Download Cost Volume Profit Analysis Break Even Approach-Accounting-Lecture Notes and more Study notes Accounting in PDF only on Docsity! LESSON# 30 COST – VOLUME – PROFIT ANALYSIS (Break-even Approach) Break-even Cost-volume-profit analysis can be used to calculate break-even. Break-even is the point where sales revenue equals total cost, i.e. (here is neither a profit nor a loss. Profit (or loss) is the difference between contribution margin and fixed costs. Thus the break-even point occurs where contribution margin equals fixed costs Target Contribution Margin Target contribution margin is the amount which if equal to fixed cost will give nil net profit, whereas, if we need to earn a target profit, such profit will be added up into the fixed cost to have target contribution margin. Contribution margin per unit can be assumed to be constant for all levels of output in the relevant range. Similarly, fixed costs can be assumed to be a constant amount in total. The relationships may be depicted thus: Contribution Margin per unit Selling price per unit less variable costs per unit Total contribution Volume x (Selling price per unit less variable costs per unit) Target Contribution Margin Fixed costs + Profit target Target Sales in number of units Target Contribution Margin Unit contribution Contribution may be calculated in total, or on a per-unit basis using selling prices and variable costs per unit. The difference between contribution and fixed costs is profit (or loss); thus when contribution equals fixed costs, break-even occurs. In this way a target profit may be converted into a target contribution margin which may be used to calculate the number of units required to achieve the desired target profit. Contribution margin to sales ratio Contribution to sales ratio (C/S ratio) = Contribution Margin in Rs Sales in Rs Note: you may encounter the term profit to volume (or P/V) ratio, which is synonymous with the contribution to sales ratio. Profit to volume is an inaccurate description, however, and should not be used. The C/S ratio is conveniently written as a percentage. Break even point refers to the volume (sales) at which the entity earns no profit and suffers no loss. It is the point where Contribution margin = Fixed cost And Target profit = 0 Contribution margin – Fixed cost = 0 Profit Contribution margin = Fixed cost + 0 Profit At break even point the target contribution is equal to the fixed cost Contribution Margin – Fixed cost = Profit docsity.com Contribution margin = Fixed cost + Profit Practice Question Q. 1 Income Statement Rs. Sales 700 units x Rs 8 5,600 Variable cost 700 units x Rs 6 4,200 Contribution margin 1,400 Fixed cost 1,000 Profit 400 Variable cost over sales 4,200 x 100 = 75% 5,600 Contribution margin over sales 1,400 x 100 = 25% 5,600 Per Unit Calculation Sales price Rs 8 Less Variable cost (6) Contribution Margin 2 6 / 8 x 100 = 75% 2 / 8 x 100 = 25% Total per unit % Sales 700 units x Rs 8 5,600 8 100% Variable cost 700 units x Rs 6 4,200 6 75% Contribution margin 1,400 2 25% Fixed cost 1,000 Profit 400 Break even sales in Rupees Remember the formula to calculate required amount in absence of certain information: Given Amount x % of required amount = Required Amount % of given amount Here, to calculate break even sale, we need contribution margin to be equal to the fixed cost so that the profit is zero. Now if the target contribution margin is equal to Rs. 1,000 then what would be the sales at this point? Now the above formula will be applied to calculate breakeven sales: Target CM is the given amount and its % is 25, so the sale which is 100% will be: Rs 1,000 x 100 = Rs 4,000 25 OR docsity.com
