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Transcript of macsmod 3

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COST
VOLUME
PROFITANALYSIS

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Module 3  syllabus
Costvolume
profit (CVP) Relationship:Profit planning behavior of expenses in
relation to volume CVP model sensitivity
analysis of CVP Model for changes inunderlying parameters assumptions of the
CVP Model Utility of the Model in
Management Decision Making.

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Examines the behaviour of total revenues, total costs, andoperating income as changes occur in the output level, sellingprice, variable costs or fixed costs
Assumptions of CVP Analysis
1. revenues change in relation to production and sales2. costs can be divided in variable and fixed categories
3. revenues and costs behave in a linear fashion
4. costs and prices are known
5. if more than one product exists, the sales mix is constant
6. we can ignore the time value of money7. Factor price, (e.g., material prices, wages rate) are constant at all
sales volume.
8. The volume of production equals the volume of sales

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Three ingredients of profit planning:
Cost of production. Selling prices & Volume of units produced/sold.
These 3 factors are interdependent because costdetermines selling price to arrive at the desired level of
profit; the selling price affects the volume of sales, the
volume of sales directly affects the volume ofproduction & volume of production in turn influences
cost. CVP is a tool to show the interrelationship of
these factors.

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To determine the Breakeven points in termsof units or sales value.
To ascertain the margin of safety ratio.
To estimate the profits or losses at variouslevels of output.
To ascertain the likely effects of managementdecisions such as an increase or a reduction
in selling price, etc., To determine the optimum selling price.

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Breakeven analysis (BEP) The level of sales at which revenue equals
expenses and net income is zero
It indicates at what level cost and revenue are
in equilibrium. It is a method of presenting to
management the effect of changes in volume on
profits.
It reveals the effect of alternative decisions which
reduce or increase costs and which increase sales
volume & income.

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Breakeven point: It is defined as the point
or sales level at which profit are zero andthere is no loss. That is, BEP is that pointat which total costs are equal to total salesrevenue. At this point profit being zero,
contribution (salesv.c) is equal to thefixed cost.
BEP (in units) =
Fixed Cost
Contribution per unit
BEP (in value)=F.C
P/V (C/S) Ratio

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ContributionIt is the difference between the sales and
the variable (marginal) cost of sales and itcontributes towards fixed expenses andprofit.
Contribution per unit = Selling Price
Variable Cost
Contribution = Fixed cost + Profit Revenue
variable cost = Fixed cost +
profit

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It is the ratio which helps in studying theprofitability of operations of a business andestablishes the relationship betweencontribution and sales. Higher the ratio, morewill be the profit and lower the ratio, lesser willbe the profit.P/V Ratio is used in the following calculations:
BEP. Profit at a given level of sales. The volume of sales required to earn a given
profit.
Profit when margin of safety is given. The volume of sales required to maintain the
present level of profit, if selling price isreduced.

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Formulae:
P/V Ratio =
P/V Ratio =
P/V Ratio =
Contribution
SalesX 100
Change in Contribution
Change in Sales
X 100
Change in profits
Change in SalesX 100

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Calculation of Sales to earn desired Profit
Sales to earn desired profit =F.C + Desired profit
Contribution per unit(in units)
Sales to earn desired profit = F.C + D.P
(in value) P/V Ratio
Profit = (Sales X P/V Ratio) Fixed Cost

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It is the difference between the actual sales and
sales at BEP. MOS is that sales or output which
is above BEP. All F.C are recovered at BEP.
If the MOS is large, it is an indicator of the
strength of a business because with a
substantial reduction in sales or prdn, profit
shall be made. If the margin is small, a small
reduction in sales or prdn will lead to a loss.

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MOS = Actual Sales BE Sales OR
MOS =Profit
P/V Ratio
Angle of Incidence: This is the angle at which thesales line cuts the total cost line. It indicates the
rate at which profits are being made. Large angle of
incidence is an indication that profits are being
made at a high rate. On the other hand, a small
angle Indicates a low rate of profit and suggests that
V.C form the major part of cost of production. A

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BEC is a graphical representation of marginal
costing. It is one of the most useful graphic
presentation of accounting data.
This Chart shows the interrelationship
between cost, volume and profit. It shows the
BEP and also indicates the estimated cost and
estimated profit or loss at various volumes of
activity.

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Output in units
Cost &revenue
V.C
F.C
SalesLine
0
AOIBEPTC line
LossArea
ProfitArea
Y
XMOS SalesBEP Sales

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Uses:1. Helps to determine the BEP i.e. that level of
sales where there zero profit & zero loss.
2. Helps to determine the sales volume to earn
a desired profit or return on capitalemployed.
3. Helps to determine the selling price whichwill give the desired amount of profit.
4. Cost & sales at various levels of output maybe determined.
5. Helps to determine the most profitablesales / product mix.

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6. Comparative profitability of each product lineor of different companies may be determined.
7. It studies the effect of change in selling priceon profit.
8. Effect of increase or decrease in F.C & V.C on
profit may be studies.9. Effect on profit and BEP of high proportion of
V.C with low F.C & vice versa may bedetermined.
10. Helps management in decision making such asmake or buy decision, acceptance of a special
job, discontinuance of a product line, etc.

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1.The assumption that all costs can be clearlyseparated into fixed & variable componentsis not possible to achieve practically.
2. The assumption that V.C per unit remainsconstant and that it gives a straight line chartis not always true.
3. The assumption that F.C remains constant isalso unrealistic.
4. The assumption regarding selling pricesremaining unchanged as volume changes is
also not true.4. The assumption that only one product is beingproduced or that product mix will remainunchanged is also not found in practice.

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6. It is assumed that the production & salesare synchronized which is need not be inpractice.
7. It completely ignores the consideration ofcapital employed which may be an important
factor in the study of profit analysis.

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PricingDecisions.Profit Planning & Desired Level ofProfit.Make or BuyDecisions.Problem of Key or LimitingFactor.Selection of asuitable orProfitable Sales Mix

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Effect of changes in SalesPrice.Alternative Methods ofProduction.
Determination of Optimum Level ofActivity.Evaluation ofPerformance.Capital InvestmentDecisions.

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