Question

explain the features of cost-volume-profit analysis and the breakeven point (answer the question in YOUR OWN WORDS and give examples)

Answer 1

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit. ... The cost-volume-profit analysis makes several assumptions, including that the sales price, fixed costs, and variable cost per unit are constant.

Objectives of CVP analysis:-

• Profit planning;
• Help in preparation of flexible budgets;
• Ascertainment of no profit and no loss level;
• Ascertainment of optimum product mix;
• Taking pricing decisions;
• Production planning;
• Taking other managerial decisions;
• Help in controlling cost;
• Achieving efficiency;

Basic Assumptions of CVP Analysis

Several assumptions commonly underlie CVP analysis:

The selling price is constant. The price of a product or service will not change as volume changes.

Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit, and the fixed element is constant in total over the entire relevant range.

In multiproduct companies, the sales mix is constant.

In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold.

While these assumptions may be violated in practice, the results of CVP analysis are often “good enough” to be quite useful.

Perhaps the greatest danger lies in relying on simple CVP analysis when a manager is contemplating a large change in volume that lies outside of the relevant range.

Meaning of Break-Even Point:

Break-even point represents that volume of production where total costs equal to total sales revenue resulting into a no-profit no-loss situation.

If output of any product falls below that point there is loss; and if output exceeds that point there is profit.

Thus, it is the minimum point of production where total costs are recovered. Therefore, at break-even point.

Sales Revenue – Total Cost

or, Sales – Variable Cost = Contribution = Fixed Cost

It can be concluded that at break-even point the contribution earned just covers the fixed cost and, at levels below the point, contribution earned is not sufficient to match the fixed cost and, at levels above the point, contribution earned more than recovers the fixed cost.

P is the break-even point in the break-even chart where OS and CT—being the sales line and total cost line—intersects. Loss results in the left side of P, i.e., before the break-even point is reached, and, beyond P, profit starts to generate. Break-even point has a wide use in the field of marginal costing and helps to decide the product mix, fixation of selling price, steps to be taken in long-term planning etc.

Break-even point can be ascertained by using the following formula: