d out production capacity utilization that enables . t the firm determine the viability of iste DCO narrow concept of C-V-P analysis is referred to as Break-even meet is the level of production activity at which there is At Break-even-point, BEP, total cost incurred for a product equates t red for selling the product is, at BEP: Cost = Total Revenue TC = TRor TR- IC = Zero Profit ere TC = Total Fixed Cost + Total Variable Cost. er the BEP, fixed cost is no longer incurred. The cost incusred after BEP is able cost. mptions of Break-even Analysis -even-analysis and Cost-Volume-Profit analysis are based upon certain ass ditions which are to be rarely found in practice. Some of these basic asst follows: ‘a. The principle of cost variability is valid. Ived into their fixed and variable components. jin constant throughout the relevant range. portionally with volume.in any one of the above by changes in factors fed in the light of the limi it than volume. Thus, to price and sale mix factors, ‘ations of underlying : can be computed through differer ‘nt mathematical approaches. pular mathematical i ~ ecintaue Approaches are: (i) equation technique or (ii) cont uatic it a aes se This technique uses the following formula which also Ee t Sea Clationship of the items of income statement. ae = Variable Expenses + Fixed Expenses +Zero Profit or TR = TC + Zero Profit. This simple equation may be adapted to any break-even or profit estimate situation. i Contribution margin or marginal income technique: obviously based on the concept of marginal costing. Contribution margin is the difference between’ sales and variable expenses. Where break-even point is desired, sales and expenses are analyzed as thus: Unit selling price - Unit variable expenses = Unit contribution And, Contribution — Fixed Cost = Profit This unit contribution margin is divided by total fixed expenses to secure the number of units which have to be sold to break-even. ie. Fixed Expenses Contribution per unit These two techniques can be illustrated by an example. Mathematical Approach Alhaji Gazali plans to sell toy rockets at Kano International Trade Fair. He may purchase these rockets at N5 each, with the privilege of returning all unsold rockets. The booth ‘ent at the fair is N2,000 payable in advance. The rockets will be sold at N9 each. Determine the number of rockets, which must be sold, to break-even as well as the mber of rockets to be sold to yield a 20 per cent operating margin on sales. a) Equation Technique Sales =Variable costs + Fixed Costs + Profit. Assuming that A is the number of units to be sold to break-even, the values in the above formula can be substituted as follows:9A = 5SA+ N2,000 + 0 9A- 5A = N2,000 4A = N2,000 A = N2,000/4 A = 500 units tion Margin Technique b) Contribul mined as: Here, BEP is deter FC Contribution per unit From the illustration, FC = N2,000 a i Unit contribution = Unit sales price - unit variable cost Le. Unit contribution = N9— N5 = N4 per unit Then, BEP in unit = Fixed Costs Contribution per unit = N2000 + 4 or 500 units Determination of production volume or production units that will realize 20% profit margin: Sales =Variable costs + Fixed costs + Profit Assuming that X is the number of units to be sold to yield desired profit, the values in the above formula can be substituted as: OX = 5X + N2,000 + .2(9 X) 9X = 5 X +N2,000 + 1.8X 9X-18X-5X = N2,000 2.2 X = N2,000 X = 909.09 units approx. Or X = 910 units. Other simple formulae that can be used to determine cost-volume-profit relationship are as follows: 1 Break-even point (in N) = Fixed Cost Contribution Margin Ratio, CMR OR C/s Ratio Note that C/S Ratio i . Where: is also termed as Profit-Volume Ratio i.e. P/V Ratio CS ratio = Contribution per unit x 100 Sales price per unit 2 Levi el of sales to result in target profit (in units)‘year isas follows: Deak N 300,000 120,000, ire 160,000 ‘Variable production overhead 80,000 Fixed production overhead i Ls Fixed Administration overhead X Fixed Sellingand Distr, Overhead 60000 595,000 Net Profit before tax ea Less: provision fortaxation (40%) 82.00 Net Profit aftertax 123,000 Required: a. Calculate the break-even point for last year. b. What do you understand by the terms ‘profit volume ratio’ and ‘margin o Illustrate using last year’s result. a c. Determine the number of units to sell in the current year to achieve ana profit of N150,000 ' d. Calculate the sales value required to achieve a net profit before tax of 15% revenue. 3 @. Assuming no change in unit selling price and cost structure, calcul percentage increase in sales volume required in the current year to pr profit before tax 20% higher than last year's results. f. Calculate the selling price per unit that the company must charge in the year to cover a potential increase of 12% in variable production costs th year and still maintain last year's contribution margin ratio. g. Determine the volume of sales (in N) that the company must achie Current year to maintain the same net profit of last year, if the s ee Temains at N20 and variable cost per unit increases by 12%. ee Recalculate last year's result if salesmen commission of 10% is i Price is reduced by 13% and volume increases by 30%.al -even point (in N) ir Contribution/unit = N235.000 x N20 11 = N427,273 ‘that P/V Ratio = Unit or Total Contribution Unit or Total Sales Price Orll +20 b. Break-even point (in units) ; = Fixed costs Contribution/unit = N 235,000 1. Calculation of fixed costs: N noduction overhead 100,000 ldministration overhead 75,000. elling &Distr. overhead 60,000 oe 235,000 2. Units of Production = N800,000 = Unit S.P = N800,000 = 20 = 40,000 units 3. Unit VC = Total vc = 40,000 units = N360,000 + 40,000 units = NO per unit 4. Contribution per unit: Selling price per unit