MANAGEMENT ACCOUNTING
BAC 3, BAIT 3
COST VOLUME PROFIT ANALYSIS
2025/26
Introduction
The CVP is a systematic examination of the
relationship between changes in activity and changes
in total sales revenue, expenses and the net income.
The CVP model provides a means of assessing
alternative courses of action easily by providing a
relatively “rough” estimate of the outcome.
Thus a thorough analysis should be done before major
changes are made.
The model describes the behavior of the total cost
and revenue over a specific range of output in a short
run.
CVP Analysis
The CVP analysis uses marginal costing and the
relationship of fixed costs and variable costs to
forecast or interpret likely profit/loss at different
activity levels (but within relevant range) or the
effect on profit due to changes in cost or sales
volume.
The CVP analysis is based on the following
assumptions:
Allorganization costs are either purely flexible or capacity
related (variable costs)
Units made equal units sold
Revenue per unit does not change as volume changes
Contribution Margin
Contribution margin is the difference between
the Selling Price per unit and the Variable Cost
per unit.
It is the excess of sales over variable costs (SP-VC)
Contribution is the incremental amount of each sale
that is available to cover fixed costs and provide a
profit.
Knowing the contribution margin allows us to predict
changes in net income that will result from a change
in sales volume
The CVP Profit Equation
Contributionper unit = Selling Price per unit
– Variable Cost per unit
Meanwhile:
Profit = Revenue - Variable costs - Fixed
costs
= (Units sold x Contribution margin per
unit) - Fixed costs
But,(SP – VC) x Units sold = Total
Contribution margin
Therefore; Profit = Total contribution
Example 1
Bakson Ltd has a plant that can produce 20,000 units of product B
each year. The demand for the product is steady and in the next
year the company expects to sell 14,000 units. The expected
selling price is TZS 15,000 each while the variable costs will be
TZS.11,000 per unit. The fixed costs will be TZS. 10,000,000 per
annum. In addition, TZS. 6,000,000 will be spent on advertising the
product. Treat each of the following calculations separately, you
are required to:
1. Based on provided information calculate budgeted profit for next year.
2. Calculate the number of units the company must sell to increase the
budgeted profit by 20% if the selling price remains Tsh 15,000 per unit
and advertising remains at TZS.6000,000 per annum.
3. Identify the maximum amount the company can spend on advertising
the product if the campaign will increase the sales to 20,000 units but
the selling price will be TZS 14,000 per unit. The Board of Directors
expects a profit of TZS.20,000,000.
Contribution Margin and Break Even Point
Contributionmargin is an important tool for
decision making
because it allows to understand how variable
costs will change in proportion to sales which
then allows managers to determine break even
point for their decision making.
Break-even is referred to the level of sales at
which the business makes neither a profit nor a
loss (Profit = 0)
Break-even Analysis
Break-even equation (in Units):
Units sold to break even = Total Fixed Costs ÷
Contribution margin per unit
The equation is derived from: Profit = (Units sold x
Price) –(Units sold x VC per unit)- TFC; At BEP profit is equal to zero.
Ifthe fixed costs are high, it will mean that a large number
of units will have to be produced and sold before the Break‐
even point is reached.
High fixed costs may arise as a result of heavy advertising and
promotional expenses.
Similarly, if the contribution per unit is relatively low, then
very high levels of sales will be needed to generate
sufficient amount to cover the fixed costs.
Contribution Margin Ratio & BEP in Sales
Contribution margin ratio is the proportion of each
sales revenue that goes towards covering fixed costs.
It is also known as profit – volume ratio and it is
calculated as follows:
= Contribution margin per unit / sales revenue per
unit
The ratio is used to determine the Break even point in sales as
follows:
Breakeven sales revenue = Total Fixed costs/Contribution
margin ratio
Also it can be used to determine the net profit as follows:
Profit = (Sales revenue x PV ratio) – Fixed Cost
Targeted Profit
The equation for break even point can also be extended
to determine the number of units the company should
sell to attain targeted profit.
Required Units/volume = Total Fixed cost + Required
profit
Contribution per unit
Example 2:
Use information provided in example 1 to calculate:
1. The break even point in quantity and in sales revenue
2. The number of units the company must sell to increase
the budgeted profit by 15% if the selling price remains
Tsh 15,000 per unit and advertising remains at
Tsh.6000,000 per annum.
3. Identify
the maximum amount the company can spend
on advertising the product if the campaign will increase
the sales to 20,000 units but the selling price will be Tsh
14,000 per unit. The Board of Directors expects a profit of
Tsh.30,000,000.
Margin of Safety
Margin of safety is a measure of how much sales (revenue
or quantity) that may decrease before the company starts
to get loss.
Margin of safety in quantity = Sales in units – BEP units
Margin of safety in revenue = Sales revenue – BEP sales
Percentage margin of safety = Expected sales – BEP sales
Expected sales
Break Even Chart
Contribution Chart
Profit Volume Graph
Multi Product CVP Analysis
Whenever more than one product is produced and sold,
there will be more than one unit contribution margins.
Ifthe fixed cost attributable to each product is known,
then the breakeven point for each product can be
easily determined.
But this is only when there are no common fixed costs at all.
Whenever there are common fixed costs in the
company, then the breakeven point can be calculated
by first converting the sales volume measure of
individual products into standard batches according to
their planned sales mix.
Multi Product CVP Analysis
Then, Breakeven number of Batches
= Total Fixed Costs/ Contribution margin
per Batch
Thereafter, the sales mix used to determine the
standard batch will be used to convert the break
even point in standard batches to breakeven
point of individual products.
Assumptions of the break‐even analysis
1. Linearity of the functions – it is likely that quantity discounts or
the effect of the learning curve will affect the VC. In addition, the
FC are likely to change at very high and low levels of sales;
2. It is possible to split the costs into the two categories of Variable
and Fixed accurately;
3. As a portion of the FC is usually included in the value of any
unsold stock, production must equal sales in each accounting
period. If this assumption is not made, then the FC would change
if the stock level of finished goods changed.
4. 4. Only one product is old or if there is more than one product,
the different products must always be sold in the same ratio. This
is necessary as different products are likely to generate different
amounts of contribution per unit.
5. All other factors, for example, efficiency remains constant.
Example 3
MKK ltd manufactures three products which have the
following revenue and costs (Tsh per unit)
Product 1 2
3
Selling price 2920 1350 2830
Variable cost 1610 720 960
Fixed Costs:
Product specific 490 350
620
Unit fixed cost is based on the following annual sales and
production volumes of 9820, 4210 and 11,180 units for
Product 1, 2 and 3 respectively.
Required:
a) Calculate the breakeven point of individual products,
and for the whole company.
b) If the company incurs general fixed cost that is
apportioned to products at a rate of Tsh 460 per unit
of each product based on their sales and production
volumes, you are required to:
i) Calculate the breakeven point sales based on existing
product mix
ii) Calculate the number of units of each product at the
breakeven point determined in (i) above
Operating Leverage
Operating leverage describes the effects that fixed
costs have on changes in operating income as changes
occur in units sold.
Organizationswith a high proportion of fixed costs
have high operating leverage.
Degreeof operating leverage = Contribution margin ÷
Operating income
= % Change in Operating Income/ % Change in Sales
= Total Contribution/(Total Contribution – Fixed Cost)
The degree of operating leverage at a given level of
sales helps managers to calculate the effect of
fluctuations in sales on operating income.
CVP Analysis and Sensitivity
Analysis
CVP analysis is used in making decision
simultaneously with sensitivity analysis to help
managers cope with uncertainty.
