Professional Development Programme on Enriching Knowledge of the
Business, Accounting and Financial Studies (BAFS) Curriculum
Course 1 : Contemporary Perspectives on Accounting
Unit 8 : Cost Accounting for Decision Making 1
Technology Education Section, Curriculum Development Institute
Education Bureau, HKSARG
August 2008
Learning objectives
On completion of this unit, you should be able to:
• Explain the objective and assumptions of cost-volumeprofit (CVP) analysis.
• Calculate and explain the break-even point (BEP) and
revenue, contribution/sales (CS) ratio, margin of safety
(MOS) and target profit.
• Construct break-even chart, contribution chart and profitvolume chart.
• Assess the effects of changes in costs, selling price and
units sold on the break-even point and target profit.
• Explain the limitations of CVP analysis.
2
1
Organisation of Unit 8
Cost-volume-profit (CVP) analysis
Introduction
and objective
Assumptions
Mathematical
approach:
- break-even point
- contribution to
sales ratio
- margin of safety
- target profit
Example 1
Graphical
approach:
- break-even chart
- contribution chart
- profit-volume chart
Effects of changes in
cost, selling price
and units sold on the
break-even point
and target profit
Example 3
Example 4
Example 2
Limitations of CVP analysis
3
Introduction and objective (1)
• CVP analysis uses basically the principles of
•
4
marginal costing and is an important short-term
planning tool.
It explores the relationship, which exists between
costs, revenue, output levels and resulting profit.
Introduction and objective (2)
• CVP analysis is useful for short-term decision
making in that it can assist managers to predict
the profits by incorporating changes in total fixed
costs, selling price per unit, unit variable cost and
units sold.
5
Assumptions of CVP analysis (1)
• Total costs can be separated into variable
costs and fixed costs.
• Total revenues and total costs are linear
within the relevant range.
• Unit selling price, unit variable costs and
fixed costs are known and constant.
• Volume is the only determinant of cost and
revenue changes.
6
Assumptions of CVP analysis (2)
• The technology and efficiency remain
unchanged.
• The company sells only single product or
there is a constant sales mix.
• The time value of money is ignored.
7
BEP, C/S ratio, MOS and
target profit (1)
• CVP analysis is also known as break-even
•
•
8
analysis.
Break-even point (BEP) means the level of sales
in units or in dollars that produces neither profit
nor loss.
Margin of safety (MOS) is the extent to which the
planned volume of sales lies above the breakeven
point. MOS can be expressed in %, units or sales
in dollars.
BEP, C/S ratio, MOS and
target profit (2)
• CVP analysis can be undertaken by simple
formulas, which are listed below:
Break-even point (in units)
= Fixed costs ÷ Contribution per unit
9
BEP, C/S ratio, MOS and
target profit (3)
Break-even revenue
= Fixed costs ÷ Contribution per unit x Sales
price per unit, OR
= Fixed costs ÷ Contribution/sales (C/S) ratio
= Contribution per unit ÷ Sales price per unit x
100%
10
BEP, C/S ratio, MOS and
target profit (4)
Margin of safety (in units or in %)
= Planned sales (in units) – Break-even
point (in units), OR
= [Planned sales (in units) – Break-even
point (in units)] ÷ Planned sales (in
units) x 100%
11
BEP, C/S ratio, MOS and
target profit (5)
Margin of safety (in $ or in %)
= Planned sales (in $) – Break-even
point (in $), OR
= [Planned sales (in $) – Break- even
point (in $)] ÷ Planned sales ($) x
100%
12
BEP, C/S ratio, MOS and
target profit (6)
Level of sales to result in target profit (in units)
= (Fixed costs + Target profit) ÷ Contribution per
unit
Level of sales to result in target profit (in $)
= (Fixed costs + Target profit) x Sales price per
unit ÷ Contribution per unit
13
Example 1 (1)
Chai Wan Limited makes and sells wooden chairs
with sales price of $30 and variable cost of $18
per unit. The fixed costs for a month are
$360,000.
Required:
Calculate:
a. Break-even point (in units),
b. Break-even point (in $ sales), and
c. Contribution/sales (C/S) ratio.
