UNSW Business School

School of Accounting
ACCT1501 Accounting and Financial Management 1A
Session 1 2017

Week 12

Management Accounting Cost-Volume-Profit Analysis

Student Handout

Lecturer:
Dr. Conor Clune
School of Accounting
UNSW

Moodle: https://moodle.telt.unsw.edu.au

Session 1, 2017 ACCT1501

 WEEK 12: Cost-Volume-Profit Analysis

1. Introduction

The final week of the course conintues with our brief overview of management
accounting by discussing cost-volume-profit (CVP) analysis. This form of
management accounting is important to managers in order to make decisions about the
products that they will produce and sell. The technique allows us to predict profit
levels based on alternative courses of action. In order to do so, we first need to discuss
fixed, mixed and variable costs and explain some of the key assumptions behind CVP
analysis. We also discuss contribution margin and test our understanding of CVP
analysis by answering two case study questions during the lecture.

Learning objectives

At the end of this topic you should be able to:

- Identify and give examples of Fixed, Mixed and Variable Costs

- Explain the assumptions behind CVP analysis
- Understand CVP concepts including: contribution margin, contribution margin per
unit, and contribution margin ratio
- Calculate CVP analysis figures in the two case study lecture examples

Required reading

Trotman & Carson Management Accounting Supplement, Chapter M2, pp. 35-53
Lecture case studies (p2-3, this document)

Session 1, 2017 ACCT1501

2. Lecture Case Studies
Case Study 1: PowerPooch

Company Overview
PowerPooch is a private company you established on 1/9/14 to make
robotic dogs. Your first dog is the TechieTerror Terrior (TTT).

PowerPooch needs to determine the optimal price of its TTT, and the
optimal level of output at that price. To do this it needs to ascertain:
(a) The nature of its costs and
(b) How costs will change with the scale of operations.

In other words, it needs to have a solid understanding of cost behaviour.

Based on a 1 year budget drawn up at the inception of the business, the following
costs are estimated (based on an activity level of 1,500 units for the year):

Fixed costs Variable Costs

$ $
Rent 120,000 Direct materials 552,000
Depreciation 75,000 Direct labour 240,000
Supervisor salary 144,000 Overheads 84,000
Marketing 28,000
Other overheads 85,000
Total 452,000 Total 876,000

Further information:
(1) Extensive market research suggests that each TTT can be sold for $1,100.
(2) PowerPooch's tax rate is 40%

Required
(a) What is the unit variable cost? What are the implications of this for TTT pricing?

(b) What price would allow all costs to be met for the year?

(c) What is the breakeven point at the $1,100 price suggested by market research?
What if PowerPooch could only get $1,000 for each dog? $1,500 for each dog?

(d) How many units would need to be sold if the sale price is $1,100, and
PowerPooch wants to make an after-tax profit of $100,000?

Session 1, 2017 ACCT1501

 Case Study 2: LGM Limited

LGM Limited sells remote-controlled toy UFOs designed specifically

for Sci-Fi loving university students. The company has identified the following costs
for 2014:

Costs
Rent expenses for factory space = $60,000
Depreciation for machinery = $37,500
Supervisor salary = $72,000
Annual marketing expenses = $25,000
Other fixed overheads = $65,000
Direct Materials = $240,000
Direct Labour = $120,000
Variable overheads = $60,000

Additional Information:

Activity level for 2014 = 2,000 units

Company tax rate = 40%

After a careful market research of university students and their spending patterns, the
company decides that a unit price of remote-controlled UFOs should be set at $395.

Questions

1. What are the Fixed Costs for the company?

2. What are the Variable Costs for the company?
3. What is the unit variable cost?
4. What is the contribution margin?
5. What is the contribution margin per unit?
6. What is the contribution margin ratio?
7. What selling price would allow all costs to be met at the current activity level?
8. If we set a price at $395 per unit as per the market research, what is the BEP in
number of units? BEP in sales dollars?
9. How many units must be sold to generate an after-tax profit of $100,000?

