University of Mosul

College of administration & economic

Department of Accounting

Cost volume
profit analysis
Seminar
Submitted by
Abdulwahed ghazi

To
Assistant Professor
Dr. Wahid Mahmood Rammo

2017-2018
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Cost-volume-profit (CVP) analysis is a mathematical representation of
the economics of producing a product. The relationships between a
product's revenue and cost functions expressed within the CVP model are
used to evaluate the financial implications of a wide range of strategic and
operational decisions. For example, CVP analysis is employed to assess
the financial implications of product mix, pricing, and product and
process improvement decisions. Perhaps equally important, CVP analysis
facilitates measuring the sensitivity of a product's profitability to
variations in one or more of its underlying parameters. Finally, CVP
analysis may be used to determine the trade-offs in profitability and risk
from alternative product design and production possibilities. In effect,
CVP is a quantitative model for developing much of the financial
information relevant for evaluating resource allocation decisions.
Assumptions of Cost-Volume-Profit Analysis
The profit-volume and cost-volume-profit graphs just illustrated rely on
some important assumptions. Some of these assumptions are as follows:
1. The analysis assumes a linear revenue function and a linear cost
function.
2. The analysis assumes that price, total fixed costs, and unit variable
costs can be accurately identified and remain constant over the relevant
range.
3. The analysis assumes that what is produced is sold.
4. For multiple-product analysis, the sales mix is assumed to be known.
5. The selling prices and costs are assumed to be known with certainty..
In other words, analysis focuses on how profits are affected by the
following five factors:

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 Factors affecting on profit

Sales Unit variable

selling price
volume. costs

Total fixed Mix of

costs products sold

Sensitivity analysis and Margin of Safety

Sensitivity analysis is a “what-if” technique managers use to examine how
an outcome will change if the original predicted data are not achieved or
if an underlying assumption changes. The analysis answers questions such
as “What will operating income be if the quantity of units sold decreases
by 5% from the original prediction?” and “What will operating income be
if variable cost per unit increases by 10%?” This helps visualize the
possible outcomes that might occur before the company commits to
funding a project.
Another aspect of sensitivity analysis is margin of safety, The margin of
safety is Margin of safety is the difference between actual or expected
sales and sales at the break-even point. It measures the “cushion” that a
particular level of sales provides. It tells us how far sales could fall
before the company begins operating at a loss. The margin of safety is
expressed in dollars or as a ratio. The formula for stating the margin of
safety in dollars is actual (or expected) sales minus break-even sales.
Assuming that actual (expected) sales $750,000, and break-even sales
500000$ the computation is:
Actual (Expected) sales - Break-Even sales = Margin of Safety in Dollars
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 $750,000 - $500,000 = $250,000
margin of safety is $250,000. Its sales could fall $250,000 before it
operates at a loss. The margin of safety ratio is the margin of safety in
dollars divided by actual (or expected) sales. The formula and
computation for determining the margin of safety ratio are:
Margin of Safety in Dollars ÷ Actual (Expected) sales = Margin of Safety ratio
$250,000 ÷ $750,000 = 33%
This means that the company’s sales could fall by 33% before it would be
operating at a loss.
The higher the dollars or the percentage, the greater the margin of safety.
Management continuously evaluates the adequacy of the margin of safety
in terms of such factors as the vulnerability of the product to competitive
pressures and to downturns in the economy.
The Break-even point
The break-even point is the volume of activity where the organization’s
revenues and expenses are equal. At this amount of sales, the
organization has no profit or loss; it breaks even.
Example
Sales revenue (8000*16 $) 128000 $

Less : variable expenses ( 80000 $ )

(8000*10 $)
Total contribution 48000 $
margin
Less : fixed expenses (48000 $)
profit 0 $

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1-Contribution Margin Approach
Fixed costs ÷ contribution margin for unit = Break-even
48000 $ ÷ ( 16 $ -10 $) = 8000 unit
must sell 8,000 unit run to break even for the Period.
Contribution-Margin Ratio: Sometimes management prefers that the
break-even point be expressed in sales dollars rather than units.
Fixed costs 48000
contribution margin for unit = 6 = 128000 $
unit sales price 16
2-Equation Approach
An alternative approach to finding the break-even point is based on the
profit equation .Income (or profit) is equal to sales revenue minus
expenses.This equation can be restated as follows:

8000 * 16 $ - 8000 * 10 $ - 48000 $ = 0 $

Using the equation approach, we have arrived at the same general formula
for computing.
3-Ghrafic Approach: A cost-volume-profit chart, sometimes called a
break-even chart, graphically shows sales, costs, and the related profit or

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loss for various levels of units sold. It assists in understanding the
relationship among sales, costs, and operating profit or loss
Example
Sales revenue (400*500 $) 200000 $

Less : variable expenses ( 120000 $ )

(400*300 $)
Total contribution 80000 $
margin
Less : fixed expenses (80000 $)
profit 0 $

450000 Total sales

400000
profit
300000 Break-even point

2500000

200000

150000 Total expenses

100000 fixed expenses

50000 loss

Dollars

units
100 200 300 400 500 600 700 800

The CVP graph discloses more information than the breakeven

calculation. From the graph, a manager can see the effects on profit of
changes in volume.

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4-Target profit
Target profit analysis is one of the key uses of CVP analysis. In target
profit analysis ,we estimate what sales volume is needed to achieve a
specific target profit. For example would like to know what sales would
have to be to attain a target profit of $40,000 per month.
Target profit + Fixed expenses
Unit sales to attain the target profit =
Unit CM
Target profit + Fixed expenses
Dollars sales to attain the target profit =
Unit CM ratio
5-Multiproduct
The CVP analyses you have conducted so far focus on decisions about a
single product. While this type of analysis is useful in small start-up
businesses and divisions with only a single product line, most companies
produce or sell more than one type of product. Companies that sell
multiple products need to know what results are required for the company,
not individual products, to achieve certain targets. To solve this type of
problem, managers must have a good grasp of the sales mix—that is, the
sales of each product relative to total sales.
Example
A B
Sales price 16 $ 20 $
Variable cost 10 $ 10 $
unit
Contribution 6 $ 10 $
margin
Mix ratio 90% 10%

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 Weighted-average unit contribution margin = ($6 * 90%) + ($10 *10%)
= $6.40
The organization’s break-even point in units is computed using the
following formula :

Fixed expenses
Break-even point =
Weighted-average unit contribution
margin
= $48,000 = 7,500 unit
$6.40
Break-even for product:
A = 7500 * 90% = 6750 unit
B = 7500 * 10% = 750 unit
A = 7650 * 16 = 108000 $
B = 750* 20 = 15000 $
Incorporating the cost of capital into CVP analysis
CVP analysis, like other managerial accounting techniques, ignores the
cost of capital and treats it as if it were zero.. From an economic point of
view that a firm does not earn a profit until its operating income after taxes
exceeds the cost of capital used to generate the operating income. A firm's
operating profit after taxes less the cost of capital used to generate the
profit measures its economic income.
The traditional CVP model is developed by specifying the mathematical
relationship between a product's accounting profit and its sales quantity,
price, and costs. The resulting equation is then manipulated to measure a
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product's financial attributes, such as its breakeven sales quantity or the
sales required to earn a given profit or profit margin. A CVP model
incorporating the cost of capital may be developed in a similar manner.
However, when the cost of capital is charged to a product as an expense,
the difference between the product's revenue and expenses is its economic
income. Unlike accounting profitability, economic income over a
product's life must be discounted to when production of the product will
begin. Therefore, CVP analysis incorporating the cost of capital is based
on an equation of the relationship between a product's discounted
economic income and its sales quantity, price, costs, investments, and cost
of capital. To develop this relationship, the following notation will be
used:
Sales revenue = variable expenses + Fixed expenses + Cost of fixed
capital + Cost of working capital
Criticism to Cost volume profit analysis
Despite its widespread application, CVP analysis is frequently criticized
for its use of simplifying assumptions, such as deterministic and linear
cost and revenue functions. Additionally, CVP is disparaged for its focus
on a single product and its single-period analysis. However, as noted by
Guidry et al.: "Non-linear and stochastic CVP models involving
multistage, multi-product, multivariate, or multi-period frameworks are
all possible, although a single model embracing all of these extensions
would seem a radical departure from the whole point of CVP analysis, its
basic simplicity". note that firms across a variety of industries have found
the simple CVP model to be helpful in both strategic and long-run
planning decisions. Furthermore, a survey of management accounting
practices indicates that CVP analysis is one of the most widely used
techniques. However, warn that, in situations where revenue and cost are
not adequately represented by the simplifying assumption of CVP
analysis, managers should consider more sophisticated approaches to
financial analysis .
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Criticism of the equivalence analysis focuses on the linearity of the
relationship between the elements and the factors on which it was founded
Tie model, ignoring the nonlinear nature of the relationship in many cases
with the practical, as that paralyzed tool equalization analysis depicts the
situation at a point of time, so some believe it is not suitable for positions
While these factors and non-static elements are affected by surrounding
economic and social conditions Are dynamic, they are influenced by the
economic factors related to competition, supply and demand The price has
a mutual effect.
Practical Limitations of Break-Even Theory :
1.Semi variable costs do exist amongst the cost components and must be
considered for appropriate estimation (apportionment) into both fixed and
variable costs.
2. The sales revenue and total costs are not always linear in as normally
assumed in the theory.
3. Two or more break-even points may exist for a particular industry
depending on a number of factors.
4. Economic factors such as demand, supply and prices do affect the
break-even point and profitability.

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 The References
A-Journals
1-Mohammed B. Ndaliman and Katsina C. Bala(2007), Practical
Limitations of Break-Even Theory, AU Journal of Technology,
Vol(11),No(1).
2-Robert Kee (2007), Cost-Volume-Profit Analysis Incorporating the
Cost of Capital, Journal of Managerial Issues,Vol(19),No(4).

B-Books
1-Charles E.Davis & Elizabeth Davis(2014), Managerial Accounting,
2nd Edition, Published by Wiley, New Jersey.
2-Charles T. Horngren & Srikant M. Datar & Madhav V. Rajan(2015),
Cost Accounting A Managerial Emphasis, Fifteenth Edition, Published
by Pearson
3-Don R.Hansen & Maryanne M.Mowen(2007),Managerial Accounting,
Eighth Edition, Published by Thomson ,USA.
4-Jerry J. Weygandt & Paul D. Kimmel & Donald E. Kieso (2015),
Managerial Accounting tools for business decision making, Sixth edition,
Published by Jon wiley & Sons inc , New Jersey.
5- Ray H. Garrison & Eric W. Noreen & Peter C. Brewer (2012), Managerial
Accounting, Fourteen Edition, McGraw-Hill , New York.
6-Ronald W. Hilton & David E. Platt (2014), Managerial Accounting,
Tenth Edition, McGraw-Hill , New York.

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