14
Example 1 (2)
Solution:
Contribution per unit = Selling price – variable cost
15
Example 1 (3)
Solution:
Contribution per unit = Selling price – variable cost
= $30 - $18
= $12
16
Example 1 (4)
Solution:
a. Break-even point (in units)
= Fixed costs ÷ Contribution per unit
17
Example 1 (5)
Solution:
a. Break-even point (in units)
= Fixed costs ÷ Contribution per unit
= $360,000 ÷ $12
= 30,000 units per month
18
Example 1 (6)
b. Break-even point (in $ sales)
= BE units x unit selling price
19
Example 1 (7)
b. Break-even point (in $ sales)
= BE units x unit selling price
= 30,000 x $30
= $900,000
20
Example 1 (8)
c. C/S ratio
= Unit contribution ÷ unit selling price x 100%
21
Example 1 (9)
c. C/S ratio
= Unit contribution ÷ unit selling price x 100%
= $(12 ÷ 30) x100%
= 40%
22
Example 2 (1)
Use the information in Example 1. The general
manager of Chai Wan Limited plans to make and
sell 40,000 wooden chairs next month.
Required:
a. Calculate and explain the margin of safety (in
units, in dollar sales and in %) for next month.
b. If the general manager wants to achieve a
profit of $300,000 next month, what number
of units will need to be sold?
c. What level of sales will achieve a profit of
$300,000 next month?
23
Example 2 (2)
Solution:
a. Margin of safety (in units)
= Planned sales (in units) – Break-even
point (in units)
24
Example 2 (3)
Solution:
a. Margin of safety (in units)
= Planned sales (in units) – Break-even
point (in units)
= (40,000 – 30,000) units
= 10,000 units
25
Example 2 (4)
Solution:
a. Margin of safety (in sales)
= Planned sales (in $) – Break-even
point (in $)
26
Example 2 (5)
Solution:
a. Margin of safety (in $ sales)
= Planned sales (in $) – Break-even
point (in $)
= $1,200,000 - $900,000
= $300,000
27
Example 2 (6)
Solution:
a. Margin of safety (in %)
= [Planned sales (in units/$) – Break-even
point (in units/$)] ÷ Planned sales (in
units/$) x 100%
28
Example 2 (7)
Solution:
a. Margin of safety (in %)
= [Planned sales (in units/$) – Break-even
point (in units/$)] ÷ Planned sales (in
units/$) x 100%
=(10,000 ÷ 40,000) units x 100%
= 25%, OR
= $(300,000 ÷ 1,200,000) x 100%
= 25%
29
Example 2 (8)
The margin of safety in next month is 10,000
units (or sales value $300,000) or 25%. It
means that if the actual volume of sales drop
more than 10,000 units (or sales value $300,000)
or 25% from its planned sales of 40,000 units,
the company will suffer a loss.
30
Example 2 (9)
b. Number of units for target profit
= (Fixed costs + target profit) ÷ unit contribution
31
Example 2 (10)
b. Number of units for target profit
= (Fixed costs + target profit) ÷ unit contribution
= $(360,000 + 300,000) ÷ $12
= 55,000 units
32
Example 2 (11)
c. Sales for units for target profit
= (Fixed costs + target profit) ÷ unit
contribution x unit selling price
33
Example 2 (12)
c. Sales for units for target profit
= (Fixed costs + target profit) ÷ unit
contribution x unit selling price
= $(360,000 + 300,000) ÷ $12 x $30
= $1,650,000
34
Break-even chart, contribution chart
and profit-volume chart
• Alternatively, CVP analysis can be conducted by
•
the graphical approach.
The graphical approach may be preferable where
a simple overview is sufficient or where there is a
need to avoid a detailed numerical approach that
may not easily be understood by non-financial
users.
35
Break-even chart (1)
Break-even chart
A break-even chart can be drawn in the following
steps:
a. Draw the horizontal and vertical axes.
The horizontal axis shows the levels of activity
expressed as sales units and the vertical axis
shows the values in dollars for costs and
revenue.
36
Break-even chart (2)
Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
37
Break-even chart (3)
b. Draw the fixed costs line and then the total
costs line.
The fixed costs line will be a straight line parallel
to the horizontal axis at the level of the fixed
costs.
The total costs line, which comprises both fixed
and variable costs, will start where the fixed
costs line intersects the vertical axis and will be
a straight line sloping upward at an angle
depending on the proportion of variable costs in
total costs.
