macs-mod 3

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    Module 3 - syllabus


    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 inter-dependent 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 inter-relationship of

    these factors.

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    To determine the Break-even 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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    Break-even 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


    It reveals the effect of alternative decisions which

    reduce or increase costs and which increase sales

    volume & income.

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    Break-even 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 (sales-v.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 +


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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 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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    P/V Ratio =

    P/V Ratio =

    P/V Ratio =


    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 inter-relationship

    between cost, volume and profit. It shows the

    BEP and also indicates the estimated cost and

    estimated profit or loss at various volumes of


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    Output in units

    Cost &revenue





    AOIBEPTC line




    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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