Session 1, 2017 ACCT1501

 3.Tutorial Questions Week 13
Students should attempt these questions before the tutorial.

Preparation Questions
DQM2.1, DQM2.2, DQM2.3, PM2.3, PM2.5, PM2.7, PM2.8, PM2.11

Tutorial Questions
DQM2.5, DQM2.6, PM2.10, PM 2.12

Session 1, 2017 ACCT1501

 ACCT1501
Accounting and Financial Management 1A

Week 12
Cost-Volume-Profit (CVP) Analysis
Session 1, 2017

Conor Clune
School of Accounting
 TOPIC 12: Learning Objectives
LO1: Identify and give examples of fixed, mixed and variable costs
LO2: Explain the concept and assumptions behind CVP
analysis
LO3: Understand and calculate contribution margin,
contribution margin per unit and contribution margin
ratio
LO4: Case Study: CVP analysis

Essential Readings
TC Management Accounting Supplement Chapter M2

2
 From Week 11 Case Study

Product Cost (manufacturing)

o DM
o DL
o OH

Period Cost (non-manufacturing)

o SG&A

At what price should PowerPooch sell its robotic terriers?

3
 Cost Classification
To support Decision
Making

Cost

Functional Behavioural

Manufacturing Non-Manuing Fixed Mixed Variable

Direct Indirect SG&A

DM DL OH
Last Week

4
 Cost Behaviour LO1

Cost behaviour deals with how costs change with respect to

changes in activity levels.

Why it is important to know cost behavior?

o Essential for planning, control and decision making:
Costing
Pricing
Product mix
Make or buy
Performance evaluation
Financial planning

5
 Cost Driver LO1

Cost driver a factor that causes (drives) activity costs.

E.g.:

Work on the production line

Activity

Costs caused by Direct labour costs

the activity

Direct labour hour

Cost driver

6
 Cost Classification LO1

Costs can be classified as:

o Fixed CVP

o Variable
o Semi-fixed (Step-variable)
o Mixed (Semi-variable)

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 Fixed Cost LO1

In total, remain constant within the relevant range as the level of

cost driver varies.
o What is relevant range?
The range over which the assumed fixed cost relationship is valid for the normal operations of
an organisation

Fixed costs per unit vary inversely with activity unit cost
changes as the level of cost driver changes.

Examples of fixed cost?

o Rent per month
o Insurance per year

8
 Fixed Cost An example LO1

Fixed costs = $1,000

If production = 10 units
Fixed Cost per unit = $1,000/10 = $100

If production = 100 units

o Fixed Cost per unit = $1,000/100 = $10
ButTotal fixed costs = $1,000

9
 Fixed Cost
LO1

Cost function:
y = a, where y represents the total cost level and a is a constant

LOOK!

$ Total costs $ Per unit costs

Activity Activity
Level Level
0 0

Relevant range

10
 Revision Question 1 LO1

AXYZ LTD produces tennis racquets. The company can produce up

to 10,000 racquets per year. The production workers are
supervised by a factory supervisor who is paid $100,000 per year.
What will be the cost of supervision if the company produces 5000
racquets?
A.$50,000
B.$10,000
C.$5,000
D.$100,000

11
 Revision Question 2 LO1

Which of the following statement(s) about fixed costs is incorrect?

i.Per unit fixed costs decreases as the number of unit produced
increases.
ii.Total fixed cost is constant within the relevant range.
iii.Per unit fixed costs and total fixed cost are constant within the
relevant range.
iv.The higher the level of level of production within the relevant
range, the higher the total fixed costs will be.
A.i and ii
B.i, ii and iii
C.ii and iii
D.iii and iv

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 Variable Cost LO1

In total, vary proportionally with changes in activity level

Remain the same on a per unit basis
Cost - Functional
Examples? Manufacturing
Metres of fabric? Non-manufacturing - SG&A
5% sales commission? Depends!
$5/hour wage rate?