38
Break-even chart (4)
Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
900
l cos
Tota
Variable
costs
ts
Fixed costs
600
Fixed
costs
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
39
Break-even chart (5)
c. Draw the revenue line, which will be a straight
line from the point of origin sloping upwards at
an angle determined by the selling price.
40
Break-even chart (6)
Break-even chart
Sales revenue/Costs ($’000)
1,500
les
Sa
1,200
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
Fixed
costs
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
41
Break-even chart (7)
d. The break-even point (in units and in $ sales)
can be determined as the inter-section of the
total cost line and the revenue line.
The profit generated from sales above the breakeven point and the loss suffered from sales below
the break-even point can easily be determined in
the chart.
42
Break-even chart (8)
Break-even chart
Sales revenue/Costs ($’000)
1,500
Break-even
point
1,200
Profit
les
Sa
Profit
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
300
0
Fixed
costs
Loss
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
43
Break-even chart (9)
e. The margin of safety (in units and in $ sales) can
be determined as the difference between the
budgeted sales (in units and in $) and the breakeven (in units and in $).
44
Break-even chart (10)
Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
Margin
of safety
Break-even
point
Profit
les
Sa
Profit
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
300
0
Margin
of safety
Loss
1,000
2,000
3,000
4,000
Fixed
costs
5,000
Activity (Sales units)
45
Contribution chart (1)
Contribution chart
A contribution chart is an alternative form of
presenting the break-even chart in that the
variable costs line is drawn first instead of the
fixed costs line.
The contribution chart can show clearly the
contribution for different level of activity and the
effect on profit for different level of sales.
46
Contribution chart (2)
Contribution chart
A contribution chart can be drawn in the following
steps:
a. Draw the horizontal and vertical axes.
The horizontal axis shows the levels of activity
expressed as sales units and the vertical axis
shows the values in dollars for costs and
revenue.
47
Contribution chart (3)
Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
300
0
1,000
2,000
3,000
4,000
Activity (Sales units)
48
5,000
Contribution chart (4)
b. Draw the variable costs line and then the total
costs line.
The variable costs line start at the origin and will
be a straight line sloping upward at an angle
depending on the level of the variable costs.
The total costs line, which comprises both
variable and fixed costs, will be a straight line
parallel to the variable costs line at the level of
the fixed costs starting from the vertical axis.
49
Contribution chart (5)
Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
osts
le c
b
a
i
V ar
300
0
1,000
2,000
3,000
4,000
Activity (Sales units)
50
5,000
Contribution chart (6)
Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
Fixed
costs
ts
l cos
Tota
600
ts
cos
ble
a
i
r
Va
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
51
Contribution chart (7)
c. Draw the revenue line, which will be a straight
line from the point of origin sloping upwards at
an angle determined by the selling price.
52
Contribution chart (8)
Contribution chart
Sales revenue/Costs ($’000)
1,500
les
Sa
1,200
900
Fixed
costs
ts
l cos
Tota
600
ts
cos
ble
a
i
r
Va
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
53
Contribution chart (9)
d. The break-even point (in units and in $ sales)
can be determined as the inter-section of the
total cost line and the revenue line.
The profit generated from sales above the breakeven point and the loss suffered from sales below
the break-even point can easily be determined in
the chart.
Contribution for different level of activity can also
be determined in the chart.
54
Contribution chart (10)
Contribution chart
Sales revenue/Costs ($’000)
1,500
Profit
900
Fixed
costs
ts
l cos
Tota
Contribution
1,200
Profit
les
Sa
Break-even
point
600
300
Loss
ts
cos
ble
a
i
r
Va
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
55
Contribution chart (11)
e. The margin of safety (in units and in $ sales) can
be determined as the difference between the
budgeted sales (in units and in $) and the breakeven (in units and in $).
56
Contribution chart (12)
Contribution chart
Sales revenue/Costs ($’000)
1,500
Profit
les
Sa
Break-even
point
Profit
900
Fixed
costs
ts
l cos
Tota
Contribution
1,200
Margin of
safety
600
300
Loss
Va
Margin of
safety
osts
le c
riab
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
57
Profit-volume chart (1)
Profit-volume chart
The profit-volume chart is a variation of the
break-even chart, which can show the effect on
profit for different level of sales.
The profit-volume chart concentrates on profit
and shows only a profit line.
The horizontal axis shows the levels of activity
expressed as sales units and the vertical axis
shows the profit or loss values in dollars.
58
Profit-volume chart (2)
Profit volume chart
A profit volume chart can be drawn in the following
steps:
a. Draw the horizontal and vertical axes.
The horizontal axis shows the levels of activity
expressed as sales units and the vertical axis
shows the profit or loss values in dollars.
59
Profit-volume chart (3)
Profit-volume chart
Profit / Loss ($’000)
400
0
600
60
1,000
2,000
3,000
4,000
5,000
Activity
(Sales units)
Profit-volume chart (4)
b. Draw the profit/loss line, which will be a straight
line from vertical axis slopping upward at an
angle depending on the level of profit (sales less
total costs) starting at a loss equal to the fixed
costs (since there would be no revenue at zero
sales).
61
Profit-volume chart (5)
Profit-volume chart
Profit / Loss ($’000)
400
0
600
62
1,000
2,000
3,000
4,000
5,000
Activity
(Sales units)
Profit-volume chart (6)
c. The break-even point (in units and in $ sales)
can be determined as the inter-section of the
total profit/loss line and the horizontal axis.
The profit generated from sales above the breakeven point and the loss suffered from sales below
the break-even point can easily be determined in
the chart.
63
Profit-volume chart (7)
Profit-volume chart
Profit / Loss ($’000)
400
0
1,000
Loss
600
64
2,000
3,000
4,000
5,000
Activity
(Sales units)
Fixed
costs
Contribution
Profit
Profit
Profit-volume chart (8)
d. The margin of safety (in units and in $ profit)
can be determined as the difference between the
budgeted profit (in units and in $) and the breakeven point (in units and in $).
65
Profit-volume chart (9)
Profit-volume chart
Profit / Loss ($’000)
400
0
1,000
Break-even point
2,000
3,000
4,000
Loss
Margin
of safety
600
66
Profit
Profit
5,000
Activity
(Sales units)
Fixed
costs
Contribution
Margin
of safety
Example 3 (1)
Example 3
Chai Wan Limited also produces and sells wireless
computer keyboards.
The company intends to produce and sell 5,000
units per year. The unit sales price is $300 and
the unit variable cost is $100. Fixed costs are
$600,000 a year.
67
Example 3 (2)
Required:
Determine the break-even point and the margin of
safety for wireless computer keyboards by
constructing:
a. break-even chart,
b. contribution chart, and
c. profit-volume chart.
68
Example 3 (3)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
69
Example 3 (4)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
900
Fixed costs
600
Fixed
costs
300
0
1,000
2,000
3,000
Activity (Sales units)
70
4,000
5,000
Example 3 (5)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
Fixed
costs
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
71
Example 3 (6)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
les
Sa
1,200
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
Fixed
costs
300
0
1,000
2,000
3,000
Activity (Sales units)
72
4,000
5,000
Example 3 (7)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
Profit
les
Sa
1,200
Profit
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
300
0
Fixed
costs
Loss
1,000
2,000
3,000
5,000
4,000
Activity (Sales units)
73
Example 3 (8)
Solution:
a. Break-even chart
Sales revenue/Costs ($’000)
1,500
1,200
Margin
of safety
Break-even
point
Profit
les
Sa
Profit
Variable
costs
900
ts
l cos
Tota
Fixed costs
600
300
0
Margin
of safety
Loss
1,000
2,000
3,000
4,000
Activity (Sales units)
74
Fixed
costs
5,000
Example 3 (9)
From the break-even chart, we can easily get the
following information:
Break-even point:
3,000 units, or $900,000
If sales are above $900,000 or 3,000 units,
the company will make a profit.
If sales are below $900,000 or 3,000 units,
the company will suffer a loss.
75
Example 3 (10)
Margin of safety:
(5,000 - 3,000) units = 2,000 units, or
$(1,200,000 – 900,000) = $600,000
If sales drop by not more than $600,000 or
2,000 units, the company will make a profit.
If sales drop by more than $600,000 or 2,000
units, the company will suffer a loss.
