Total contribution
X
15000 Units X Rs.12
=
Rs.1,80,000
Y
7500 Units X Rs.10
=
Rs. 75,000
Rs.2,55,000
Less: Fixed Cost
X
10000 X 3
=
30000
Y
5000 X 3
=
15000
Z
8000 X 2
=
16000
Rs. 61,000
-------
--------------
Projected Profit
=
Rs.1,94,000
--------------
Statement Of Present Profit With Products X, Y And Z
Rs.
Product X =
10000 Units X Rs.9 =
90,000
Product Y =
5000 Units X Rs.7 =
35,000
Product Z
=
8000 Units X Rs.6 =
48,000
------------
1,73,000
----------
Since by discontinuing product z and increasing the production of products
X andY the profit increases from Rs.1,73,000 to Rs.1,94,000. The directors
proposal may be implemented.
214
------
215
216
Lesson 4.2 - Cost Volume Profit Analysis
4.2.1 Introduction
The cost of a product consists of two items: fixed cost and variable
cost. Fixed costs are those which remain the same in total amount regardless
of changes in volume. Variable costs are those which vary in total amount
as the volume of production increases or decreases. As a result, at different
levels of activity, the cost structure of a firm changes. The effect on profit
on account of such variations is studied through break even analysis or
cost-volume-profit analysis. This lesson deals with the various concepts,
tools and techniques of cost-volume profit analysis.
4.2.2 Learning Objectives
After reading this lesson, the reader should be able to:
Ֆ understand the meaning of cost-volume-profit analysis.
Ֆ apply cost-volume-profit analysis while taking decisions.
Ֆ construct the break-even chart.
Ֆ evaluate the advantages and limitations of break-even analysis.
4.2.3 Contents
4.2.3.1 Meaning Of Cost-Volume-Profit Analysis
4.2.3.2 Application Of Cost-Volume-Profit Analysis
4.2.3.3 Break Even Chart
4.2.3.4 Consultation Of Break Even Chart
4.2.3.5 Profit Volume Graph
4.2.3.6 Advantages And Limitations Of Break Even Analysis
4.2.3.7 Summary
4.2.3.8 Key Words
4.2.3.9 Self Assessment Questions
4.2.3.10 Key To Self Assessment Questions
4.2.3.11 Case Analysis
217
4.2.3.1 Meaning of Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis focuses on the way cost and
profit change when volume changes. It is, broadly speaking, that system of
analysis which determines the probable profit at any level of activity. This
technique is generally used to analyse the incremental effect of volume on
costs, revenues and profits. At what volume of operations are costs and
revenues equal? What volume of output or sales would be necessary to earn
a profit of say rs.2 lakhs? How much profit will be earned at a volume of,
say 10,000 units? What will happen if there is a reduction of 10 percent in
the selling price? Questions like these are sought to be answered through
cvp analysis. This detailed analysis will help the management to know the
profit levels at different activity levels of production and sales and various
types of costs involved in it.
4.2.3.2 Application Of Cost-Volume-Profit Analysis
CPV analysis helps in:
Ֆ Forecasting the profit in an accurate manner
Ֆ Preparing the flexible budgets at different levels of activity
Ֆ Fixing prices for products
Illustration 1:
(Profit Planning) based on the following information, find out the break
even point, the sales needed for a profit of rs.6,00,000 and the profit if
4,00,000 units are sold at rs.6 per unit.
Units Of Output
5,00,000
Fixed
Costs
Rs.7,50,000
Variable Cost Per Unit
Rs. 2
Selling Price Per Unit
Rs. 5
Solution:
(1)Break-Even Point (Of Sales)
Fixed Costs
= -------------------------- X Selling Price Per Unit
Contribution Per Unit
218
7,50,000
= ------------- x 5
=
Rs.12,50,000
3
(2) Sales Needed For A Profit Of Rs.6,00,000
Fc + Desired Profit
Sales = --------------------------
P/V Ratio
7,50,000 + 6,00,000
=
---------------------------
3/5
5
= 13,50,000 X -----
3
= Rs.22,50,000 [or]
22,50,000
=
---------------
(SP) 5
= 4,50,000 Units
(3) Profit On Sale Of 4,00,000 Units At Rs.6 Per Unit
Sales = 4,00,000 Units
= 4,00,000 X Rs.6
=
Rs.24,00,000
Sales – V. Cost = Contribution
24 Lakhs – (4 Lakhs X 2 Per Unit) = 16,00,000
C – Fc
= Profit
16,00,000 – 7,50,000 = Rs.8,50,000 [Or]
Unit Sales X Contribution Per Unit – Fc
4 Lakhs X Rs.4 = 16 Lakhs – 7,50,000 = 8,50,000
Illustration 2: (Pricing)
A company is considering a reduction in the price of its product by
10% because it is felt that such a step may lead to a greater volume of sales.
It is anticipated that there will be no change in total fixed costs or variable
costs per unit. The directors wish to maintain profit at the present level.
219
You are given the following information:
Sales (15,000 Units)
Rs.3,00,000
Variable Cost
Rs.13 Per Unit
Fixed Cost
Rs.60,000
From the above information, calculate P/V ratio and the amount of sales
required to maintain profit at the present level after reduction of selling
price by 10%.
Solution:
S – V
3,00,000 – (15,000 X 13)
P/V Ratio = ----------
= -------------------------------
S
3,00,000
= 0.35 Or 35%
After reduction of price by 10% it will be Rs.18 (original price per unit
Rs.20).
Present profit level = (35% of 3,00,000) – 60,000
=
Rs.45,000
P/v ratio after price reduction
S – V 18 – 13 5
= -------- = ---------- = ---- %
S
18 18
To earn the same profit level
F + Desired Profit
= ------------------------
P/V Ratio
18
= 1,05,000 X ------
5
= Rs.3,78,000
Illustration 3:
From the following data, calculate the break-even point.
First
year
Second
Year
Sales
80,000
90,000
Profit
Rs.10,000
Rs.14,000
220
Solution:
Fixed Costs
Bep Sales = ----------------
P/V Ratio
Change In Profit
P/V Ratio = -------------------- X 100
Change In Sales
4,000
= --------- X 100 = 40%
10,000
Fixed Cost = Contribution – Profit
40
= 80,000 X ------ − Rs.10,000
100
= 32,000 – 10,000
= 22,000
22,000 X 100
Bep Sales = ---------------- =
Rs.55,000
40
Illustration 4:
A company is considering expansion. Fixed costs amount to
rs.4,20,000 and are expected to increase by rs.1,25,000 when plant
expansion is completed. The present plant capacity is 80,000 units a year.
Capacity will increase by 50 percent with the expansion. Variable costs
are currently rs.6.80 per unit and are expected to go down by re.0.40 per
unit with the expansion. The current selling price is rs.16 per unit and is
expected to remain the same under either alternative. What are the break-
even points under either alternatives? Which alternative is better and why?
221
Solution:
Computation of BEP Under Two Alternatives
Items
Currently
Afterthexpansion
Rs.
Rs.
---------------------------------------------------------------------------------
Fixed
Costs
4,20,000
5,45,000
Capacity
80,000 Units
1,20,000Units
Variable Cost Per Unit
6.80
6.40
Contribution Margin Per Unit
9.20
9.60
Selling Price Per Unit
16
16
4,20,000
5,45,000
BEP = ------------
-----------
9.20
9.60
= 45,652 Units
= 56,771 Units
---------------------------------------------------------------------------------
Assuming that the whole production can be sold, the profit under
The two alternatives will be:
Items
Currently
After The Expansion
Sales
12,80,000
19,20,000
- Variable Cost
5,44,000
7,68,000
------------
------------
Contribution
7,36,000
11,52,000
- Fixed Cost
4,20,000
5,45,000
------------
------------
3,16,000
6,07,000
------------
------------
---------------------------------------------------------------------------------
It is obvious from the above calculations that the profits will be almost
double after the expansion. Hence, the alternative of expansion is to be
preferred.