13
 Variable Cost - An example LO1

Variable costs = $10 per unit

o If units = 10
o Total VC = 10 x $10 = $100

o If units = 100
o Total VC = 100 x $10 = $1,000

14 14
 Variable Cost LO1

Cost function:
y = bx - where y represents total cost level, b is the unit variable
cost and x is output volume

LOOK!

$ Total costs $ Per unit costs

0 Activity Level
0 Activity Level

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 Fixed and Variable Costs Assumptions LO1

Cost behaviour is defined with respect to a single, specific cost

object/driver
Linearity
Specified time span
o Because
o E.g. rent per month
Changes in output volume are moderate
o Capacity?

16 16
 Semi-Fixed Cost LO1

Some fixed costs do not fit the fixed cost classification

completely
o Fixed over a moderate range of activity and, then, rise or fall to
new levels beyond that range

Example?

17 17
 Semi-Fixed Cost LO1

Cost function:
o y = a1, 0 < x <x1
o y = a2, x1 < x < x2, etc
where y represents the total cost level and a1 and a2 are
constants

$ Total costs

a2

a1

0 x1 x2 Activity

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 Semi-Variable Cost LO1

Some variable costs do not fit the variable cost classification

completely
o Although they are directly proportional to activity, they have a
fixed component

Examples?
o ISP $19.95/month up to 30GB, $5 per extra 1GB download
o Electricity bill service fee + usage

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 Semi-Variable Cost LO1

Cost function:
o y = a + bx
where y represents total cost level, a is the fixed cost
component, b is the unit variable cost and x is output volume

$ Total costs

0 Activity

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 Revision Question 3 LO1

Which of the following statement(s) about variable costs is incorrect?

i.Per unit variable costs decreases as the number of unit produced increases.
ii.If the variable cost per unit is $20 and the production is 100 units, the total
variable cost will be $200.
iii.Per unit variable costs remain the same regardless of the number of units
produced.
iv.Total variable cost increases in direct proportion to increases in units of product.
A. i
B. i and ii
C. ii and iii
D. iii and iv

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 CVP Analysis LO2

CVP analysis examines the effect of changes in costs and

volumes on a firms profits

Factors considered
o Volume or activity level
o Unit selling price
o Variable cost per unit
o Total fixed cost
o Sales mix

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 If you were the manager LO2

Volume or activity level

Unit selling price

Variable cost per unit

Total fixed cost

Sales mix

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 CVP Assumptions LO2

Behaviour of costs and revenues is linear over the relevant range

All units produced are sold

Costs can be classified as either fixed or variable

Only changes in activity affect costs

Selling prices and costs are assumed to be known with certainty

Sales mix remains constant in multi-product firms

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 Contribution Margin LO3

Contribution margin (CM):

o Revenue Variable Cost
o Contributes to meeting fixed costs

Contribution margin per unit:

o Unit selling price Unit Variable Cost

Contribution margin ratio:

CM per unit
Unit selling price

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 Break-Even Analysis LO3

Determination of level of activity at which total revenues equal

total costs (fixed + variable)
o known as a Break-Even Point (BEP)

Can be calculated by:

o Graphical method
o Equation method
Units-sold approach
Sales revenue approach

26
 Break-Even Analysis Graphical Method LO3

$
Revenue = SX

BEP
Total cost = VX + F
Profit

Activity

27
 Break-Even Analysis Equation Method
LO3
Units-Sold Approach

Uses the following relationship Fixed Cost

Profit = Total Revenue Total Costs Variable

= SX VX F Cost

where S = unit selling price

X = number of units
V = unit variable cost
F = fixed costs

28
 Break-Even Analysis Equation Method
LO3
Units-Sold Approach
Rearrange the equation

ProfitBT = Total revenue Total costs

= SX (VX + F)
= (S V)X F
X = F + ProfitBT At breakeven:
Profitbt = 0
(S V)
Note:
Profit in our equation is profit before tax
(S-V) = unit contribution margin

