Accounting+-+Cost-volume-profit+analysis - Cost Volume...

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Cost – Volume - Profit Analysis ONE issue of paramount interest to management is the impact of costs and volume on profits. If a linear relationship could be established among costs, volume and profits, it would help decision-makers to figure out the right volume, the right cost and consequently the right profit. That profit is the difference between sales turnover (in value) and cost is common knowledge. Sales turnover equals sale price per unit multiplied by the number of units. This means that sales turnover goes up with higher volume and comes down with lower volume. One also knows intuitively that total cost rises with higher volume and falls with lower volume, but the extent of this movement is not known. Under the cost-volume-profit analysis (CVP analysis), given the cost pattern, the impact of costs on profits for various volumes, as also of volumes on profits, is studied. The analysis would be easier if the cost can be segregated into fixed and variable. In fact, the basic tenet of CVP analysis is to split the cost into variable, which varies with volume, and fixed, which remains constant regardless of the volume. Let us assume that such a division of costs is easily possible. And it may be noted that even when such an absolute segregation is not possible, there are statistical tools which enable the analyst to do so with a fairly high degree of accuracy. Consider the following example: A firm sells its products at Rs 10 per unit. The variable cost per unit is Rs 6. And regardless of the volume, the firm has to spend Rs 50,000 on other expenses (fixed expenses). In this case, the profit chart of the firm for various volumes can be analyzed as follows: Sale price per unit - Rs 10 Variable cost per unit - Rs 6 Contribution per unit - Rs 4 (Rs 10 - Rs 6) No. of units required to meet fixed costs - Rs. 50,000/Rs 4 = 12,500 units Here, the difference between the sales price per unit and the variable cost per unit is called the contribution per unit. This means that for every unit sold, Rs 4 comes in as a contribution to meet fixed expenses. How many such units will be needed to meet the fixed expenses completely? This can easily be computed as 12,500. So, in terms of units, 12,500 units are required to meet both the variable and the fixed costs. This is called the break-even point (BEP) in units.
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The relationship between contribution and sales can also be expressed as a ratio, which is called contribution margin. In the example, the contribution margin is 4/10 or 0.4. The BEP in rupees can be found by dividing the fixed cost with the contribution margin. This will be Rs 50,000/0.4 = Rs 125000. Understanding the BEP concept enables one to take a number of strategic decisions. The following is an illustrative list of the uses of CVP and BEP analyses:
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This note was uploaded on 07/29/2010 for the course ACCOUNTS 2332 taught by Professor Piyush during the Fall '10 term at Amity University.

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Accounting+-+Cost-volume-profit+analysis - Cost Volume...

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