have decided to have an evening to promote their college. Staff members and parents have been invited. Students will pay $5 per ticket and it is expected that 100 will attend. Each student will bring one parent and 20 staff members have accepted the invitations. The staff members are not expected to pay (of course not!), but there has been disagreement over whether or not parents should be charged. You establish the following costs will be incurred: Supper and refreshments (per person) Hire of hall Advertising & ticket costs
$2 50 40
1. Calculate the total revenue and total costs costs for the evening evening if parents parents are admitted free.
2. Calculate the amount amount each student will will have to pay for for the function to break-even if parents are admitted free.
3. The principal of NZIC has agreed to pay for the hire of the hall if 10 Chinese education education agents are allowed allowed to attend free of charge. charge. What would the price of the student ticket be to break-even if:
Parents attend free?
Parents pay $1 per ticket?
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Have you checked out the activities on Language Perfect? PAGE 17
GOALS CHECKLIST - ARE YOU ABLE TO DO THE FOLLOWING?
1 Identify and explain why costs are fixed, fixed, variable, variable, semi-variable. semi-variable. 2 Explain what is meant by the “relevant “relevant range” and the significance of this. 3 Calculate total revenue, total costs and profit. 4 Explain what is meant by the break-even point. 5 Explain what is meant by the margin of safety. 6 Calculate the contribution contribution margin per per unit (selling price less variable cost). 7 Calculate break-even in quantity quantity (number (number of units) and and in sales dollars (total revenue). 8 Calculate the quantity (number (number of units) units) needed to be sold to make a given level of profit. 9 Calculate the sales dollars (total revenue) to make a given level of of profit.
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