Accounting and Management

ACCT 1003 – INTRO TO COST & MANAGEMENT ACCOUNTING

LECTURE NO. 5 CVP ANALYSIS

LESSON OBJECTIVES
1. Understand & explain what CVP business decisions it can aid 2. Appreciate the assumptions of CVP analysis 3. Calculate & Explain the significance of: • Contribution Margin • Break Even Point • Margin of Safety 4. Prepare and explain a CVP graph 5. Use CVP analysis to: • Plan Profits • Determine volume – given profit target • Perform Sensitivity Analysis 6. Incorporate Income Tax Rates in CVP analysis 7. Use CVP analysis in a multi product environment

CVP ANALYSIS
C V P - COST - VOLUME - PROFIT

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5 KEY ELEMENTS IN CVP ANALYSIS
• Uses basic concepts of cost behavior: Fixed Cost, Variable Cost, Linear Relationship etc. • CVP looks at the interrelationship between 5 key elements as they impact Operating Income
UNIT SELLING PRICE

VOLUME / ACTIVITY

SALES / PRODUCT MIX

UNIT VARIABLE COST

TOTAL FIXED COST

ASSUMPTIONS OF CVP
• Cost and Revenue behavior - linear throughout the relevant range • All costs are either variable or fixed • Changes in activity are the only factors that affect costs • All units produced are sold • When more than one type of product is sold, the sales mix will remain constant

BUSINESS APPLICATION OF CVP
Decisions where CVP analysis used • Break even point • Sales Level to achieve target profit • Optimum sales / product mix • Impact of changes in any of the 5 key elements • Impact of substituting Variable Cost with Fixed cost

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Contribution Margin
What is Contribution Margin:
• Revenue less Variable Cost • The Contribution Margin is used to cover Fixed Costs • In profitable organizations the following exists • Contribution Margin > FC + VC Formula to Calculate Contribution Margin:
Contribution Margin = Sales Revenue – Variable Costs

Contribution Margin
Contribution Income Statement: (the starting point to do CVP analysis)
Ø A statement for internal use Ø Classifies costs and expenses as fixed or