Cost-Volume-Profit (CVP) Relationships

Question 1

What is CVP?

Answer 1

Cost-volume-profit: The interrelationship between the key elements of the management accounts (cost, production levels, sales volumes and revenue) and profit.

Question 2

What is the 2 main models for conducting a CVP analysis?

Answer 2

The economist’s model

The accountant’s model

Question 3

What does the economist’s model recognise?

Answer 3

That the rate of change in total cost and total revenue is unlikely to remain constant as volumes change.
Initially small reductions in selling price result in relatively large increases in sales volumes.

Question 4

What does the accountant’s model assume?

Answer 4

That as volume increase, the rate of change in both total revenue and total costs is constant (linear relationship).
Selling price per unit remains fixed.

Question 5

Which model is easier to apply?

Answer 5

The accountant’s model

Question 6

What is the most common application of CVP?

Answer 6

To perform a break-even analysis.

Question 7

What is the break-even point?

Answer 7

The level of activity where neither a profit or loss is made.

Question 8

What are the 3 methods to calculate the break-even point?

Answer 8

The profit formula.
The contribution margin formula.
The break-even chart

Question 9

What is the profit formula?

Answer 9

Difference between Revenue and cost.
CVP assumes volume is the only revenue and cost driver - therefore dependent on number of units sold.
Total costs are split between fixed and variable.

Question 10

What formula is used for the profit formula?

Answer 10

P = SPx - (FC + VCx)

P: Profit
SP: Selling price per unit
x: number of units sold
FC: Total Fixed Costs per annum
VC: Variable costs per unit

Question 11

What is the contribution margin formula?

Answer 11

Contribution is calculated as selling price less VARIABLE cost - indicates how much each unit contributes toward covering fixed costs.
Therefore where total contribution = FIXED costs, the break-even point is reached.

Question 12

What formula is used for the contribution margin formula?

Answer 12

Break-even units = total FIXED costs / contribution PER UNIT.

Alternatively

Break-even sales revenue = total FIXED costs / contribution margin ratio.
Where contribution margin ratio = contribution / selling price

Question 13

What is a sensitivity analysis?

Answer 13

It indicates how sensitive one value is to changes in another variable in the same modal

Question 14

What is CVP also used for in addition to break-even?

Answer 14

Performing sensitivity analysis

Question 15

Can profit be calculated for any level of activity?

Answer 15

Yes, if the selling price, fixed - and variable costs are given.

Question 16

What is the margin of safety?

Answer 16

A measure of the extent to which the current level of sales can drop before a loss incur.
Provides useful indicator for the amount of risk associated with a product.

Question 17

How do a higher margin of safety affect sales?

Answer 17

The higher the MOS, the greater the level of sales can drop before a loss.

Question 18

When is a margin of safety useful?

Answer 18

When managers need to consider the impact of new competition.
Where there is a reduction in demands.
Uncertainty surrounding the exact level of expected sales (new product).

Question 19

How can the margin of safety be calculated?

Answer 19

As a percentage.
Total sales value or
The number of units

Question 20

Margin of safety formulae

Answer 20

% = (current sales - break-even sales) / current sales x 100

Units = current sales volume - break-even sales volume

Sales value = current sales - break-even sales

OR

Sales value = MOS units x selling price per unit

Question 21

When can these formulas be used?

Answer 21

Only in scenarios where there is 1 product sold or service being delivered

Question 22

What is common fixed costs?

Answer 22

When companies sell multiple products and the fixed costs are not directly attributable to the products.

Question 23

How can common fixed costs be treated?

Answer 23

Allocate it to the products.
Ignore these.
Use the sales mix (most common).

Question 24

What is an organisation’s sales mix?

Answer 24

The proportion in which products are sold.

A weighted-average unit contribution margin is calculated.

Question 25

What is important in designing computerized CVP models?

Answer 25

Suitably qualified and knowledgeable management accountants are involved as the output is only as good as the input.

Question 26

What is an example of compute programmes available to perform CPV?

Answer 26

Microsoft Excel

Question 27

What is standard deviation?

Answer 27

A statistical tool used to quantify the extent to which a spread of possible outcomes differs from the mean (expected value).

Question 28

Why is the use of standard deviation often criticized?

Answer 28

It provides a quantified estimate as an absolute value

Question 29

What is coefficient of variation?

Answer 29

The expression of the relative amount of dispersion (simply put: standard deviation divided by expected values)