Accounting for Decision MakingUNIT-I

COST VOLUME PROFIT ANALYSIS

INTRODUCTION:
• Cost volume Profit Analysis is a device which attempts to determine the effects of
changes in Cost Volume, Product mix & Selling Price on Profit.
• Cost Volume Profit Analysis explain the relationship between cost, revenue level
output & Profit, It is nothing but Break Even Analysis.
• Earning the maximum profit is the main objective of any business enterprise. Hence,
the management must know which factors affect the profit.
• Profit is the result of interplay of various factors like volume of production and sales,
cost and sales revenue.
• So the knowledge of relationship of cost, volume and profit is required for profit
planning.
• The technique which indicates the behavior of profit in response to change in volume,
costs and prices is called the Cost - Volume - Profit analysis.
• Through the use of cost volume profit analysis, the sales volume required to achieve
the desired profit objective can be determined.
• As Colin Drury has written, “It is a systematic method of examining the relationship
between changes in activity or output and changes in total sales revenue, costs and net
profit”.
• The objective of CVP analysis is to establish what will happen to the financial result if
a specified of activity or volume fluctuates.
• CVP analysis is in a fact extension of marginal costing.
• It uses the same technique of marginal costing like classifying expanses into fixed
costs and variable costs.
• There are many techniques used in CVP analysis, the most important of them being
break-even analysis.
• It is a method of determining the profit, cost and sales value at different levels of
activity.
OBJECTIVES OF CVP ANALYSIS
• The main objectives of CVP analysis may be stated as follows:
1. Such analysis is undertaken to forecast profit fairly accurately and so it is necessary to
know the relationship between costs and profit on one hand and volume on the other.
2. For the purpose of control, evaluation of performance is necessary, in which area CVP
analysis is useful to management. The change in costs and volume as compared to
budgeted figures and its effect on profit can be ascertained with the help of CVP
analysis.
3. It helps in establishing flexible budgets, which show costs, prices and profits at
various levels of activity. Flexible budget basically makes use of classification of
costs into fixed and variable.
4. It is used to assist management in profit planning. Profit planning is the planning of
future operations to attain maximum profit or to maintain a specified level of profit
and the most significant single factor in profit planning is the relationship between the
volume of business, costs and profits.

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5. This analysis helps in determining price policies, as it shows the effects of different
prices on costs and profits. That price would be determined which would give
maximum profits.
6. In addition, it also helps in arriving at the overhead costs of a product at various level
of working. On the basis of various levels of operations, the pre- determined rates can
be fixed.
7. CVP analysis is very useful in budgeting and budgetary control. CVP analysis gives
amounts of profits at various levels of volume of production and sales, which forms
the base for preparing various budgets.
8. Finally, it must be remembered that it has great utility in taking important decisions
like determining sales-mix, accepting special orders, shift working etc.
ASSUMPTIONS OF BREAK EVEN ANALYSIS OR COST VOLUME PROFIT
ANALYSIS:
➢ The principle of Cost Variability is Valid.
➢ All Cost can be divided in to fixed & variable components or elements.
➢ Behavior of different cost is linear.
➢ Fixed cost remains constant at all levels of output while variable cost fluctuates.
➢ Selling Price remains constant at all volume of sales.
➢ Prices paid for input factors remain the same.
➢ Technological method & efficiency of employees & machines do not change.
➢ Cost control will be maintained at a similar level.
➢ Production & sales will be same.
➢ Revenue & Cost are compared with common activity base.
➢ The efficiency of plant can be pre-ducted with efficiency.
LIMITATIONS OF BREAK EVEN ANALYSIS OR COST VOLUME POINT
ANALYSIS:
➢ The Break Even Analysis assume static situation that cannot exist for long term.
➢ The Break Even Analysis assumes that all the Cost can be separated in to fixed &
variable component that they vary in linear. The principle of variable cost applies to
them, but in practice this assumption do not hold true. In many cases cost does not
remain either fixed or absolutely variable in relation to the volume of output & cost
curve is exactly a straight line.
➢ The Break Even Analysis assume that Fixed Cost are constant at all the level of
volume & variable cost vary at Direct Proportion to volume but the behavior of fixed
& variable cost is valid in a limited range of operation above or below this range
behavior patent change.
➢ The assumption that the Production & sales is same & that sales remain constant is
not true.
➢ The Analysis pre. Suppose selling price do not change but in actual practice prices do
change as a result of several factors.
➢ Break Even Analysis completely ignores the consideration of the capital employed in
production & therefore it presents only fact of profit planning.
➢ Break Even Analysis is doubtful validity when business is selling product with
different profit margined.
BREAK EVEN ANALYSIS (BEA):
➢ The break Even Analysis is a system for determination of that level of activity where
total cost equal to selling price i.e. cost & revenue are in equilibrium.

