Page 227 - DCOM302_MANAGEMENT_ACCOUNTING

Management Accounting

Notes Analysis of cost-volume-profit involves consideration of the interplay of the following factors:

1. Volume of sales
2. Selling price
3. Product mix of sales
4. Variable cost per unit
5. Total fi xed costs
The relationship between two or more of these factors may be (a) presented in the form of reports
and statements, (b) shown in charts or graphs, or (c) established in the form of mathematical
deduction.
11.3.1 Objectives of Cost-Volume-Profi t Analysis

The objectives of cost-volume-profit analysis are given below:

1. In order to forecast profit accurately, it is essential to know the relationship between profi ts
and costs on the one hand and volume on the other.

2. Cost-volume-profit analysis is useful in setting up flexible budgets which indicate costs at
various levels of activity.
3. Cost-volume-profi t analysis is of assistance in performance evaluation for the purpose of
control. For reviewing profits achieved and costs incurred, the effects on cost of changes in

volume are required to be evaluated.

4. Pricing plays an important part in stabilising and fixing up volume. Analysis of cost-volume-
profit relationship may assist in formulating price policies to suit particular circumstances

by projecting the effect which different price structures have on costs and profi ts.
5. As predetermined overhead rates are related to a selected volume of production, study
of cost-volume relationship is necessary in order to know the amount of overhead costs
which could be charged to product costs at various levels of operation.

11.3.2 Profit-Volume (P/V) Ratio
The ratio or percentage of contribution margin to sales is known as P/V ratio. This ratio is known

as marginal income ratio, contribution to sales ratio or variable profit ratio. P/V ratio, usually

expressed as a percentage, is the rate at which profits increase with the increase in volume. The
formulae for P/V ratio are:
P/V ratio = Marginal contribution/Sales
Or

Sales value – Variable cost/Sales value
Or
1 – Variable cost/Sales value
Or
Fixed cost + Profi t/Sales value
Or

Change in Profi ts/Contributions/Changes

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