Variable cost per unit =N20-N9=Ni1 profit volume (P/V) ratio indicates the relationship between contribu 2s otherwise referred to as contribution margin ratio (CMR) or contr R). ; Iscalculated in the following ways: ‘+ PAratio = [ SP-vc] = sp - P/Vratio = cM = sp 3. P/Vratio = Ts -IVC AGN Nv ratio = [ Total Contribution] = Total sales -The Concept of Margin of Safety Br or ste ich forecast revenu i fety is expressed as the amount at whicl for e excee Arrears (CIMA). It is the difference between short of that required to break even ¢ i sales at profit rel and that of sales at break-even point. It is expressed mat! as: 1. MWS = Sf- Sb (in monetary value) Where: Sf = forecast sales Sb = sales at Break-even point IL M/S Ratio: Sf - Sb x 100 Calculation of Margin of Safety N Units Sales (B) 800,000 40,000 Break-even point 427,273 21,364 Margin of safety (A) 372,727 18,636 in percentage for or M/S Ratio: (A/B x 100%) 47% 47% M/S =Sf-Sb = N800,000 - 427.273 = NB ‘The margin of safety of 47% means that our sales must fall by more than 47% sustain loss. of ‘Sales Tequired to achieve a target profit (after tax) of N150,000 (in wt is given by Target profit- 0.55Y = N235,000 + 0.15Y - 0.55Y - 0.15Y= N235,000 0.40Y = N235,000 Y = N235,000 0.4 = N587,500 ings: Ast. (pntribution margin ratio is determined as follows: lly = Selling price - Variable cost Selling price =[20-9] +20 Or 11 + 20 = 0.55 el of sales to result in target profit. = Fixed costs +Target profit Contribution per unit = N235,000 + (120% of 205,000) asl _ = N235,000 + N246,000 ll = 43,727 unit centage increase: = 43,727 units- 40,000 units x 100% 40,000 units = 9.32% ntribution margin ratio of last year =Contribution margin ratic = Revised SP-Revised VCper unit Revised SP. RSP = RSP-(9 x a2); RSP P- 0.55 RSP = 10.08vPO. Variable Production Cost ‘Unit VPC 360,000 + 40,000 = N9 per unit Sales value required to achieve a target profit of N205,000 = FC+TP x Unit selling price Contribution/unit = N235,000 + 205,000 x20 9.92 = N887,097 Workings: ‘ Contribution per unit is determined as follows = SP -RVCU | = N20 -(N9 x 1.12) = N20 - N10.08 =N 9.9 Revised Income Statement Sales{{N20 x 0.87) x (40,000 x1.30)) Less: Variable Cost (52,000units x 9) Salesmen comm.(10% of 904,800) Contributionaise the business profitability at a glance ia yet bn danger accompanying many accounting re| gged down with unnecessary details in such come to grip with the heart of the matter. = C-V-P graphs can be split into different component grapt only covers two types of C-V-P x -V-P graphs that 7 greak-Even Point Graph, and graphs ie iProfit-Volume, P/V Graph he Break-Even Point Graph $ break-even chart shows the level at which total cost incurred for a product enue realized. The break-even point is obtained where total cost graph inters he total revenue graph. The costs and revenues are indicated in the Y-axis while out a units is indicated in the X-axis. ; hhe total cost line is obtained from: otal Fixed Cost + Variable Cost at different production units ile: e total revenue line is obtained from: otal revenue at each level of output, which is the product of output multiplied by ling price. aphical demonstration company makes and sells a single product. The variable cost of production is lit, 4 nd the variable cost of selling is N1 per unit. Fixed costs total N6,000, andt ling ce is N6. The company budgets to make and sell 3,600 units in the Quired: A break-even chart and later to plot (i)Profit-Volume graph, ving the expected amount of output and sales required to break ev in in the budget.plotting P/V graph: a Determine break even sales in monetary value, having 2 ji, Determine the loss incurred when there is no production equal to the total fixed cost. iii, Join the two points with a straight line. 6.000 ts.0001 21,000 Sater OYzero profit = N18,000 21,600 ~ N18,000 = N3.600 Le. Sf - sh t Break even sales at fi Margin of Safety = budgeted revenue k-Even Analysis , Limitations of ~pai concept stems from its numerous underlying assumptio The limitations 0 Il remain constant at all activity levels ion that fixed cost wi Q V F ~ Br because fixed costs are likely to vary at different activity |¢ giving preference to the use of a stepped fixed cost as the most i break-even analysis. ae t Peerisries ofthe analysis can only be rae on within the activity level that ts can be correctly determined. 7 ; i See Riise profit Brace represents short term relationships and for this reason it is considered inappropriate in long term relationships. ‘ d. The postulations that variable cost and sales will be linear appears incorrect seeing that the effect of extra discount, overtime payments, learning curve, Special price contracts, and other similar matters present variable cost and revenue as a curve rather than a straight-line. e. Break-even analysis assumes a perfect knowledge of cost and revenue function thereby ignoring risk and uncertainty which in practice remains a crucial factor in economic decision-making process. f The concept of CVP analysis relies heavily on cost behavior and classification, This implies that activity level determines the changes in revenue and costs, this assumption sounds so good theoretically. There are numerous factors, in practice, that will influence changes in cost and revenue in addition to their activity levels. & Revenue and variable cost do vary with the level of activity nonetheless the Teaction of individual cost components such as material cost, labor cost, etc. are not the same. h. CVP analysis unrealistically assumes a single product /constant product mix’ Constant rate of markup on marginal cost. This is considered an oversimplification of the concept. i. The concept relies on a the firm is a price taker, ¥ Wrong assumption that a perfect market exists