76
Example 3 (11)
b. Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
300
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
77
Example 3 (12)
b. Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
600
osts
le c
b
a
i
V ar
300
0
1,000
2,000
3,000
4,000
Activity (Sales units)
78
5,000
Example 3 (13)
b. Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
900
Fixed
costs
ts
l cos
Tota
600
ts
cos
ble
a
i
r
Va
300
0
1,000
2,000
3,000
5,000
4,000
Activity (Sales units)
79
Example 3 (14)
b. Contribution chart
Sales revenue/Costs ($’000)
1,500
1,200
Profit
900
To
Fixed
costs
st s
tal co
600
300
Loss
osts
le c
b
a
i
V ar
0
1,000
2,000
3,000
4,000
Activity (Sales units)
80
5,000
Contribution
Profit
les
Sa
Example 3 (15)
b. Contribution chart
Sales revenue/Costs ($’000)
1,500
Profit
les
Sa
Break-even
point
Profit
900
Fixed
costs
ts
l cos
Tota
Contribution
1,200
Margin of
safety
600
300
Loss
Va
Margin of
safety
osts
le c
riab
0
1,000
2,000
3,000
4,000
5,000
Activity (Sales units)
81
Example 3 (16)
The information you can get from the
contribution chart is similar to that from the
break-even chart.
82
Example 3 (17)
c. Profit-volume chart
Profit / Loss ($’000)
400
0
1,000
2,000
3,000
4,000
5,000
Activity
(Sales units)
3,000
4,000
5,000
Activity
(Sales units)
600
83
Example 3 (18)
c. Profit-volume chart
Profit / Loss ($’000)
400
0
600
84
1,000
2,000
Example 3 (19)
c. Profit-volume chart
Profit / Loss ($’000)
400
0
1,000
2,000
3,000
5,000
4,000
Activity
(Sales units)
Fixed
costs
Loss
Contribution
Profit
Profit
600
85
Example 3 (20)
c. Profit-volume chart
Profit / Loss ($’000)
400
0
1,000
Break-even point
2,000
3,000
4,000
Loss
Margin
of safety
600
86
Profit
Profit
5,000
Activity
(Sales units)
Fixed
costs
Contribution
Margin
of safety
Example 3 (21)
From the profit-volume chart, we can easily get the following
information:
At sales of 3,000 units:
The company will break-even with no profit and no loss.
At sales of 0 units:
The company will suffer a loss of $600,000.
At target sales of 5,000 units:
The company will make a profit of $400,000.
The margin of safety is:
2,000 (5,000 – 3,000) units, or
$400,000 ($200 x 2,000 units) contribution/profit
87
Effects of changes in costs, selling price and units sold on
the break-even point and target profit
• CVP is a very useful management tool in that by
varying the variable cost, fixed cost, selling price
and units sold, simple and quick estimates of
break-even points and profitability can be made.
88
Example 4 (1)
Example 4
One of the divisions of Chai Wan Limited
produces and sells laser pointers. The following
information is extracted from its current year’s
budget:
Production and sales units
60,000 units
Selling price per unit
$40
Variable cost per unit
$30
Fixed costs per annum
$400,000
89
Example 4 (2)
Required:
To calculate the following for Chai Wan Limited:
a. the break-even point (in units and $ sales),
b. the budgeted profit for current year,
c. the revised breakeven point (in units) and revised
budgeted profit, under each the following independent
changes:
i. the variable cost increases by $2.
ii. the fixed costs decrease by 10% and sales volume
increases by 5%, selling price and variable cost
remain unchanged.
iii. the fixed costs and variable cost increase by 10%,
selling price decreases by 5% while sales volume
increases by 20%.
90
Example 4 (3)
Solution:
a. Contribution per unit
= Selling price – variable cost
91
Example 4 (4)
Solution:
a. Contribution per unit
= Selling price – variable cost
= $40 - $30
= $10
92
Example 4 (5)
Solution:
a. Break-even point (in units)
= Fixed costs ÷ Contribution per unit
93
Example 4 (6)
Solution:
a. Break-even point (in units)
= Fixed costs ÷ Contribution per unit
= $400,000 ÷ $10
= 40,000 units
94
Example 4 (7)
Solution:
a. Break-even point (in sales)
= BE units x unit selling price
95
Example 4 (8)
Solution:
a. Break-even point (in sales)
= BE units x unit selling price
= 40,000 x $40
= $1,600,000
96
Example 4 (9)
b. Total contribution
Less: Fixed costs
Profit
$
_______
_______
97
Example 4 (10)
b. Total contribution ($10 x 60,000)
Less: Fixed costs
Profit
98
$600,000
400,000
$200,000
Example 4 (11)
c.i. Revised contribution per unit
= Selling price – variable cost
99
Example 4 (12)
c.i. Revised contribution per unit
= Selling price – variable cost
= $40 - $32
= $8
100
Example 4 (13)
c.i. Break-even point (in units)
= Fixed costs ÷ unit contribution
101
Example 4 (14)
c.i. Break-even point (in units)
= Fixed costs ÷ unit contribution
= $400,000 ÷ $8
= 50,000 units
102
Example 4 (15)
c.i. Total contribution
Less: Fixed costs
Profit
$
_______
_______
103
Example 4 (16)
c.i. Total contribution ($8 x 60,000)
Less: Fixed costs
Profit
104
$480,000
400,000
$80,000
Example 4 (17)
ii. Contribution per unit remains at $10
Break-even point (in units)
= Revised fixed costs ÷ unit contribution
105
Example 4 (18)
ii. Contribution per unit remains at $10
Break-even point (in units)
= Revised fixed costs ÷ unit contribution
= $400,000 x 90% ÷ $10
= 36,000 units
106
Example 4 (19)
ii.
Total contribution
Less: Fixed costs
Profit
$
________
________
107
Example 4 (20)
ii.
108
Total contribution ($10 x 60,000 x 105%) $630,000
Less: Fixed costs ($400,000 x 90%)
360,000
Profit
$270,000
Example 4 (21)
iii. Revised contribution per unit
= Revised selling price per unit – revised variable
cost per unit
109
Example 4 (22)
iii. Revised contribution per unit
= Revised selling price per unit – revised variable
cost per unit
= $(40 x 95% – 30 x 110%)
= $5
110
Example 4 (23)
iii. Revised break-even point (in units)
= Revised fixed costs ÷ revised contribution per
unit
111
Example 4 (24)
iii. Revised break-even point (in units)
= Revised fixed costs ÷ revised contribution per
unit
= $400,000 x 110% ÷ $5
= 88,000 units
112
Example 4 (25)
iii. Total contribution
Less: Fixed costs
Profit/(Loss)
$
________
________
113
Example 4 (26)
iii. Total contribution ($5 x 60,000 x 120%)
Less: Fixed costs ($400,000 x 110%)
Loss
114
$360,000
440,000
($80,000)
Limitations of CVP analysis (1)
• CVP can provide very useful insights to the
relationship between fixed costs, variable costs
and the volume of sales. However, there are
major limitations which affect its usefulness.
• These limitations are shown in the following.
115
Limitations of CVP analysis (2)
a. Non-linear relationships of unit variable cost and
selling price
Unit variable cost and selling price are assumed
to be the same at all levels of output or sales
under the CVP. However, it may not be true in
reality because of bulk purchase discounts from
suppliers of raw materials or trade discounts
offered to customers to attract more sales.
116
Limitations of CVP analysis (3)
b. Step cost function
Fixed costs remain fixed within a relevant range
and beyond that relevant range, it might
become a step cost.
117
Limitations of CVP analysis (4)
c. Companies selling multi-products
CVP analysis is quite helpful for companies
selling single product where the measure of
activity is simply the unit of output. For
companies selling multi-products, it is not easy
to split the fixed costs among the products.
CVP cannot work properly unless there is a
standard mix for the products of the company.
118
Limitations of CVP analysis (5)
d. Inappropriateness for long-term planning
purpose
CVP analysis has many applications in profit
planning and short-term decision making, where
fixed costs do not change as a consequence of
the decision taken. It is, however, not
appropriate for long-term planning because all
costs, in the long-run, are variable costs.
119
Further readings (1)
• Horngren et al, (2006), Cost Accounting , A
•
•
•
120
Managerial Emphasis, Pearson, 12th Edition,
Chapter 3.
Drury, C. (2004), Management and Cost
Accounting, London, Thomson, 6th Edition,
Chapter 8.
Garrison et al, (2006), Managerial Accounting,
McGraw-Hill, 11th Edition, Chapter 6.
Li, T. M. and Ng, P. H. (2007), HKAL – Principles
of Accounts (Volume 2), Pilot Publishing Company
Ltd, 2nd Edition, Chapter 24.
Further readings (2)
• 王怡心 (二00二年)，管理會計，台北:三民書局，
修訂二版，第七章 。
121
End of the Unit
End-of-unit Assessment
This is the end of Unit 8.
Please go to the Unit
Assessment before
attempting the next unit.
122