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➢ It is an analytical technique that can be used to determine the probable profit of any
level of production.
➢ It is an extension of marginal costing. Break Even Analysis may be presented
graphically.
➢ It establishes the relationship among cost of production, volume of production Profit
& Sales Volume.
➢ Hence Break Even analysis is also designated as cost volume profit analysis. (CVPA)
SIGNIFICANCE OF BREAK EVEN ANALYSIS:
1. Production Planning
2. Activity Planning
3. Profit Planning
4. Make or Buy Decision
5. Purchase or Lease Decision
6. Capital Projects Decision
BREAK EVEN POINT (BEP):
➢ Break Even Point is a particular Point at which the specific level of activity or volume
of sales breaks the revenue & cost equal i.e. income just balance with expenses.
➢ When the selling price exceeds the cost, the firm makes a profit, when the selling
price is below cost it makes loss.
➢ But when production is sold at cost, it means cost equals to Sales.
➢ It is a Break Even Point, at where there is no profit, no loss.
BREAK EVEN CHART
➢ In order to find out break-even point and profit at different levels of production, a
break-even chart is prepared.
➢ A break even chart is a graphic presentation of relationship between total cost, sales
and profit or cost volume analysis profit relationship.
➢ It is a device to show relationship between sales volume, marginal cost and fixed cost
and profit or loss at different levels of production.
➢ Three lines are drawn in this chart, one for fixed costs, and another for total costs and
third for total sales.

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➢ On X axis, units of volume of output and sales are shown whereas on Y axis total cost
and sales value are shown.
➢ The point of intersection of total cost line and total sales line is called the breakeven
point.
➢ As this chart shows the breakeven point, it is popularly known as the break even
chart.
➢ The following steps are taken to prepare Break-even Chart.
➢ On horizontal (or x) axis, volume of output and sales in units or in terms of value are
shown, whereas on vertical (or y) axis, both sales and costs in terms of value are
shown.
➢ Now break even chart will be drawn as follows:
• Firstly, a fixed cost line will be drawn. It will be parallel to the x-axis as fixed
costs are unaffected by changes in the volume of output.
• Then the total cost line will be drawn. Total cost line will be drawn by adding
variable costs to fixed costs. The starting point of this line will be the fixed cost
line on y-axis.
• Thirdly the sales line will be drawn. The starting point of this line will be zero at
the junction of two axes and it forms an angle of 45 from that junction.
• Lastly, the point at which total cost line and total sales (revenue) line intersect
each other will be the break-even point.
UTILITY OF BREAK EVEN POINT
➢ To find out the sales required to earn the profit necessary for reasonable return on
investment, paying reasonable dividend on preference and equity shares after
transferring a reasonable amount to reserves.
➢ To fix up the selling price so as to reach a desired level of break-even point and that
of profits.
➢ To determine with the help of break even chart, variable cost per unit of output.
➢ To ascertain the cost and revenue at different levels of production, so that figures are
available for preparation of Sales Budget.
SOME SPECIFIC TERMS:
1. Profit Volume Ratio (PVR) :
➢ The ratio of contribution to sales is known as Profit-Volume Ratio or P.V. Ratio. In
fact it should be called Contribution to Sales Ratio. For a given sales, P/V Ratio may
be calculated as under:
Contribution
P. V. Ratio = × 100
Sales

➢ If P.V. Ratio is known, the variable costs at any level of sales can be easily calculated.
We can also BEP on the basis of P.V. Ratio. The management should try to raise the
P. V. Ratio, as higher the P.V .ratio, higher will be the profitability.
2. Variable Cost Ratio (VCR):
➢ This ratio is complementary to P.V.Ratio. It shows the proportion of variable costs to
sales. This ratio can be represented as follows:
Variable Cost
V. C. Ratio = × 100
Sales

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➢ Variable Cost Ratio and P.V.Ratio are complementary. It means Variable Cost Ratio
+ P.V.Ratio = 100%.
3. Margin of Safety:
➢ The difference between the actual sales and sales at break – even point is known as
Margin of Safety.
➢ Margin of Safety = Actual Sales - Sales at Break Even Point
➢ It is necessary for the management to know the margin of safety as it shows the
strength of business.
➢ It works as a buffer when sales decline and there is a loss.
➢ Margin of Safety shows how near the BEP Sales is to actual sales.
➢ The bigger the margin, the greater would be the capacity of business to withstand the
depression as profit will be earned even when there is a large reduction in actual sales.
LIST OF IMPORTANAT FORMULAE FOR C.V.P. ANALYSIS:-
(1) 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 = 𝑺𝒂𝒍𝒆𝒔 (𝑺) − 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝒄𝒐𝒔𝒕 (𝑽)
= 𝑺𝒂𝒍𝒆𝒔 × 𝑷𝒓𝒐𝒇𝒊𝒕 𝑽𝒐𝒍𝒖𝒎𝒆 𝑹𝒂𝒕𝒊𝒐 (𝑷𝑽𝑹)
= 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 (𝑭) + 𝑷𝒓𝒐𝒇𝒊𝒕 (𝑷)
𝑺−𝑽
(2) 𝑷. 𝑽. 𝑹𝒂𝒕𝒊𝒐 = 𝑺 × 𝟏𝟎𝟎
𝑪
= × 𝟏𝟎𝟎
𝑺
# WHEN INFORMATION RELATING TO TWO PERIODS IS GIVEN IN THE
FOLLOWING FORMULA MAY BE USED:
𝑪𝒉𝒂𝒏𝒈𝒆𝒔 𝒊𝒏 𝑷𝒓𝒐𝒇𝒊𝒕
𝑷. 𝑽. 𝑹𝒂𝒕𝒊𝒐 = × 𝟏𝟎𝟎
𝑪𝒉𝒂𝒏𝒈𝒆𝒔 𝒊𝒏 𝑺𝒂𝒍𝒆𝒔
(3) 𝑩𝒓𝒆𝒂𝒌 𝑬𝒗𝒆𝒏 𝑷𝒐𝒊𝒏𝒕 (𝑩. 𝑬. 𝑷)
𝑭
𝒂) 𝑩𝑬𝑷(𝑰𝒏 𝑼𝒏𝒊𝒕𝒔) =
𝑪
𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕
𝒃) 𝟏) 𝑩𝑬𝑷(𝑰𝒏 𝑹𝒔. ) =
𝑷. 𝑽. 𝑹.
𝒃) 𝟐) 𝑩𝑬𝑷(𝑰𝒏 𝑹𝒔. ) = 𝑩. 𝑬. 𝑷. (𝑼𝒏𝒊𝒕𝒔) × 𝑺𝒆𝒍𝒍𝒊𝒏𝒈 𝑷𝒓𝒊𝒄𝒆 𝒊𝒏 𝑼𝒏𝒊𝒕𝒔(𝑹𝒔. )

(4) 𝑴𝒂𝒓𝒈𝒊𝒏 𝒐𝒇 𝑺𝒂𝒇𝒆𝒕𝒚 (𝑴. 𝑶. 𝑺)

