Page 68 - DCOM206_COST_ACCOUNTING_II

Unit 4: Cost Volume Profit Analysis

6. To ascertain the effect of changes in the volume of output, costs and prices on the planned Notes
profit, and
7. To determine the sale of a product of a plant to be discontinued or the operation of the
business firm should be temporarily stopped.

Self Assessment

Fill in the blanks:
1. CVP is one of the most versatile and widely applicable tools used by managerial accountants
to help managers make better …………………….
2. …………………… as a variable is the reflection of a number of internal and external
conditions which exert influence on sales revenue and costs.

3. The cost-volume-profit analysis is the relationship among cost, ………………… and profit.
4. The basic purpose of cost-volume-profit analysis is to determine the impact of
………………… in cost and volume on the financial results of the business firm or
organisation.

4.2 Marginal Cost Equation

The element of cost can be written in the form of an equation. This equation is known as
‘marginal cost equation’. The equation is shown below:
Sales = Variable cost + Fixed cost + Profit OR S = VC + FC + P
Sales – Variable cost = Fixed cost + Profit OR S – VC = FC + P

Sales – Variable cost = Contribution OR S – VC = C
From the above marginal cost equation, we can understand that in order to earn profit, the
contribution must be more than the fixed cost. To avoid any loss, the contribution must be equal
to fixed cost.

4.2.1 Contribution

The important element of the marginal cost equation is the ‘contribution’ factor which is resulted
from the sales value after deduction of variable costs. It has been stated above that ‘contribution’
is the composition of fixed costs plus profit. Contribution is also known as gross margin. In the
other words, contribution is the difference between sales and marginal cost. Contribution enables
to meet fixed costs and add to the profit.

Note Contribution minus fixed cost is profit, but where fixed cost is more than
contribution, the difference is loss.

Contribution can be expressed by the following formula:
Contribution = Sales – Marginal cost OR C = S – MC
Contribution = Sales – Variable cost OR C = S – VC
Contribution = Fixed cost + Profit OR C = FC + P

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