Page 88 - DCOM206_COST_ACCOUNTING_II

Unit 4: Cost Volume Profit Analysis

 CVP analysis can address many issues, such as the number of units that must be sold to Notes
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.

 The important element of the marginal cost equation is the ‘contribution’ factor which is
resulted from the sales value after deduction of variable costs.
 Contribution is also known as gross margin. In the other words, contribution is the
difference between sales and marginal cost.
 The profit-volume ratio, popularly known as the P/V ratio, expresses the relation of
contribution to sales. This ratio is also known as contribution to sales or the marginal
income ratio. The profit-volume ratio is often expressed as a percentage and is a guide to
the profitability of a business firm.

 According to Joseph Baggot, ‘Break-even analysis refers to a system of analysing cost into
its fixed and variable components to determine the probable profits at given level of
activity.”
 Break-even point is a point where the total sales or revenue are equal to total costs. In
break-even point, there is no profit or loss in the volume of sales.

 Margin of safety is an important concept in marginal costing approach. Margin of safety is
the difference between the actual sales and the sales at break-even point. This is represented
by excess sales over and above the break-even point.

 A break-even chart is a graphical representation of marginal costing or cost-volume-
profit analysis. It is an important aid to profit planning. It has been defined as “a chart
which shows the profitability or otherwise of an undertaking at various levels of activity
and as a result indicates the point at which neither profit nor loss is made.”
 Decision-making describes the process by which a course of action is selected as the way
to deal with a specific problem. A decision involves the act of choice and the alternative
chosen out of the available alternatives.

4.9 Keywords

Break-even Chart: It is a graphical representation of marginal costing or cost-volume-profit
analysis.
Angle of Incidence: This is the angle between sales and total cost line.
Break-even Analysis: It refers to a system of analysing cost into its fixed and variable components
to determine the probable profits at given level of activity.

Break-even Point: It is a point where the total sales or revenue are equal to total costs. In break-
even point, there is no profit or loss in the volume of sales.
Contribution: It is the difference between sales and marginal cost.

Cost-volume-profit Analysis: It is the study of the effects on future profits of changes in fixed
cost, variable cost, sales price, quantity and mix.
Decision-making: It is defined as the selection of a course of action from among alternatives.
Margin of Safety: It is the difference between the actual sales and the sales at break-even point.

Marginal Cost Equation: The element of cost can be written in the form of an equation which is
called marginal cost equation.
Profit-volume Ratio: Popularly known as the P/V ratio, it expresses the relation of contribution
to sales.

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