𝒂) 𝑴𝒂𝒓𝒈𝒊𝒏 𝒐𝒇 𝑺𝒂𝒇𝒆𝒕𝒚 = 𝑨𝒄𝒕𝒖𝒂𝒍 𝑺𝒂𝒍𝒆𝒔 − 𝑩. 𝑬. 𝑷. 𝑺𝒂𝒍𝒆𝒔
𝑷𝒓𝒐𝒇𝒊𝒕
𝒃) 𝑴𝒂𝒓𝒈𝒊𝒏 𝒐𝒇 𝑺𝒂𝒇𝒆𝒕𝒚 =
𝑷. 𝑽. 𝑹.
𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕+𝑷𝒓𝒐𝒇𝒊𝒕
(5) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 𝒕𝒐 𝒆𝒂𝒓𝒏 𝒂 𝒅𝒆𝒔𝒊𝒓𝒆𝒅 𝒑𝒓𝒐𝒇𝒊𝒕 = 𝑷.𝑽.𝑹.
𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕−𝑳𝒐𝒔𝒔
(6) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 𝒊𝒇 𝒍𝒐𝒔𝒔 𝒊𝒔 𝒈𝒊𝒗𝒆𝒏 = 𝑷.𝑽.𝑹.

(7) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 𝒊𝒏 𝑼𝒏𝒊𝒕𝒔 𝒊𝒇 𝑷𝒓𝒐𝒇𝒊𝒕 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕 𝒊𝒔 𝑮𝒊𝒗𝒆𝒏

𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕
= 𝑺−(𝑽+𝑷𝒓𝒐𝒇𝒊𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕)
(8) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 𝒊𝒏 𝑼𝒏𝒊𝒕𝒔 𝒊𝒇 𝑳𝒐𝒔𝒔 𝒑𝒆𝒓 𝑼𝒏𝒊𝒕 𝒊𝒔 𝑮𝒊𝒗𝒆𝒏
𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕
=
𝑺 − (𝑽 − 𝑳𝒐𝒔𝒔 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕)
(9) 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 = 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 − 𝑷𝒓𝒐𝒇𝒊𝒕

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= (𝑺𝒂𝒍𝒆𝒔 × 𝑷. 𝑽. 𝑹. ) − 𝑷𝒓𝒐𝒇𝒊𝒕
= 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 – 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕

(10) 𝑷𝒓𝒐𝒇𝒊𝒕 = 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 − 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕

= (𝑺𝒂𝒍𝒆𝒔 × 𝑷. 𝑽. 𝑹. ) − 𝑷𝒓𝒐𝒇𝒊𝒕
= 𝑺𝒂𝒍𝒆𝒔 − 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕

(11) 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕 𝑹𝒂𝒕𝒊𝒐 + 𝑷𝒓𝒐𝒇𝒊𝒕 𝑽𝒐𝒍𝒖𝒎𝒆 𝑹𝒂𝒕𝒊𝒐 = 𝟏𝟎𝟎%

(12) 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕 = 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 − 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕

= 𝑺𝒂𝒍𝒆𝒔 × 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕 𝑹𝒂𝒕𝒊𝒐
= 𝑺𝒂𝒍𝒆𝒔 − 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏
(13) 𝑺𝒂𝒍𝒆𝒔 = 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 + 𝑷𝒓𝒐𝒇𝒊𝒕
= 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕 + 𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 + 𝑷𝒓𝒐𝒇𝒊𝒕
𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕+𝑫𝒆𝒔𝒊𝒓𝒆𝒅 𝑷𝒓𝒐𝒇𝒊𝒕
(14) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 (𝒊𝒏 𝑼𝒏𝒊𝒕𝒔) = 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝑷𝒆𝒓 𝑼𝒏𝒊𝒕

𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 –𝑳𝒐𝒔𝒔

(15) 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑺𝒂𝒍𝒆𝒔 (𝒊𝒏 𝑼𝒏𝒊𝒕𝒔) = 𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝑷𝒆𝒓 𝑼𝒏𝒊𝒕

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