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Managerial Accounting

• Cost accounting profitability analysis

• Budgeting planning

• Performance control

• Quality

• Time

• ……

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Cost-Volume-Profit (CVP) analysis

• CVP analysis: a most basic planning tool.

• Relationship among ‘Revenue’, ‘Cost’, ‘Profit’: Operating income = f (Total revenues, Total costs)

Where: Total revenue = f (Sales volume, Selling pric

e)

Rewritten as:

Operating income = f (Sales volume, Selling price, Total costs)

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CVP analysis

Definition

• CVP analysis is the analytical technique used to ‘examine the behavior of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable costs per unit, or fixed costs.’

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Examples of the Questions That Can Be Addressed by CVP Analysis

• How will a firm’s profit change if

(1) 1000 instead 1200 units are sold?

(2) the cost of one of its products changes?

(3) the selling prices are lowered?

(4) the business is expanded into overseas market?

• How many units must a firm sell to break even for the year, or make a profit of, say, $20,000?

• What effects does an increase in population have on sales-tax revenues and the cost of providing services, such as education, transportation, and police protection?

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A practice of CVP analysis

A small retailer of software package• Purchase cost: $120/package• Rental fee: $2000• Selling price: $200/package

What profits will the retailer make if she sell(1) 2 packages?(2) 35 packages?(3) 0 package?

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Ways to compute OI

@2 packages:

(1) 200*2 – 120*2 – 2000 = -1840 equation method

(2) 200-120 = 80; 2*80-2000 = -1840 contribution margin method

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CVP Assumptions

1. Operating revenues, operating costs

2. Variable costs, fixed costs

3. Linearity

4. Constant prices and costs

5. Constant sales mix

6. Ignoring the time value of money

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Assignment 1.1

1. Why do we need assumptions 3, 4 and 5 in CVP analysis?

2. How is CVP analysis affected if the three assumptions are absent?

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CVP-based Sensitive analysis

Examples of the problems to be solved

• What will operating income be if units sold decreases by a certain percentage or a certain amount of units?

• What will operating income be if unit variable costs increase by a certain percentage?

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Key concepts in CVP analysis I: CM

Contribution margin (CM)

• CM is the difference between total revenues and total variable costs.

• CM represents the amount of revenues minus variable costs that contribute to recovering fixed costs, and contribute to operating income.

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Key concepts in CVP analysis I: CM

Definition

Contribution margin (CM)

= total revenue - total variable cost

Unit contribution margin (UCM)

= unit selling price - unit variable cost

Contribution margin percentage (CM%)

= UCM / unit selling price

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Key concepts in CVP analysis I: CM

Usefulness

• To manager: ‘CM is an effective summary of the reasons that operating income changes as the number of units sold changes.’

• To investors: CM demonstrates the ability of the company to recover its fixed costs and make profits.

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Key concepts in CVP analysis I: CM

Computation

CM = total revenues - total variable costs (1)

= UCM * sales volume (2)

= CM% * total revenues (3)

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Key concepts in CVP analysis II: BEP

Breakeven = zero operating incomeBreakeven point = the point where operating income is zero

Two forms of breakeven points1. Breakeven point in units = quantity of output where

operating income is zero

2. Breakeven point in dollar = amount of revenue dollars where operating income is zero

= breakeven point in units * unit selling price (1) = total fixed costs / CM% (2)

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Key concepts in CVP analysis II: BEP

Computation

1. Equation method 2. 2. CM methods

3. Graph method)