29
 Revision Question 4
LO3

Red Ltd produces product X. It sells the product for $200 per
unit. The variable cost per unit is $125. The total fixed cost is
$560000. Calculate the number of units that must be sold for
Red Ltd to break-even.
A. 2800 units
B. 7466.67 units
C. 4480 units
D. 7467 units

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 Sales Mix LO3

For multi-product firms, impact of product mix is taken into

account by determining the appropriate weighted average
contribution margin (WACM)

Recall Contribution Margin?

o Revenue Variable Cost
o (S V)X

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 Weighted Average Contribution Margin LO3

Example:

Product A Product B
CM $10 $4
Production ratio 40% 60%

WACM is ($10 x 0.4) + ($4 x 0.6) = $6.40

Use this WACM to calculate the breakeven units
Of those units, 40% are expected to be Product A and 60% are
expected to be Product B.

32
 So far LO3

Contribution Margin

BEP

What about profit?

Profit = Total Revenue Total Costs
= SX (VX + F)

33
 Target Profit LO3

Profit in our equation is profit before tax

ProfitBT = Total revenue Total costs

= SX (VX + F)
= (S V)X F Target Profit

X = F + ProfitBT
(S V)

34
 Target profit LO3

Effect of taxation
o You may want to determine volume necessary to achieve a certain
level of profit after tax

o The after-tax profit target must be first converted to a before-tax

profit target
ProfitAT is Profit after tax

o Let be the tax rate

ProfitAT = ProfitBT ProfitBT.
= ProfitBT(1 )
ProfitBT = ProfitAT/(1 )

35
 Break-Even Analysis Equation Method
LO3
Sales Revenue Approach
This method is particularly useful when:
o individual units are not easily identifiable
o a company has a very large number of different product

ProfitBT = R F (vr)R

Where:
R = SX (i.e., Selling price x Units Sold)
vr = V/S (i.e., Total variable cost/Sales Revenue)
F = Total fixed cost
ProfitBT = Profit before tax

36
 Break-Even Analysis Equation Method
LO3
Sales Revenue Approach
To obtain break even point in sales dollar:

Sales dollars = F + ProfitBT

CM Ratio
Where:
F = Total fixed cost
ProfitBT = Profit before tax
CM Ratio = Contribution margin ratio

Recall: At break even, ProfitBT (i.e., Profit before tax) is equal to 0

37
 Break-Even Analysis Equation Method
LO3
Sales Revenue Approach
Recall that:
Contribution margin per unit:
o Unit selling price unit VC

Contribution margin ratio: CM per unit

Unit selling price

However, for Sales revenue approach, to get the CM Ratio, we

divide total contribution margin with total sales revenue

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 Break-Even Analysis Equation Method
Sales Revenue Approach LO3

For example, refer to p. 51 TGC

Assume a university bookstore sells a wide range of books with
different mark-ups. Assume the bookstore has the following
projected profit for the quarter:
$
Sales 400,000
Less: Variable expenses (325,000)
Contribution margin 75,000
Less: Fixed costs (45,000)
Profit before tax 30,000
CM Ratio = 75,000
400,000
=
0.1875
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 Revision Question 5
LO3

The operating results for My Ltd in 2015 are as follows:

Sales 850,000
Less: Variable costs 320,000
Contribution margin 530,000
Less: Fixed costs 175,000
Net Profit 355,000

What is the contribution margin ratio in 2015?

A. 0.41
B. 0.62
C. 0.37
D. None of the above

40
 Revision Question 6
LO3

The operating results for My Ltd in 2015 are as follows:

Sales 850,000
Less: Variable costs 320,000
Contribution margin 530,000
Less: Fixed costs 175,000
Net Profit 355,000

In 2016, variable costs is expected to increase by 5% while sales is

expected to increase by 7%. What will be the contribution margin
ratio for My Ltd in 2016?

41
 Case Study 1: PowerPooch LO4

Questions in your weekly handout

42
 Case Study 2: LGM LO4

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