Page 67 - DCOM206_COST_ACCOUNTING_II

Cost Accounting – II

Notes Cost-volume-profit (CVP) analysis estimates how changes in costs (both variable and fixed),
sales volume, and price affect a company’s profit. CVP is a powerful tool for planning and
decision making. In fact, CVP is one of the most versatile and widely applicable tools used by
managerial accountants to help managers make better decisions.
Thus, cost-volume-profit analysis is the analysis of three variables, viz., cost, volume and profit.
In cost-volume-profit analysis, an attempt is made to measure variations of various costs and
profit with the volume. Profit as a variable is the reflection of a number of internal and external
conditions which exert influence on sales revenue and costs. CVP analysis can address many
issues, such as the number of units that must be sold to break even, the impact of a given
reduction in fixed costs on the break-even point, and the impact of an increase in price on profit.
Additionally, CVP analysis allows managers to do sensitivity analysis by examining the impact
of various price or cost levels on profit.

4.1 Concept of Cost-Volume-Profit Analysis

According to CIMA, London, “Cost-volume-profit analysis is the study of the effects on future
profits of changes in fixed cost, variable cost, sales price, quantity and mix.”
In the words of Heiser, “The most significant single factor in profit planning of the average
business is the relationship between the volume of business, costs and profit.”

The cost-volume-profit analysis is the relationship among cost, volume and profit. Profit of a
business organisation depends upon a number of factors such as selling price, sales volume, per
unit of variable cost, fixed cost and sales mix. The cost-volume-profit analysis explains the inter
relationships of these variables for decision-making. The management is always interested in
knowing that which product or product mix is most profitable; what effect a change in the
volume of output will have on the cost of production and profit etc.

Note Under cost-volume-profit analysis, when volume of output increases, unit cost of
production decreases, and vice-versa; because, the fixed cost remains unaffected. When the
output increases, the fixed cost per unit decreases. Therefore, profit will be more, when
sales price remains constant.

The basic purpose of cost-volume-profit analysis is to determine the impact of fluctuations in
cost and volume on the financial results of the business firm or organisation. All these problems
are solved with the help of the cost-volume-profit analysis.

4.1.1 Objectives of Cost-Volume-Profit Analysis

Following are the main objectives of cost-volume-profit analysis:
1. To achieve the minimum level of sales for avoiding losses

2. To arrive at the desirable product mix so as to maximise profit
3. The required level of sales that will fetch the planned rate of profit
4. To ascertain the most viable product and the least profits required to gain ground in the
market
5. To determine the resultant impact on cost-volume-profit relationships on account of the
planned expansion of activities

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