1. Cost volume profit analysis
Chapter 17
Cost volume profit analysis

2. Cost volume profit (CVP) analysis
A technique used to determine the effects of changes in an organisation’s sales volume on its costs, revenue and profit
Can be used in profit-seeking and not-for profit organisations
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

3. Slides prepared by Kim Langfield-Smith
The break-even point
The volume of sales where the total revenues and expenses are equal, and the operation breaks even
Can be calculated for an entire organisation or individual projects or activities
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

4. Slides prepared by Kim Langfield-Smith
Formulas
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
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5. Slides prepared by Kim Langfield-Smith
Terminology
Contribution margin (or variable costing) statement
A reporting format where costs are reported by cost behaviour and a contribution margin is calculated
Total contribution margin
The difference between the sales revenue and the variable costs
The amount available to cover fixed costs and then contribute to profits
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

6. Slides prepared by Kim Langfield-Smith
Terminology
Unit contribution margin
The difference between the sales price per unit and variable cost per unit
Contribution margin ratio
The unit contribution margin divided by the unit sales price
The proportion of each sales dollar available to cover fixed costs and earn a profit
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

7. Slides prepared by Kim Langfield-Smith
Terminology
Contribution margin percentage
The unit contribution margin ratio multiplied by 100
The percentage of each sales dollar available to cover fixed costs and earn a profit
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

8. Cost volume profit (CVP) graph
Shows how costs, revenue and profits change as sales volume changes
Five steps
Draw the fixed expense line
Draw the total expense line
Draw the total revenue line
Break-even point—where the total revenue and total expense lines intersect
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

9. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

10. Profit volume (PV) graph
Shows the total amount of profit or loss at different sales volumes
The graph intercept the vertical axis at the amount equal to the fixed costs
The break-even point is the point at which the line crosses the horizontal axis
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

11. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

12. Slides prepared by Kim Langfield-Smith
Target net profit
A desired profit level determined by management
Can be used within the break-even formula
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

13. CVP analysis and management decision making
Common applications include
Safety margin
Changes in fixed expenses
Changes in the unit contribution margin
Multiple changes in key variables
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

14. Slides prepared by Kim Langfield-Smith
Safety margin
Difference between the budgeted sales revenue and the break-even sales revenue
Gives a feel for how close projected operations are to the break-even point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

15. Changes in fixed expenses
When estimates of fixed costs are revised, the break-even point will change
Percentage change in fixed expenses will lead to similar increase in the break-even point (in units or dollars)
Different fixed costs may apply to different levels of sales/production volume
More than one break-even point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

16. Changes in the unit contribution margin
Change in unit variable expenses
Changes the unit contribution margin
A new break-even point
An increase in unit variable expenses will increase the break-even point
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

17. Changes in the unit contribution margin
Change in sales price
Changes the unit contribution margin
A new break-even point
An increase in unit price will lower the break-even point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

18. Multiple changes in key variables
May involve
Increasing unit prices
Undertaking an advertising campaign
Hiring a new storage facility
An incremental approach
Focuses on the difference in the total contribution margin, fixed expenses and profits under the two alternatives
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

19. CVP analysis with multiple products
Sales mix
The relative proportions of each type of product sold by the organisation
Weighted average unit contribution margin
The average of the products’ unit contribution margins, weighted by the sales mix
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

20. Including income taxes
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
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21. Assumptions underlying CVP analysis
The behaviour of total revenue is linear
The behaviour of total costs is linear over a relevant range
Costs can be categorised as fixed, variable or semivariable
Labour productivity, production technology and market conditions do not change
There are no capacity changes during the period under consideration
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

22. Assumptions underlying CVP analysis
For both variable and fixed costs, sales volume is the only cost driver
The sales mix remains constant over the relevant range
In manufacturing firms, levels of inventory at the beginning and end of the period are the same
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

23. CVP analysis and long-term decisions
CVP analysis is usually regarded a short-term or tactical decision tool
Classification of costs as variable or fixed is usually based on cost behaviour over the short-term
The financial impact of long-term decisions best analysed using capital budgeting techniques
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

24. Treating CVP analysis with caution
CVP analysis is merely a simplified model
The usefulness of CVP analysis may be greater in less complex smaller firms, or stand-alone projects
For larger firms, CVP analysis can be valuable as a decision tool for the planning stages of new projects and ventures
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

25. An activity-based approach to CVP analysis
ABC categorises activities as facility, product, batch or unit costs
Facility, product and batch activities are non-volume activity costs
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

26. Limiting assumption of using activity-based costs
Batch costs are based on likely production levels
New planned production levels lead to changes in the number of production batches, and changes in total non-volume activity costs -> new break-even or target profit volume
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

27. Sensitivity analysis and CVP analysis
An approach which examines how an outcome may change due to variations in the predicted data or underlying assumptions
Can be run using spreadsheet software, such as Excel
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
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28. Slides prepared by Kim Langfield-Smith
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

29. Sensitivity analysis and CVP analysis
Goal seeking approaches
Allows the analyst to specify the outcome, so that software can specify the necessary inputs
What-if analysis
The analyst specifies changes in assumptions to examine the effect of these changes on the output
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith

30. Slides prepared by Kim Langfield-Smith
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith