Accounting: Cost-Volume-Profit Analysis (PDF)

Chapter 10 Cost–volume–profit analysis ©2020 John Wiley & Sons Australia Ltd  Learning objectives After studying this presentation you should be able to: 10.1 define fixed, variable and mixed costs 10.2 prepare a break-even analysis for single-product and multi-product e...

Chapter 10 Cost–volume–profit analysis ©2020 John Wiley & Sons Australia Ltd  Learning objectives After studying this presentation you should be able to: 10.1 define fixed, variable and mixed costs 10.2 prepare a break-even analysis for single-product and multi-product entities 10.3 apply the contribution margin ratio to CVP calculations 10.4 explain the key assumptions underlying CVP analysis 10.5 discuss the uses of break-even data  Learning objectives 10.7 assess the profitability of output when there are resource limitations 10.8 assess relevant information for decision making 10.9 analyse an outsourcing decision 10.10 analyse a special order decision. Introduction to cost–volume–profit analysis Cost–volume–profit (CVP) analysis is concerned with the change in profits in response to changes in sales volumes, costs and prices. Helps answer the following questions: – How many units need to be sold, or services performed, to break even (for example, earn zero profit)? – What is the impact on profit of a change in the mix between fixed and variable costs?  Introduction to CVP analysis Helps answer the following questions: – How many units need to be sold, or services performed, to achieve a particular level of profit? – What is the impact on profit of a 15 per cent increase in costs?  Cost behaviour Examining cost behaviour enables us to consider: – the way in which costs change – the main factors that influence those changes. Costs can be classified as fixed, variable or mixed. An understanding of these is important for basic cost– volume–profit analysis: – investigate the change in profits in response to changes in sales volumes, costs and prices.  Cost behaviour Fixed, variable and mixed costs: – Fixed costs are those costs which remain the same in total (within a given range of activity and timeframe) irrespective of the level of activity (e.g. lease costs and depreciation charges). – When we consider levels of activity in terms of units of output: − total fixed costs remain the same − but, fixed costs per unit will decrease as the number of units produced increases.  Cost behaviour Fixed cost behaviour:  Cost behaviour Variable costs change in total as the level of activity changes. – For example: costs as ingredients for a food manufacturer fuel costs for a courier. Variable costs can be considered on either a total or unit basis.  Cost behaviour Variable cost behaviour:  Cost behaviour Fixed, variable and mixed costs: – The relevant range is the range of activity over which the cost behaviour is assumed to be valid. – If the activity level goes outside the relevant range, then the expected behaviour of costs changes can no longer be assumed to be fixed.  Cost behaviour Mixed cost behaviour:  Break-even analysis Break-even analysis relates to the calculation of the necessary levels of activity required in order to break even in a given period. Break-even occurs when total revenue and total costs are equal resulting in zero profit: Revenue = FC + VC  Break-even analysis Break-even analysis involves the contribution margin concept. Contribution margin is calculated by deducting total variable costs from total revenue. Contribution margin per unit can be calculated by deducting variable cost per unit from revenue per unit. Contribution margin = Revenue – VC  Break-even analysis Break-even analysis for a single product or service: Break-even calculation can be expressed as: 𝐅𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭𝐬 $ = x break-even (units or players) 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 (𝐨𝐫 𝐩𝐥𝐚𝐲𝐞𝐫) $  Break-even analysis Break-even analysis for a single product or service: The break-even point for ATC in number of players attending the championship is:  Break-even analysis Break-even analysis for a single product or service: – Units to earn a desired profit: 𝐅𝐢𝐱𝐞𝐝 𝐜𝐨𝐬𝐭𝐬 + 𝐝𝐞𝐬𝐢𝐫𝐞𝐝 𝐩𝐫𝐨𝐟𝐢𝐭 ($) = x sales units to earn a desired profit 𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭 ($) – Example 1: Expected profit (before tax) $600  Break-even analysis Break-even analysis for a single product or service: – Example 1: VC increased to $17 per unit FC reduced to $32 000 $ 𝟏𝟖𝟎𝟎 Break-even = = 45 units ( or players) $ 𝟒𝟎 Can also be expressed in an equation format: s(x) = vc(x) + fc (for break-even) s(x) = vc(x) + fc + p (for meeting desired profit)  Break-even analysis Break-even analysis for a single product or service: – Graphical representation of CVP:  Break-even analysis Break-even analysis for multiple products:  Break-even analysis Break-even analysis for multiple products:  Break-even analysis Break-even analysis for multiple products:  Break-even analysis Break-even analysis for multiple products:  Contribution margin ratio The contribution margin ratio can be express in 2 ways: 1. the percentage by which revenue exceeds VC 2. the CM expressed as a percentage of revenue.  Contribution margin ratio Example — contribution margin ratio: $𝟏𝟓𝟎 − $𝟗𝟎 CM ratio = = 0.40 or 40% $𝟏𝟓𝟎 $𝟏𝟖𝟎𝟎 = $4500 in sales (total parents’ contributions) 𝟎. 𝟒𝟎  CVP assumptions The behaviour of costs can be neatly classified as fixed or variable. Cost behaviour is linear. Fixed costs remain ‘fixed’ over the time period and/or a given range of activity. Unit price and cost data remain constant over the time period and relevant range. For multi-product entities, the sales mix between the products is constant.  Using break-even data Break-even data can be used to assist with a variety of decision situations, including: – identifying the number of products or services required to be sold to meet break-even or profit targets – planning products and allocating resources by focusing on those products that contribute more to profitability.  Using break-even data Break-even data can be used to assist with a variety of decision situations, including: – determining the impact on profit of changes in the mix of fixed and variable costs – pricing products.  Summary CVP analysis is an important part of the planning process and serves as a useful decision-making tool. An understanding of fixed, variable and mixed costs is necessary to execute break-even analysis. Break-even analysis can be conducted for single- product/service entities and multi-product/service entities.