Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos

Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith

18-1

Chapter 18

Cost volume profit analysis


18-2

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 organisations and not-for-profit organisations

• Not confined to profit-seeking enterprises• Commonly used in many not-for-profit situations


18-3

The break-even point

• The volume of sales where the total revenues and expenses are equal, and the operation breaks even

• At this level of sales, there is no profit or loss• Can be calculated for an entire organisation or

individual projects


18-4

Formulas

ratiomargin on contributiUnit

costs Fixed =Rands) sales(in point even -Break

margin oncontributi Unit

costs Fixed =units) (in point even-Break


18-5

Terminology

• Contribution margin (or variable costing) statement– A profit report where costs are reported by cost behaviour

and a contribution margin is calculated– Fixed and variable costs are separated

• Total contribution margin– The difference between the total sales revenue and the

total variable costs– The amount available to cover fixed costs and then

contribute to profits

continued


18-6

Terminology

• Unit contribution margin– The difference between the sales price per unit and the

variable cost per unit

• Contribution margin ratio– The unit contribution margin divided by the unit sales

price– The proportion of each sales Rand available to cover

fixed costs and earn a profit

• Contribution margin percentage– The contribution margin ratio multiplied by 100– The percentage of each sales Rand available to cover

fixed costs and earn a profit


18-7

Projected revenues & costs at a theatre company (CTC)

Revenue

Price per ticket R 100.00Variable costs per ticket

Royalties R 18.75Theatre rental 16.25

R 35.00

Fixed costs of the play

Creative:

Director R 30,000Stage designer 25,000Lighting designer 12,500Extra artistic staff 5,000Actors 350,000

Pre-production:

Sets and props R 60,000Wardrobe 25,000Freight 7,500Stage management 89,000Set up and demolish stage 20,000

R 624,000


18-8

Break-even number of tickets

fixed costsunit contribution margin

R 624,000R 65

= 9,600

=

Break-even point (in units) =


18-9

Break-even point (in Rands)

• Unit Contribution margin = R100 – R35 = R65• Unit contribution margin as % of selling price =

R65/R100 = 0.65. Also called the unit contribution margin ratio.

R 624,0000.65

= R 960,000

Break-even point (in sales Rands) =fixed costs

unit contribution margin ratio

=

Break-even point (in Rands) =fixed costs

unit contribution margin/unit sales price


18-10

Cost-volume-profit graph for CTC


18-11

Profit volume (PV) graph

• Shows the total amount of profit or loss at different sales volumes

• The graph intercepts 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


18-12

Profit volume graph, CTC production of Calypso


18-13

Target net profit

• A desired profit level determined by management • Can be used within the break-even formula

marginon contributiUnit

profit target + expenses Fixed = volumesalesTarget


18-14

Target net profit

• Assume that the target profit for the theatre company is R70 000 (we will use R70 005 to avoid rounding differences)

R 624,000 + R 70,005R 65

= 10,677 units

=

Target sales volume (in units) =fixed costs + target profitunit contribution margin


18-15

Using CVP analysis for management decision making

• Common applications include– Safety margin– Changes in fixed expenses– Changes in the unit contribution margin– Multiple changes in key variables


18-16

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


18-17

Changes in fixed costs

• When estimates of fixed costs are revised, the break-even point will change– Percentage change in fixed expenses will lead to a

similar increase in the break-even point (in units or Rands)

• Different fixed costs may apply to different levels of sales/production volume– More than one break-even point


18-18

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

• 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

continued


18-19

Change in variable cost per ticketOriginal estimate New estimate

Variable costs per ticket R 35.00 R 41.25

Unit contribution margin per ticket R 65.00 R 58.75

R 624,000 R 624,000R 65.00 R 58.75

Break-even point (units ie. No. of tickets) = 9,600 10,622 [rounded-up]

Price x R 100.00 R 100.00

Break-even point (Rands) R 960,000 R 1,062,200 *

Break-even calculation

* If we use a contribution margin of 0.5875, then B/E (Rands) = R664000/0.5875 = R1062128 (slight difference due to rounding)


18-20

Change in selling price & fixed costs

R 100.00 R 90.00

Sales revenue:

Currently 10,032 x R 100.00 R 1,003,200

New 12,500 x R 90.00 R 1,125,000

Less Variable costs:

Currently 10,032 x R 35.00 R 351,120

New 12,500 x R 35.00 R 437,500

Total contribution margin R 652,080 R 687,500

Less Fixed costs of the play R 624,000 R 650,000

Profit R 28,080 R 37,500

Ticket price


18-21

Cost volume profit graph with step-fixed costs, CTC production of Calypso


18-22

Multiple changes in key variables

• May involve– Increasing unit prices – Increasing selling prices– Undertaking a new advertising campaign– Leasing a new office

• An incremental approach to analysis– Focuses on the differences in the total contribution

margin, fixed expenses and profits under the two alternatives


18-23

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

margin oncontributi unit average Weighted

expenses Fixed=point even-Break


18-24

CVP Analysis with multiple products

• Weighted average unit contribution margin = (R90 x 75%) + (R50 x 25%) = R80

• Break-even

R 624,000R 80.00

= 7,800 tickets

fixed costsweighted average unit contribution margin

=

Break-even point =

Seat type Unit ticket price Unit variable costUnit contribution

marginNumber of seats

in theatreA R 125 R 35 R 90 495

B R 85 R 35 R 50 165


18-25

Profit volume graph with multiple products, CTC production of Calypso


18-26

Including income taxes in CVP analysis

margin oncontributi unit

)-(1

tax after profit net target + costs Fixed

=

profittax -after target earn to required volume Sales

t


18-27

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


18-28

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, the levels of inventory at the beginning and end of the period are the same– Thus, the number of units produced and sold during a

period are equal


18-29

CVP analysis and long-term decisions

• CVP analysis is usually regarded as 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 is best analysed using capital budgeting techniques– Takes into account the time value of money


18-30

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


18-31

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

unit per costs-unit per price Selling

costs levelfacility and product batch, Total=point even-Break


18-32

Limiting assumptions of CVP analysis using activity-based costs• Total batch level costs are dependent on the batch

size and the break-even/target production level• Management may change the batch size at certain

production volume levels and this will change the break-even volume

• More complex models are needed where there are multiple products


18-33

Including customer-related costs in CVP analysis

• Some ABC systems include customer-related costs– Order level

– Customer level

– Market level

– Facility level

costs) levelfacility costs levelmarket

costs levelcustomer costs levelorder costs levelproduct

costs levelbatch costs level(unit - revenue sales Profit


18-34

Sensitivity analysis and CVP analysis

• Sensitivity analysis– An approach that 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

• Goal seek approaches– The analyst specifies the outcome, and the software

specifies the necessary inputs

• What-if analysis– The analyst specifies changes in assumptions and data

to examine the effect of these changes on the outputscontinued


18-35

Simple sensitivity analysis at KubiliTime


18-36

Customer-related costs at KubiliTime Pty Ltd

Activity levelCost per

activity (cost) driver

Volume of activity (cost)

drivers

Estimated cost

Order R 7.50 15,000 112,500

Customer R 30.00 8,000 240,000

Market R 47,500 1 47,500

Facility 744,000

Total cost 1,144,000


18-37

Profit model for KubiliTime under activity-based costing


18-38

Real life

• CVP analysis in the hotel sector– High occupancy rates– Lower fixed costs, IT & internet bookings has reduced

the break-even occupancy rate

• Reducing the break-even cost of mining gold at Gold Fields, was one of the reasons for the failed take-over attempt by Harmony of Gold Fields

MinesBreakeven price per

kg under GF management

Breakeven price per kg under HAR management

Breakeven price in $ per oz. under GF

management

Breakeven price in $ per oz. under HAR

managementDriefontein

9# R 97,382 R 82,775 $432 $3685# R 85,057 R 72,298 $378 $321

Kloof

Kea R 89,056 R 75,698 $395 $336EBA R 86,198 R 73,268 $383 $325


18-39

Real life• Break-even at ATMS

– Decision to install an ATM driven by its break-even– Revenue depends on fees from the different types of transactions. Estimate the mix of

transactions to determine the revenue mix– Fixed costs include installation, rent & depreciation and planned maintenance– Variable costs include paper, replacing deposit envelopes, variable component of communications

costs and costs of physical cash management

• Break-even of a major radiation medicine centre– Advanced radiation and diagnostic equipment at cost of $96m– Revenue mix and number of patients– International and local patients

• Break-even in the airline industry– Break-even of A380 increased from 270 to 420 planes for the Airbus Co.– Boeing’s Dreamliner uses less fuel than comparable planes resulting in over 700 orders– Both the A380 and the Dreamliner have been subject to delays which increases the break-even

number of planes– Break-even load factor is about 70% but SAA moved from the Boeing 747 to the A340 as SAA

estimated that this would reduce the break-even load factor from 70% to 55% at the time.

• Break-even for wine producers in South Africa– Production cost (in 2001) amounted to R9933 per hectare. If a farm achieves a recovery of 773

litres of wine per ton of grapes and if the farm was producing 10 tons per hectare, then the cost of production was about R1.28 per litre

– Add cellar costs of R0.93 per litre– Yet the average selling price for bulk wine was about R1.25 per litre at the time.– Break-even depends on the yield of grapes per hectare– For branded bottled wines, we need to take into account the bottling costs, the marketing costs,

storage and financing costs

Documents

Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos