Australian School of Business

ACCT 1501 Accounting and Financial Management 1A

Session 2 2014

Week 12

Management Accounting:
Cost-Volume-Profit Analysis
Student Handout

Lecturer:
Dr. Radzi Jidin
School of Accounting
UNSW
QUAD 3114
r.jidin@unsw.edu.au

Moodle: https://moodle.telt.unsw.edu.au/login/index.php

WEEK 12: Management Accounting: Cost-Volume-Profit Analysis

1. Introduction
In this weeks lecture we will examine how costs have traditionally been treated in a
manufacturing environment to support inventory valuation. We will explore how
management decision-making can be improved and supported through an
understanding of cost behaviour and Cost-Volume-Profit (CVP) analysis.

At the end of this topic, you should be able to:

1) Identify and give examples of Fixed, Mixed, and Variable Costs
2) Explain the concepts and assumptions behind CVP analysis
3) Understand CVP concepts including: Contribution margin; Contribution margin
per unit; and Contribution margin ratio
4) Compute the units that must be sold to achieve a targeted level of profit and assess
the effects of changes in costs and prices on the profitability of a firm
5) Calculate the CVP analysis figures to complete the two CVP case study lecture
examples Power Pooch & LGM Ltd

Required reading
Trotman, Gibbins & Carson Management Accounting Supplement
Chapter M2 Cost-Volume-Profit Analysis, pp. 36-60
2. Tutorial Questions Week 13
Students should attempt these questions before the tutorial.
Preparation Questions
DQM2.3, 2.6, PM2.1, PM2.7, PM2.10, PM2.13
Tutorial Questions
DQM2.7, PM2.9, PM2.11, PM2.12
Group Presentation Topic
PM2.12

Week 12 Lecture Case Study 1

`
Company Overview (Continued from Week 11)
PowerPooch is a private company you established on 1/9/12 to make
robotic dogs. Your first dog is the TechieTerror Terrior (TTT).
PowerPooch needs to determine the optimal price of its TTT, and the
optimal level of output at that price. To do this it needs to ascertain:
(a) The nature of its costs and
(b) How costs will change with the scale of operations.
In other words, it needs to have a solid understanding of cost behaviour.
Based on a 1 year budget drawn up at the inception of the business, the following
costs are estimated (based on an activity level of 1,500 units for the year):
Fixed costs
Rent
Depreciation
Supervisor salary
Marketing
Other overheads
Total

Variable Costs
$
120,000
75,000
144,000
28,000
85,000
452,000

Direct materials
Direct labour
Overheads

$
552,000
240,000
84,000

Total

876,000

Further information:
(1) Extensive market research suggests that each TTT can be sold for $1,100.
(2) PowerPooch's tax rate is 40%
Required
(a) What is the unit variable cost? What are the implications of this for TTT pricing?

(b) What price would allow all costs to be met for the year?

(c) What is the breakeven point at the $1,100 price suggested by market research?
What if PowerPooch could only get $1,000 for each dog? $1,500 for each dog?

(d) How many units would need to be sold if the sale price is $1,100, and
PowerPooch wants to make an after-tax profit of $100,000?

Case Study 2: LGM Limited

LGM Limited sells remote-controlled toy UFOs designed specifically

for Sci-Fi loving university students. The company has identified the following costs
for 2011:
Costs
Rent expenses for factory space
Depreciation for machinery
Supervisor salary
Annual marketing expenses
Other fixed overheads
Direct Materials
Direct Labour
Variable overheads

=
=
=
=
=
=
=
=

$60,000
$37,500
$72,000
$25,000
$65,000
$240,000
$120,000
$60,000

Additional Information:
Activity level for 2011
Company tax rate

=
=

2,000 units
40%

After a careful market research of university students and their spending patterns, the
company decides that a unit price of remote-controlled UFOs should be set at $395.
Questions
1. What are the Fixed Costs for the company?
2. What are the Variable Costs for the company?
3. What is the unit variable cost?
4. What is the contribution margin?
5. What is the contribution margin per unit?
6. What is the contribution margin ratio?
7. What selling price would allow all costs to be met at the current activity level?
8. If we set a price at $395 per unit as per the market research, what is the BEP in
number of units? BEP in sales dollars?
9. How many units must be sold to generate an after-tax profit of $100,000?

Australian School of Business

ACCT1501
Accounting and Financial Management 1A

Week 12
Cost-Volume-Profit (CVP) Analysis
Session 2 2014

Radzi Jidin
School of Accounting

TOPIC 12: Learning Objectives

LO1: Identify and give examples of fixed, mixed and
variable costs

LO2: Explain the concept and assumptions behind CVP
analysis

LO3: Understand and calculate contribution margin,
contribution margin per unit and contribution margin
ratio

LO4: Case Study: CVP analysis

Essential Readings

TGC Management Accounting Supplement Chapter M2

From Week 11 Case Study

Product Cost (manufacturing)

DM
DL
OH

Period Cost (non-manufacturing)

SG&A

At what price should PowerPooch sell its robotic terriers?

Cost Classification
To support
Decision Making
Cost
Functional
Manufacturing
Direct
DM

Indirect
DL

Behavioural

Non-Manuing

Fixed

Mixed

Variable

SG&A

OH

Last Week

Cost Behaviour

LO1

Cost behaviour deals with how costs change with respect to

changes in activity levels.

Why it is important to know cost behavior?

Essential for planning, control and decision making:

 Costing
 Pricing
 Product mix
 Make or buy
 Performance evaluation
 Financial planning

Cost Driver

LO1

Cost driver a factor that causes (drives) activity costs.

E.g.:
Work on the production line
Activity
Costs
caused by
the activity

Direct labour costs

Direct labour hour

Cost driver

Cost Classification

LO1

Costs can be classified as:

Fixed
CVP
Variable
Semi-fixed (Step-variable)
Mixed (Semi-variable)

Fixed Cost

LO1

In total, remain constant within the relevant range as the

level of cost driver varies.

What is relevant range?

 The range over which the assumed fixed cost relationship
is valid for the normal operations of an organisation

Fixed costs per unit vary inversely with activity

Examples?

Rent per month

Insurance per year

Fixed Cost An example

LO1

Fixed costs = $1,000

If production = 10 units

Fixed Cost per unit = $1,000/10 = $100

If production = 100 units

Fixed Cost per unit = $1,000/100 = $10

ButTotal fixed costs = $1,000

Fixed Cost

LO1

Cost function:

y = a, where y represents the total cost level and a is a
constant
LOOK!
$

Total costs

Per unit costs

a
Activity
Level

Activity
Level

Relevant
range

Revision Question 1

LO1

AXYZ LTD produces tennis racquets. The company can

produce up to 10,000 racquets per year. The production
workers are supervised by a factory supervisor who is paid
$100,000 per year. What will be the cost of supervision if
the company produces 5000 racquets?
A. $50,000
B. $10,000
C. $5,000
D. $100,000

Revision Question 2

LO1

Which of the following statement(s) about fixed costs is incorrect?

i. Per unit fixed costs decreases as the number of unit produced
increases.
ii. Total fixed cost is constant within the relevant range.
iii. Per unit fixed costs and total fixed cost are constant within the
relevant range.
iv. The higher the level of level of production within the relevant
range, the higher the total fixed costs will be.

A.
B.
C.
D.

i and ii
i, ii and iii
ii and iii
iii and iv

Variable Cost

LO1

In total, vary proportionally with changes in activity level

Remain the same on a per unit basis

Examples?

Metres of fabric?
5% sales commission?
$5/hour wage rate?

Manufacturing
SG&A
Depends!

Variable Cost - An example

LO1

Variable costs = $10 per unit

If units = 10
Total VC = 10 x $10 = $100
If units = 100
Total VC = 100 x $10 = $1,000

14

Variable Cost

LO1

Cost function:

y = bx - where y represents total cost level, b is the unit
variable cost and x is output volume
LOOK!
$

Total costs

Per unit costs

b
0

Activity Level

Activity Level

Fixed and Variable Costs Assumptions

LO1

Cost behaviour is defined with respect to a single,

specific cost object/driver

Linearity

Specified time span

Because
E.g. rent per month

Changes in output volume are moderate

Capacity?

16

Semi-Fixed Cost

LO1

Some fixed costs do not fit the fixed cost classification

completely

Fixed over a moderate range of activity and, then, rise or

fall to new levels beyond that range

17

Semi-Fixed Cost

LO1

Cost function:

y = a1, 0 < x <x1

y = a2, x1 < x < x2, etc

where y represents the total cost level and a1 and a2 are

constants
$

Total costs

a2
a1
0

x1

x2

Activity

Semi-Variable Cost

LO1

Some variable costs do not fit the variable cost

classification completely

Although they are directly proportional to activity, they

have a fixed component

Examples?

ISP $19.95/month up to 30GB, $5 per extra 1GB

download
Electricity bill service fee + usage

Semi-Variable Cost

LO1

Cost function:

y = a + bx

where y represents total cost level, a is the fixed cost

component, b is the unit variable cost and x is output
volume
$

Total costs

a
0

Activity

10

Revision Question 3

LO1

Which of the following statement(s) about variable costs is incorrect?

i. Per unit variable costs decreases as the number of unit produced
increases.
ii. When the units produced is zero, total variable costs is equal to
total fixed cost.
iii. Per unit variable costs remain the same regardless of the number
of units produced.
iv. Total variable cost increases in direct proportion to increases in
units of product.
A. i and ii
B. i, ii and iii
C. ii and iii
D. iii and iv

CVP Analysis

LO2

CVP analysis examines the effect of changes in costs and

volumes on a firms profits

Factors considered

Volume or activity level

Unit selling price
Variable cost per unit
Total fixed cost
Sales mix

11

If you were the manager

LO2

Volume or activity level

Unit selling price

Variable cost per unit

Total fixed cost

Sales mix

23

CVP Assumptions

LO2

Behaviour of costs and revenues is linear over the relevant

range

All units produced are sold

Costs can be classified as either fixed or variable

Only changes in activity affect costs

Selling prices and costs are assumed to be known with
certainty

Sales mix remains constant in multi-product firms

12

Contribution Margin

LO3

Contribution margin (CM):

Revenue VC

Contribution margin per unit:

Unit selling price unit VC

Contribution margin ratio:

CM per unit
Unit selling price

Break-Even Analysis

LO3

Determination of level of activity at which total revenues

equal total costs (fixed + variable)

known as a Break-Even Point (BEP)

Can be calculated by:

Graphical method
Equation method
 Units-sold approach
 Sales revenue approach

13

Break-Even Analysis Graphical Method

LO3

$
Revenue = SX
BEP
Profit

Total cost = VX + F

Activity

Break-Even Analysis Equation Method

Units-Sold Approach

LO3

Uses the following relationship

Profit

where

=
=

Total Revenue Total Costs

SX
VX F

S
X
V
F

= unit selling price

= number of units
= unit variable cost
= fixed costs

14

Break-Even Analysis Equation Method

Units-Sold Approach

LO3

Rearrange the equation

ProfitBT

=
=
=
=

Total revenue Total costs

SX (VX + F)
(S V)X F
F + ProfitBT
(S V)

Note:

Profit in our equation is profit before tax

(S-V) = unit contribution margin

Sales Mix

LO3

For multi-product firms, impact of product mix is taken

into account by determining the appropriate weighted
average contribution margin (WACM)

Recall Contribution Margin?

Revenue Variable Cost

(S V)X

15

Weighted Average Contribution Margin

LO3

Example:
Product A

Product B

CM

$10

$4

Production ratio

40%

60%

WACM is ($10 x 0.4) + ($4 x 0.6) = $6.40

Use this WACM to calculate the breakeven units

Of those units, 40% are expected to be Product A and
60% are expected to be Product B.

So far

LO3

Contribution Margin

BEP

What about profit?
Profit

=
=

Total Revenue Total Costs

SX
(VX + F)

16

Target Profit

LO3

Profit in our equation is profit before tax

ProfitBT

=
=
=
=

Total revenue Total costs

SX (VX + F)
(S V)X F
F + ProfitBT
(S V)

Target profit

LO3

Effect of taxation

You may want to determine volume necessary to achieve a

certain level of profit after tax

The after-tax profit target must be first converted to a

before-tax profit target

Let be the tax rate

ProfitAT
=
=
ProfitBT
=

ProfitBT ProfitBT.
ProfitBT(1 )
ProfitAT/(1 )

17

Break-Even Analysis Equation Method

Sales Revenue Approach

LO3

This method is particularly useful when:

individual units are not easily identifiable

a company has a very large number of different product

ProfitBT

R F (vr)R

Where:
R = SX (i.e., Selling price x Units Sold)
vr = V/S (i.e., Total variable cost/Sales Revenue)
F = Total fixed cost
ProfitBT = Profit before tax

Break-Even Analysis Equation Method

Sales Revenue Approach

LO3

To obtain break even point in sales dollar:

Sales dollars = F + ProfitBT
CM Ratio
Where:
F = Total fixed cost
ProfitBT = Profit before tax
CM Ratio = Contribution margin ratio

Note: At break even, ProfitBT (i.e., Profit before tax) is equal to 0

18

Break-Even Analysis Equation Method

Sales Revenue Approach

LO3

Recall that:

Contribution margin per unit:

Unit selling price unit VC

Contribution margin ratio:

CM per unit
Unit selling price

However, for Sales revenue approach, to get the CM Ratio, we

divide total contribution margin with total sales revenue

Break-Even Analysis Equation Method

Sales Revenue Approach

LO3

For example, refer to p. 51 TGC

Assume a university bookstore sells a wide range of books
with different mark-ups. Assume the bookstore has the
following projected profit for the quarter:
Sales
Less: Variable expenses
Contribution margin
Less: Fixed costs
Profit before tax

$
400,000
(325,000)
75,000
(45,000)
30,000

CM Ratio =

75,000
400,000
= 0.1875

19

Case Study 1: PowerPooch

LO4

PowerPooch

LO4

Variable costs
Direct materials
Direct labour
Overheads
Total

Activity level

=
=
=
=

$552,000
$240,000
$84,000
$876,000

1,500 units

(a) What is the unit variable cost?

20

PowerPooch

LO4

(b) What price would allow all costs to be met?

PowerPooch

LO4

(c) BEP if S = $1,100

21

PowerPooch

LO4

PowerPooch

LO4

(d) How many units must be sold to generate an after-tax

profit of $100,000 if sale price is $1,100 per unit?

22

PowerPooch

LO4

Functional vs. Behavioural Costs

LO4

Fixed costs
Rent
Depreciation
Sup salary
Marketing
Overheads
Total

=
=
=
=
=
=

$120,000
$75,000
$144,000
$28,000
$85,000
$452,000

23

Functional vs. Behavioural Costs

LO4

Variable costs
Direct materials
Direct labour
Overheads
Total

=
=
=
=

Case Study 2: LGM

$552,000
$240,000
$84,000
$876,000

LO4

24

Question 1 - Fixed Costs

LO4

Question 2 - Variable Costs

LO4

25

Question 3 - Unit Variable Cost

LO4

Question 4 Contribution Margin

LO4

26

Question 5 - CM per unit

LO4

Question 6 - CM ratio

LO4

27

Question 7 Break-Even Point

LO4

Question 8 BEP at $395

LO4

28

Question 9 NPAT $100,000

LO4

Question 9 NPAT $100,000

LO4

29

Question 9 - NPAT $100,000

LO4

30