Cost -Volume- Profit -Analysis -marginal costing Flashcards
What is CVP.
The study of the relationship between costs and volume (level of output) and the effect on profit at various levels of activity
What is the purpose of CVP analysis?
Used by management to find:
- number of units that must be manufactured to break even
- number of units that must be manufactured and sold to achieve target profit
- selling price that will achieve break even point and target profit
- the margin of safety
-the outcome of producing and selling one extra unit of product
- profit at different levels of activity
- most profitable level of production
Principles (assumptions) of marginal costing
-total cost of producing a product can be easily divided into fixed and variable elements
- fixed costs remain fixed and are not affected by the volume of output (number of products produced)
- when one more unit of product is manufactured, the unit cost of production will increase only by the variable cost of this extra unit
What happens when one extra unit of product is produced?
- income will increase by the selling price of the extra unit
- costs will increase by the variable cost of this extra unit (VC is the TC and not just the VC’s of production)
- profits will increase by the selling prices less the variable cost I.e contribution
Know how to draw up a marginal costing statement
What is contribution?
The amount each unit of sales contributes towards covering fixed costs and profits. The contribution earned initially covers fixed costs and once these are recovered the remaining contribution is profit
Formula: selling price less variable costs
What is the break even point?
The point at which profit is zero (the business is making neither a profit nor a loss). Contribution equals fixed costs. The number of units that must be sold so that sales revenue equals total cost
Formula: fixed cost divided by contribution per unit
What is the margin of safety ?
The a,lung by which sales can fall before break even point is reached. It can be expressed in units, sales value, or as a percentage of budgeted sales
Formula: forecast output (sales) less break even point
What is target profit?
The level of production and sales required for a business to reach its profit goal. It is an aid to decision making. It is treated like a fixed cost. The contribution required will need to cover the target profit as well as the fixed costs
Formula: fixed cost plus target profit divided by contribution per unit
What is contribution to sales ratio?
It is an alternative way to find the break even point, margin of safety, or units to achieve target profit. It is essential to use this ratio when necessary figures are not shown .
Formula: contribution x 100 divided by sales
Or contribution per unit x 100 divided by selling price
What are the limitations of marginal costing?
Marginal costing assumes that:
Variable costs are completely variable at all levels of output
Fixed costs are fixed in the long term
All costs can easily be classified into fixed and variable elements
Selling price is constant
All stock is sold
Only one product is produced
There are no faulty products
Limitation (in order):
Not always the case as variable costs can decrease because of economies of scale or increase due to increased costs
Most fixed costs are fixed only within a relevant range
Not always possible
No account of price reductions for sale items or discounts given for large orders
Fixed costs are charged in total to the period and are not carried forward to the next period when stock is carried over
Most businesses produce more than one product and these are usually in variable quantities
It is not possible that all products are 100% quality 100% of the time