222
Illustration 5:
A factory engaged in manufacturing plastic buckets is working at
40% capacity and produces 10,000 buckets per annum:
Rs.
Material
10
Labour cost
3
Overheads
5 (60% fixed)
The selling price is rs.20 per bucket.
If it is decided to work the factory at 50% capacity, the selling price falls by
3%. At 90% capacity the selling price falls by 5%, accompanied by a similar
fall in the prices of material.
You are required to calculate the profit at 50% and 90% capacities and also
the break-even points for the same capacity productions.
Solution:
Statement showing profit and break-even point at different capacity levels:
Capacity Level
50%
90%
Production (Units)
12,500
22,500
Per Unit
Total
Per Unit
Total
Rs.
Rs.
Rs.
Rs.
---------------------------------------------------------------------------------
(A) Sales
19.40
2,42,500
19.00
4,27,500
Variable Cost
Materials
10.00
1,25,000
9.50 2,13,750
Wages
3.00
37,500
3.00
67,500
Variable
Overhead
2.00
25,000
2.00 45,000
---------------------------------------------------------------------------------
(B)Total Variable Cost 15.00
1,87,500
14.50 3,26,250
---------------------------------------------------------------------------------
(C) Contribution
(S-V)
4.40
55,000
4.50 1,01,250
Or (a-b)
Less Fixed Cost
30,000
30,000
----------
----------
25,000
71,250
----------
--------
223
Break-even points at
50%
at 90%
Fixed
Costs
Units = ---------------------------
Contribution Per Unit
30,000
30,000
= ---------- = 6818 ----------
= 6667
4.40
4.50
Sales Value = Rs.1,32,269 = Rs.1,26,667
Illustration 6:
Calculate:
Ֆ The amount of fixed expenses
Ֆ The number of units to break-even
Ֆ The number of units to earn a profit of rs.40,000
The selling price can be assumed as rs.10.
The company sold in two successive periods 9,000 units and 7,000
units and has incurred a loss of rs.10,000 and earned rs.10,000 as profit
respectively.
Solution:
Year
Sales
Profit/Loss
I
7,000 Units
Rs. (- )10,000
II
9,000 Units
Rs. (+)10,000
-------
----------
2,000
20,000
(Change)
-------
----------
Year
I
Year
II
(I) Contribution = 9,000Units X Rs.10
7,000Units Xrs.10
= Rs. 90,000
= Rs. 70,000
Less: Profit/Loss = Rs. -10,000
= Rs.+10,000
-----------
--------------
Fixed Cost = Rs. 80,000
= Rs. 80,000
(Contribution = Fixed Cost + Profit)
224
Rs.20,000
(Ii) Contribution
= ---------------
= Rs.10 Per Unit
2,000 Units
FC
Rs.80,000
BEP = ---------
= -------------
= 8,000 Units
C
Rs.10
(Iii) The No. Of Units To Earn A Profit Of Rs.40,000
F + Desired Profit
=
-----------------------
C
Per
Unit
80,000 + 40,000
= ---------------------
= 12,000 Units
10
Illustration 7:
From The Following Data Calculate:
Ֆ P/V Ratio
Ֆ Profit When Sales Are Rs.20,000
Ֆ Net Break-Even If Selling Price Is Reduced By 20%
Fixed Expenses Rs.4,000
Break-Even Point 10,000
Solution:
Fixed Expenses
(I) Break-Even Sales = --------------------
P/V Ratio
Fixed Expenses
or P/V Ratio = ----------------------
Break-Even Sales
4,000
= --------
= 40%
10,000
(II) Profit When Sales Are Rs.20,000
Profit = Sales X P/V Ratio – Fixed Expenses
= Rs.20,000 X 40% − Rs.4,000
= Rs. 8,000 – Rs.4,000
= Rs. 4,000
225
(III) New Break-Even Point If Selling Price Is Reduced By 20%
If Selling Price Is Rs.100, Now It Will Be Rs.80
V. Cost Per Unit = Rs.60 (I.E., 100 – 40% Old P/V Ratio)