Page 264 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 12: Marginal Costing and Profit Planning

Notes
* Deciding on a level of sales to achieve a targeted profit: At the BEP of sales, there is
neither profit nor loss. It means that the contribution (sales minus variable expenses) has
just about covered the fixed expenses. This suggests that for sales beyond this point, the
entire contribution will be profits because there is no more fixed expenses to meet. So, if
a profit of, say, 1,00,000 is targeted in the illustration, all that is to be done is to sell
additional un its that will make the incremental contribution beyond meeting the fixed
expenses as 1,00,000.

In other words, the new volume is targeted to cover not only the fixed expenses of
50,000, but also the profit of 1,00,000. So, dividing 1,50,000 by the contribution per unit
of 4 gives us 37,500 units. Thus, 37,500 units will have to be manufactured to achieve a
profit of 1,00,000.
The number of units to be manufactured to achieve target profit = target profit plus fixed
expenses divided by contribution per unit.
* Determining the profit at a targeted level of sales: Similarly, if the management has
targeted a level of sales on the basis of its market survey or otherwise, the profits that will
emerge from that level of sales can be determined using CVP analysis. The contribution
margin per unit multiplied by the number of units produced over and above the BEP gives
us this figure. Of course, profits can always be computed as the difference between sales
and total cost. But what CVP analysis achieves is that incremental profits from selling
additional units can be easily calculated on the basis of the established relationship between
cost and volume.

* Determining the impact of additional fixed costs: If the fixed costs go up, the revised BEP
can be computed. A no-profit, no-loss situation comes up only at the increased point now,
consequent to the increased fixed costs. The entire structure of relationship between cost
and volume will undergo a change consequent to this increase in fixed cost.

In real life, it may be difficult to segregate cost strictly into its fixed and variable elements.
What can be attempted is to bring about as close a split as possible. The advantages of CVP
analysis would far outweigh whatever difficulties one might face in segregation.

Source: thehindubusinessline.com

12.5 Break-even Analysis

Break even analysis examines the relationship between the total revenue, total costs and total
profits of the firm at various levels of output. It is used to determine the sales volume required
for the firm to break even and the total profits and losses at other sales level. Break even analysis
is a method, as said by Dominick Salnatore, of revenue and total cost functions of the firm.
According to Martz, Curry and Frank, a break even analysis indicates at what level cost and
revenue are in equilibrium.
In case of break even analysis, the break even point is of particular importance. Break even point
is that volume of sales where the firm breaks even i.e., the total costs equal total revenue. It is,
therefore, a point where losses cease to occur while profits have not yet begun. That is, it is the
point of zero profit.
Fixed Costs
BEP =
Selling price – Variable costs per unit

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