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COST-VOLUME-PROFIT RELATIONSHIPS

Cost-Volume-Profit(CVP) analysis is one of the most


powerful tools that managers have at their command
and know the relationships among them which
influences in the overall performance of business
operations. CVP emphasize the behavior of cost and
therefore is extremely helpful to managers in judging
the impact on profits of changes in selling price, cost
or volume. It helps them understand the relationships
among Cost, Volume, and Profit by focusing on
interactions among the following five elements:

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Elements:
1. Prices of products
2. Volume or level of activity
3. Per unit variable cost
4. Total fixed costs
5. Mix of product sold

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Because CVP analysis helps managers to understand
the interrelationships among cost, volume, and profit,
it is a vital tool in many business decisions. These
decisions includes

1. What products and services to offer?


2. What pricing policy to follow?
3. What marketing strategy to employ?
4. What basic cost structure to use?

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To help understand the role of CVP analysis in Business
decisions, consider the numbers of issues are to be
analyzed such as:

1. Basic component: (Cost-Volume - Profit)


2. Contribution Margin: (Sales – Variable
cost = Fixed cost + Profit)
3. Break Even Analysis (BEA)
4. Margin of Safety (M/S)
5. Angle of Incidence
6. Target Net Income
7. Sales Mix
8. Changes in Business Environment
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There are three related ways to think more deeply about and model
CVP relationships:

1.The equation method


2. The contribution margin method
3. The graph method

The equation method and the contribution margin method are most
useful when managers want to determine operating income at
few specific levels of sales. The graph method helps managers
visualize the relationship between units sold and operating
income over a wide range of quantities of units sold.
Ref : Cost Accounting-C T Horngren, p:68

Break – Even Point is the level of sales at which profit is zero i. e.


no profit no loss.

CVP graph sometimes called Break – Even Chart. 5


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Cost – Volume – Profit analysis may be shown in a
graphical representation which is given below:

Ref: Managerial Accounting- R H Garrison, p:239

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Cost – Volume – Profit analysis may be shown in
Mathematical Equation, few formulas are given
below:

1) Sales = Variable Expenses + Fixed


Expenses + Profit
2) Contribution = Sales – Variable Cost
3) Contribution = Fixed Cost + Net Profit
4) Marginal Profit = Contribution
5) .

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6) BEP (Sales Value) =

 Or

 Or

 Or

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Formulas (cont…)
7) Margin safety = Actual Sales – Break
Even Sales
8) Margin of safety = Profit ÷
9) Margin of safety =
10) Profit / Volume Ratio =
11) Sales =
12) Marginal Income = sales × P/V Ratio

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Problem #01
 Jamuna Company Limited is currently
working at 50% capacity and produces 1,
00, 000 units. At 60% working, Raw
Material cost increases by 2% and selling
price falls by 2%. At 80% working Raw
Material cost increases by 5% and selling
price falls 5%.
 At 50% capacity working, the product
costs Tk. 180 per unit and is sold TK. 200
per Unit.
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The unit cost of Tk. 180 is made up
as follows:
 Material 100/-
 Wages 30/-
 Factory Overheads 30/- (40% Fixed)
 Administrative Overheads 20 /-(50% Fixed)
 Total 180/-

Prepare a Cost- Volume-Profit relationship


statement when it operated at 60% and 80%
capacity. As an expert of the Cost- Volume-
Profit analysis, put your recommendation in
these situations.
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Jamuna Company Limited
Solution Cost- Volume-Profit relationship Statement

Details 50% capacity 60% capacity 80% capacity


1, 00, 000 units 1, 20, 000 units 1, 60, 000 units
Per Total Per Total Per Total
Unit Unit Unit
Tk. Tk. Tk. Tk. Tk. Tk.
A. Sales 200 2, 00, 00, 000 196 2, 35, 20, 000 190 3, 04, 00, 000
B. Variable Cost
Material 100 1, 00, 00, 000 102 1, 22, 40, 000 105 1, 68, 00, 000
Wages 30 30, 00, 000 30 36, 00, 000 30 48, 00, 000
Factory Overheads (60% Variable) 18 18, 00, 000 18 21, 60, 000 18 28, 80, 000
Administrative Overheads(50% 10 10, 00, 000 10 12, 00, 000 10 16, 00, 000
Variable)
Total Variable Cost 158 1, 58, 00, 000 160 1, 92, 00, 000 163 2, 60, 80, 000

C. Contribution (A-B) 42 42, 00, 000 36 43, 20, 000 27 43, 20, 000

D. Fixed Cost
Factory Overheads (40%Fixed) 12 12, 00, 000 10 12, 00, 000 7.5 12, 00, 000
Administrative Overheads(50% 10 10, 00, 000 8.33 10, 00, 000 6.25 10, 00, 000
Fixed)
Total Fixed Cost 22 22, 00, 000 18.33 22, 00, 000 13.75 22, 00, 000

E. Profit (C-D) 20 20, 00, 000 17.67 21, 20, 000 13.25 21, 20, 000 12
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Recommendations:
 ifwe look on the above statement, as
an expert my recommendation will be
produced at 60% capacity which is
also providing same profit as per
80% capacity.

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Problem # 02

You are given the following information for the Nokia Limited for the
next year;

Tk.
Sales (1,00,000 units) 60,00,000
Variable Costs 24,00,000
Fixed Costs 30,00,000
Required :

A) Find out the P/V ratio, Break Even Point and Margin of Safety
B) Evaluate the effect of :
i) 10% decrease in variable cost.
ii)10 % increase in variable cost.

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Solution
A) Calculation of P/V ratio , Break Even Point and Margin of Safety :

100

30,00,000
Tk. 50,00,000

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B) i) 10% Decrease in variable cost :

Variable Cost after 10% decrease (24,00,000 – 2,40,000) = Tk. 21,60,000

Contribution = Sales – Variable Cost


= Tk. 60,00,000 - 21,60,000 = Tk. 38,40,000

P/V Ratio

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