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Cost-Volume-Profit Analysis

TOPIC

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COST VOLUME PROFIT ANALYSIS

• CVP analysis shows the relationship between costs (both variable and CVP analysis shows the relationship between costs (both variable and fixed), volume (the number of units produced and sold), and profit or fixed), volume (the number of units produced and sold), and profit or loss. loss.

• CVP is a useful management tool; it allows managers to understand CVP is a useful management tool; it allows managers to understand and predict how changes in sales prices, sales volumes, and expenses and predict how changes in sales prices, sales volumes, and expenses will affect an organization’s profitability.will affect an organization’s profitability.

• CVP analysis is an CVP analysis is an examination of the relationships examination of the relationships of prices, costs, volume, and of prices, costs, volume, and mix of products. It involves the mix of products. It involves the separation of costs into their separation of costs into their variable and fixed categories at variable and fixed categories at the outset of the analysis. the outset of the analysis.

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Assumptions of CVP:

• Revenues and costs are linear throughout the relevant Revenues and costs are linear throughout the relevant range.range.

• Costs can be identified as either fixed or variable.Costs can be identified as either fixed or variable.• Changes in activity levels are the only factors affecting Changes in activity levels are the only factors affecting

costs.costs.• The number of units produced and sold is the same. The number of units produced and sold is the same. • In companies with more than one product, the sales mix In companies with more than one product, the sales mix

is constant.is constant.

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COST VOLUME PROFIT ANALYSIS

There are three main tools offered by CVP analysis:There are three main tools offered by CVP analysis:

• breakeven analysisbreakeven analysis, which tells us the sales volume our , which tells us the sales volume our need to break even, under different price or cost scenarios need to break even, under different price or cost scenarios

• contribution margin analysiscontribution margin analysis, , which compares the which compares the profitability of different products, lines, or services we profitability of different products, lines, or services we offer offer

• operating leverageoperating leverage,, which examines the degree to which which examines the degree to which our business uses fixed costs, which magnifies our profits our business uses fixed costs, which magnifies our profits as sales increase, but also magnifies our losses as sales as sales increase, but also magnifies our losses as sales drop. drop.

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Contribution Margins

• contribution margin is simply the percentage of each sales contribution margin is simply the percentage of each sales dollar that remains after the dollar that remains after the variable costsvariable costs are subtracted. are subtracted.

• CM = Selling price - Variable cost CM = Selling price - Variable cost • CM may be shown as a per unit amount or a total amount CM may be shown as a per unit amount or a total amount

at a specific level of sales.at a specific level of sales.• The contribution margin is the amount available to cover The contribution margin is the amount available to cover

fixed costs (below the break even point) and the amount to fixed costs (below the break even point) and the amount to add to profit (above the break even point). add to profit (above the break even point).

• The contribution margin may be expressed as a The contribution margin may be expressed as a per unit per unit amountamount or as a or as a total amounttotal amount..

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Contribution margin ratio

• CMR = Contribution margin / selling priceCMR = Contribution margin / selling price• The contribution margin ratio is the percent The contribution margin ratio is the percent

of each sales dollar that is available to cover of each sales dollar that is available to cover fixed costs (below the break even point) and fixed costs (below the break even point) and the amount to add to profit (above the break the amount to add to profit (above the break even point).even point).

• The contribution margin ratio is usually The contribution margin ratio is usually expressed as a percentage.expressed as a percentage.

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Contribution marginContribution margin SalesSales = CM Ratio= CM Ratio

Fixed expenseFixed expense CM RatioCM Ratio

Break-even pointBreak-even point(in sales dollars)(in sales dollars)==

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Contribution Margin Ratio

Total Per Unit PercentSales (400 surf boards) 200,000$ 500$ 100%Less: variable expenses 120,000 300 60%Contribution margin 80,000$ 200$ 40%

Less: fixed expenses 80,000 Net income -$

Total Per Unit PercentSales (400 surf boards) 200,000$ 500$ 100%Less: variable expenses 120,000 300 60%Contribution margin 80,000$ 200$ 40%

Less: fixed expenses 80,000 Net income -$

$80,000$80,000 40%40%

$200,000 sales$200,000 sales==

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Breakeven Analysis

• A second tool for management decision making A second tool for management decision making • breakeven point can be determined by using the breakeven point can be determined by using the

following formulas:following formulas:• Sales Price per Unit — Variable Costs per Unit = Sales Price per Unit — Variable Costs per Unit =

Contribution Margin per Unit. Contribution Margin per Unit. • Contribution Margin per Unit divided by Sales Contribution Margin per Unit divided by Sales

Price per Unit = Contribution Margin Ratio. Price per Unit = Contribution Margin Ratio. • Breakeven Sales VolumeBreakeven Sales Volume = Fixed Costs divided = Fixed Costs divided

by Contribution Margin Ratio.by Contribution Margin Ratio.

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Breakeven Analysis

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The Accounting Cycle

TransactionsOccur

PrepareDocuments

Record inJournals

Post to Ledgers

PrepareUnadjustedTrial Balance

Prepare and Post AdjustingEntries

Prepare Adjusted TrialBalance

PrepareFinancialStatements

PrepareClosingEntries

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IDENTIFICATION & MEASURMENT OF TRANSACTION

In order to be a transaction, a dealing must satisfy In order to be a transaction, a dealing must satisfy the following characteristics:-the following characteristics:-

It involves at least two parties or two aspects It involves at least two parties or two aspects technically termed as accounts.technically termed as accounts.

It results in transfer of or exchange of goods or It results in transfer of or exchange of goods or services.services.

It can be measured in terms of money value. In It can be measured in terms of money value. In shorts, if there is a change in the variables of the shorts, if there is a change in the variables of the fundamental accounting equation, which is,fundamental accounting equation, which is,

Assets = Liabilities + CapitalAssets = Liabilities + Capital, it may be , it may be regarded as a transaction.regarded as a transaction.

For example : Tk. 2000 deposited in bank.For example : Tk. 2000 deposited in bank.

ACCOUNTIGCYCLE

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Journalize transactions in the journal

ACCOUNTIGCYCLE

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What is the general ledger?What is the general ledger?• It is the book of final entry.It is the book of final entry.

• The information from the journal is transferred to The information from the journal is transferred to the ledger in the posting process.the ledger in the posting process.

• Debits and credits in the journal remain exactly Debits and credits in the journal remain exactly the same when posted to the accounts in the the same when posted to the accounts in the ledger.ledger.

Record (journalize) transactionsRecord (journalize) transactions ACCOUNTIGCYCLE

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EXAMPLE OF JOURNAL

Date ParticularsL.F

.Dr.Tk. Cr.Tk.

2003Janu. 1

Cash A/C Dr. To Capital A/C Cr.(Being cash brought in as initial capital)

1,00,000 1,00,000

2003 Transaction Tk.

January1 Started business with cash as capital 1,00,000

Journal

ACCOUNTIGCYCLE

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Journalizing

• Debits are always recorded first.Debits are always recorded first.

• Indent, then record the credit below the Indent, then record the credit below the debit.debit.

• A short explanation is included on the A short explanation is included on the second line.second line.

• Leave a space between journal entries.Leave a space between journal entries.

ACCOUNTIGCYCLE

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• Debits Debits must alwaysmust always equal credits. equal credits.

• Amounts incurred for items that benefit Amounts incurred for items that benefit future accounting periods are recorded future accounting periods are recorded as assets.as assets.

• What are some examples?What are some examples?

– prepaid rentprepaid rent

– prepaid insuranceprepaid insurance

ACCOUNTIGCYCLEJournalizing

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Posting: Posting: transferring transferring informationinformation

from a journal to a ledger.from a journal to a ledger.

ACCOUNTIG CYCLE

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Posting

• All transactions are recorded in the journal, All transactions are recorded in the journal, then amounts are copied to the ledger then amounts are copied to the ledger accounts named on the journal line.accounts named on the journal line.

• Once the amounts are entered into the Once the amounts are entered into the accounts, a posting reference (PR) must be accounts, a posting reference (PR) must be entered in the journal.entered in the journal.

• New balances are computed in the running New balances are computed in the running ledger accounts.ledger accounts.

ACCOUNTIGCYCLE

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Preparing a trial Preparing a trial balance.balance.

ACCOUNTIG CYCLE

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Preparing the Trial Balance

• The trial balance lists the accounts that have The trial balance lists the accounts that have balances in the same order as they appear in balances in the same order as they appear in the chart of accounts.the chart of accounts.

• The trial balance will show if debits/credits The trial balance will show if debits/credits have been interchanged, or if amounts have have been interchanged, or if amounts have been transposed, or if a debit/credit was been transposed, or if a debit/credit was omitted or recorded twice.omitted or recorded twice.

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• Some errors do not show, such as omissions Some errors do not show, such as omissions or recording to the wrong account.or recording to the wrong account.

• Corrections before posting are made in the Corrections before posting are made in the journal.journal.

• An audit trail must be left.An audit trail must be left.

• Do not erase – cross out errors and enter Do not erase – cross out errors and enter corrections.corrections.

ACCOUNTIGCYCLE

Preparing the Trial Balance

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ADJUSTING ADJUSTING ENTRIESENTRIES

ACCOUNTIG CYCLE

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ADJUSTING ENTRIES

• Adjustments or adjusting entries are necessary for Adjustments or adjusting entries are necessary for transactions that extend over more than one transactions that extend over more than one period. The five main types of adjustments are period. The five main types of adjustments are Prepaid Expenses, Unearned Revenues, Prepaid Expenses, Unearned Revenues, Depreciation, Accrued Expenses and Accrued Depreciation, Accrued Expenses and Accrued Revenues.Revenues.

• Adjusting entries are necessary for each of these Adjusting entries are necessary for each of these so that revenues, assets and liabilities are correctly so that revenues, assets and liabilities are correctly reported.reported.

ACCOUNTIGCYCLE

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ADJUSTING ENTRIES

There are two general classes of adjustments:There are two general classes of adjustments:• AccrualsAccruals - revenues or expenses that have accrued but have - revenues or expenses that have accrued but have

not yet been recorded. An example of an accrual is interest not yet been recorded. An example of an accrual is interest revenue that has been earned in one period even though the revenue that has been earned in one period even though the actual cash payment will not be received until early in the actual cash payment will not be received until early in the next period. An adjusting entry is made to recognize the next period. An adjusting entry is made to recognize the revenue in the period in which it was earned.revenue in the period in which it was earned.

• DeferralsDeferrals - revenues or expenses that have been recorded but - revenues or expenses that have been recorded but need to be deferred to a later date. An example of a deferral need to be deferred to a later date. An example of a deferral is an insurance premium that was paid at the end of one is an insurance premium that was paid at the end of one accounting period for insurance coverage in the next period. accounting period for insurance coverage in the next period. A deferred entry is made to show the insurance expense in A deferred entry is made to show the insurance expense in the period in which the insurance coverage is in effect.the period in which the insurance coverage is in effect.

ACCOUNTIGCYCLE

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ADJUSTING ENTRIES

• Pass necessary adjustment entries for the Pass necessary adjustment entries for the following : -following : -

• 1.Salary TK.1,000 is outstanding.1.Salary TK.1,000 is outstanding.

• 2.Interest accrued on investment TK.200.2.Interest accrued on investment TK.200.

• 3.Rent received in advanceTK.400.3.Rent received in advanceTK.400.

• 4.Insurance prepaid TK.300.4.Insurance prepaid TK.300.

• 5.Depreciate furniture by TK.800.5.Depreciate furniture by TK.800.

ACCOUNTIGCYCLE

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ADJUSTING ENTRIES

Date Particulars L.FDebit

Tk.

Credit Tk.

1Salary A/COutstanding Salary A/C(Being outstanding salary adjusted)

1,000 1,000

2Accrued Interest A/CInterest A/C(Being accrued int. on investment adjusted)

200 200

3Rent A/CRent Received in advance A/C

400 400

4Prepaid Insurance A/CInsurance A/C

300 300

5Depreciation A/CFurniture A/C

800 800

ACCOUNTIGCYCLE

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PREPARATION OF

FINANCIAL STATEMENTS

• In order to ascertain the profit or loss of the business In order to ascertain the profit or loss of the business concern, it has to prepare final accounts such as Trading concern, it has to prepare final accounts such as Trading A/c, Profit and Loss A/C and Balance Sheet or financial A/c, Profit and Loss A/C and Balance Sheet or financial statements such as the Income Statement.statements such as the Income Statement.

• The Four Financial StatementsThe Four Financial Statements : :

Balance Sheet

Income Statement

Statement of Owner's Equity

Statement of Cash Flows

ACCOUNTIGCYCLE

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Different Formats ofthe Balance Sheet

• The report format lists assets first, then The report format lists assets first, then liabilities and then owners’ equity. liabilities and then owners’ equity.

• The account format reports assets on The account format reports assets on the left side and liabilities and the left side and liabilities and owners’ owners’ equity on the right side. equity on the right side.

ACCOUNTIGCYCLE

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The Classified Balance Sheet

• The debit sideThe debit side

– Current assetsCurrent assets

– Long-term assetsLong-term assets

• Assets are listed in order of decreasing Assets are listed in order of decreasing liquidity.liquidity.

ACCOUNTIGCYCLE

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The Classified Balance Sheet

• The credit sideThe credit side

– Current liabilitiesCurrent liabilities

– Long-term liabilitiesLong-term liabilities

• Liabilities are listed in the order of how Liabilities are listed in the order of how soon they must be paid.soon they must be paid.

ACCOUNTIGCYCLE

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Balance Sheet

At 31st December, 2003.

Assets Liabilities

Current Assets Current Liabilities

Cash 12,100 Accounts Payable 1,200

Accounts Receivable 3,050 Salary Payable 1,100

Supplies 150 Unearned Revenue 1,500

Total Current Assets 15,300 Total Liabilities 3,800

Plant Assets Owners’ Equity

Equipment 15,500 Capital 19,300

Less Accum Deprec 7,700 7,800

Total Liabilities and Total Assets 23,100 Equity

23,100

ACCOUNTIGCYCLE

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Income Statement

• The income statement presents the results of the The income statement presents the results of the entity's operations during a period of time, such as one entity's operations during a period of time, such as one year. The simplest equation to describe income is:year. The simplest equation to describe income is:

Net Income  =  Revenue  -  ExpensesNet Income  =  Revenue  -  Expenses

• The income can be described by:The income can be described by:

Net Income  =  Revenue  -  Expenses  +  Gains  -LossesNet Income  =  Revenue  -  Expenses  +  Gains  -Losses

ACCOUNTIGCYCLE

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Statement of Owners' Equity

• The equity statement explains the changes in retained The equity statement explains the changes in retained earnings. Retained earnings appear on the balance earnings. Retained earnings appear on the balance sheet and most commonly are influenced by income sheet and most commonly are influenced by income and dividends. and dividends.

• The following equation describes the equity The following equation describes the equity statement for a sole proprietorship:statement for a sole proprietorship:

Ending EquityEnding Equity  =    =  Beginning Equity  + Beginning Equity  +  Investments  -  Withdrawals  +  Income Investments  -  Withdrawals  +  Income

ACCOUNTIGCYCLE

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Cash Flow Statement

• The statement of cash flows is useful in The statement of cash flows is useful in evaluating a company's ability to pay its bills. evaluating a company's ability to pay its bills. For a given period, the cash flow statement For a given period, the cash flow statement provides the following information:provides the following information:

== Sources of cash Sources of cash

= = Uses of cash Uses of cash

= = Change in cash balance Change in cash balance

ACCOUNTIGCYCLE

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Cash Flow Statement

• The cash flow statement represents an analysis of The cash flow statement represents an analysis of all of the transactions of the business, reporting all of the transactions of the business, reporting where the firm obtained its cash and what it did where the firm obtained its cash and what it did with it. It breaks the sources and uses of cash into with it. It breaks the sources and uses of cash into the following categories:the following categories:

= = Operating activities Operating activities

= = Investing activities Investing activities

= = Financing activities Financing activities

ACCOUNTIGCYCLE

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Accounting Work Sheet

• A work sheet is a multi-columned A work sheet is a multi-columned document used by accountants to help move document used by accountants to help move data from the trial balance to the financial data from the trial balance to the financial statements.statements.

• It is an internal document.It is an internal document.

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The Accounting Work SheetAdjusted Trial Balance

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCASH 12,100ACCTS RECEIVABLE 1,350SUPPLIES 250EQUIPMENT 15,500ACCUM DEPRECIATION 7,500ACCOUNTS PAYABLE 1,200SALARY PAYABLE 1,100UNEARNED REVENUE 1,500CAPITAL 7,200WITHDRAWALS 1,000REVENUE 23,700SALARY EXPENSE 12,000

TOTALS 42,200 42,200

TRIAL BALANCE ADJUSTMENTS ADJ. TRIAL BAL.

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The Accounting Work SheetAdjusted Trial Balance

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCASH 12,100 12,100ACCTS RECEIVABLE 3,050 3,050SUPPLIES 150 150EQUIPMENT 15,500 15,500ACCUM DEPRECIATION 7,700 7,700ACCOUNTS PAYABLE 1,200 1,200SALARY PAYABLE 1,100 1,100UNEARNED REVENUE 1,500 1,500CAPITAL 7,200 7,200WITHDRAWALS 1,000 1,000REVENUE 25,400SALARY EXPENSE 12,000SUPPLIES EXPENSE 100DEPRECIATION EXP 200 TOTALS 44,100 44,100 31,800 18,700

ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

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The Accounting Work SheetAdjusted Trial Balance

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCASH 12,100 12,100ACCTS RECEIVABLE 3,050 3,050SUPPLIES 150 150EQUIPMENT 15,500 15,500ACCUM DEPRECIATION 7,700 7,700ACCOUNTS PAYABLE 1,200 1,200SALARY PAYABLE 1,100 1,100UNEARNED REVENUE 1,500 1,500CAPITAL 7,200 7,200WITHDRAWALS 1,000 1,000REVENUE 25,400 25,400SALARY EXPENSE 12,000 12,000SUPPLIES EXPENSE 100 100DEPRECIATION EXP 200 200 TOTALS 44,100 44,100 12,300 25,400 31,800 18,700

ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

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The Accounting Work SheetAdjusted Trial Balance

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCASH 12,100 12,100ACCTS RECEIVABLE 3,050 3,050SUPPLIES 150 150EQUIPMENT 15,500 15,500ACCUM DEPRECIATION 7,700 7,700ACCOUNTS PAYABLE 1,200 1,200SALARY PAYABLE 1,100 1,100UNEARNED REVENUE 1,500 1,500CAPITAL 7,200 7,200WITHDRAWALS 1,000 1,000REVENUE 25,400 25,400SALARY EXPENSE 12,000 12,000SUPPLIES EXPENSE 100 100DEPRECIATION EXP 200 200 TOTALS 44,100 44,100 12,300 25,400 31,800 18,700

NET INCOME 13,100 13,10025,400 25,400 31,800 31,800

ADJ. TRIAL BAL. INC. STATEMENT BALANCE SHEET

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ACCOUNTING CYCLE

CLOSING CLOSING

ENTRIESENTRIES

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Closing Entries

• Closing the accounts is the end of period Closing the accounts is the end of period process that prepares the accounts for process that prepares the accounts for recording transactions during the next recording transactions during the next period.period.

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CLOSING ENTRIES

• It prepares accounts for recording the transactions It prepares accounts for recording the transactions of the next period. of the next period.

• Recording and posting closing entries is to transfer Recording and posting closing entries is to transfer the end-of-period balances in revenue, expense the end-of-period balances in revenue, expense and withdrawal accounts to the owner’s capital and withdrawal accounts to the owner’s capital account. account.

• Closing entries are necessary at the end of a period Closing entries are necessary at the end of a period after financial statements are prepared because after financial statements are prepared because Revenue, expense, and withdrawal accounts must Revenue, expense, and withdrawal accounts must begin the next period with zero balances. begin the next period with zero balances.

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Closing Entries

• What accounts are closed at the end of the What accounts are closed at the end of the period?period?

• Revenue, Expenses and Withdrawals.Revenue, Expenses and Withdrawals.

• These relate to a specific period and are These relate to a specific period and are called temporary accounts.called temporary accounts.

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Closing Entries

• The Income Summary account is used to The Income Summary account is used to close the temporary accounts.close the temporary accounts.

• This is the “most temporary” account.This is the “most temporary” account.

• It is used only to facilitate the closing It is used only to facilitate the closing process.process.

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Closing Entries

• Revenues and Expense accounts are closed Revenues and Expense accounts are closed to Income Summary.to Income Summary.

• Income Summary is closed to Capital.Income Summary is closed to Capital.

• Withdrawals are closed to Capital.Withdrawals are closed to Capital.

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Closing Entries

• Net income will be represented by a credit Net income will be represented by a credit balance in the Income Summary.balance in the Income Summary.

• Net loss by a debit balance.Net loss by a debit balance.

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Flowchart of Closing Process

Revenue Income Summary12,000

7,500 9,000

Salary Exp 3,300

28,500

1,500 1,800

4,450 28,500

Rent Exp 800 800

Supplies Exp 350 350

24,050

24,050

(Close Revenue Account)

(Close Expense Accounts)

(Close Income Summary)

Withdrawals2,500 2,500

2,500

Capital Account

(Close Withdrawals Account)

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ACCOUNTING CYCLE

POST – CLOSING TRIAL BALANCEPOST – CLOSING TRIAL BALANCE

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Post closing Trial Balance

• The accounting cycle ends with the post The accounting cycle ends with the post closing trial balance.closing trial balance.

• The post closing trial balance is dated as of The post closing trial balance is dated as of the end of the period for which the the end of the period for which the statements have been prepared.statements have been prepared.

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Post closing Trial Balance

• The aim of post-closing trial balances is to The aim of post-closing trial balances is to verify thatverify that

(1) total debit equal total credits for permanent (1) total debit equal total credits for permanent accounts ;&accounts ;&

(2) all temporary a/cs have zero balances. This is (2) all temporary a/cs have zero balances. This is the last step in the accounting process. the last step in the accounting process.

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Use the current and debt Use the current and debt ratios to evaluate a business.ratios to evaluate a business.

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Comparative Financial Statements...

– are statements that show two or more are statements that show two or more consecutive periods.consecutive periods.

• They enhance the user’s ability to analyze a They enhance the user’s ability to analyze a company’s past performance.company’s past performance.

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Trend Analysis

• Decision makers compare various ratios Decision makers compare various ratios over a period of time, looking for over a period of time, looking for improving trends.improving trends.

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PREPARED BY

• MD. HASNAIN CHOWDHURYMD. HASNAIN CHOWDHURY

• ROLL NO # 06ROLL NO # 06

• 22NDND SEMESTER SEMESTER

• BBA PROGRAMBBA PROGRAM