Cost Volume Profit Analysis (CVP) AFM 31130 STDM - Cost Volume Profit Analysis (CVP) By Isuru Manawadu B.Sc in Accounting Sp. (USJP), ACA, 1

Learning Outcomes After studying this session you will be able to: Understanding Marginal Costing Understand Absorption Costing Distinguish between marginal costing and absorption costing Determine BEP and margin of safety Prepare different types of break even charts

Marginal Costing Marginal costing is a costing technique where only variable or direct cost will be charged to the cost unit produced. In Marginal costing, fixed costs are never charged to production. They are treated as period charge and is written off to the comprehensive income statement (P & L) in the period incurred.

Marginal Costing Cont… Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for management's decision-making.

Assumptions of Marginal costing or CVP Analysis. Fixed cost will remain constant Operating efficiency will not increase or decrease There will not be any change in pricing policy due to change in volume, competition etc Semi variable cost can be segregated into variable and fixed elements Product mix will remain unchanged Price of variable cost factors (Such as wage rates, price of materials) will remain unchanged

Marginal cost – Cost of one additional unit of output Marginal cost per unit (The additional cost needed to produce one more unit of a good or service) = Direct Material cost per unit xx Direct Labor cost per unit xx Other Variable costs xx

Total cost of producing 10,000 units is Rs. 50,000/= Example: Total cost of producing 10,000 units is Rs. 50,000/= If the total production is 10,001 units the total cost is Rs. 50,005/= The Marginal cost of producing the next unit was Rs. 5/=

Absorption costing Absorption costing is that all manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method.

Absorption costing Cont… Absorption costing is often contrasted with variable costing or direct costing. Absorption costing is required for external financial reporting and for income tax reporting.

Cost classifications--Absorption versus Variable costing Absorption Costing Variable Costing Product cost Direct materials Direct Labor Variable Manufacturing overhead Fixed manufacturing overhead Period cost Variable selling and administrative expenses Fixed selling and administrative expenses Source – www.accontingformanagement.com

Exercise A small company that produces a single product has the following cost structure. No. of units produced 6,000 Variable costs per unit: Direct materials Rs. 2 Direct labor Rs. 4 Variable manufacturing overheads Rs. 1 Variable selling & Administrative expenses Rs. 3 Fixed cost per year: Fixed manufacturing overhead Rs. 30,000 Fixed selling & administrative expenses Rs. 10,000 1. Compute the unit product cost under absorption costing method. 2. Compute the unit product cost under marginal costing method.

Absorption Vs. Marginal Costing - Exercise Following details relate to the 100,000 units of product X produced and sold by ABC Ltd. during the year. Rs. Sales @ Rs. 10 per unit 1,000,000 Direct material @ Rs. 3 per unit 300,000 Direct labor @ Rs. 2 per unit 200,000 Variable overheads @ Rs. 1 per unit 100,000 Fixed overheads for the year Prepare the profit statements under marginal costing and under absorption costing.

Contribution = Selling price – Variable cost Contribution is the difference between sales And the marginal (Variable) cost Contribution = Selling price – Variable cost

Break Even Point (BEP) BEP (units) = Fixed cost Contribution per unit Break Even is the point where businesses are not making profits At this stage; TR = TC BEP (units) = Fixed cost Contribution per unit

Break Even Point (BEP) BEP (Sales value) = Fixed cost PV ratio

Profit Volume Ratio (PV) PV = Contribution X 100 Sales

Margin of Safety (MOS) MOS = Budgeted Sales − Break-even Sales In break-even analysis, margin of safety is the extent by which actual or projected sales exceed the break-even sales. It may be calculated simply as the difference between actual or projected sales and the break-even sales. formula to calculate margin of safety: MOS = Budgeted Sales − Break-even Sales

Use the following information to calculate: Contribution BEP in units BEP in sale value Margin of safety Sales price per unit Rs. 40 Variable cost per unit Rs. 32 Total fixed cost Rs. 7,000 Budgeted sales 1000 units