PowerPoint to accompany

Chapter 7
Unit 8

Cost-Volume-
Profit
 Learning Objectives
Explain the importance of a detailed understanding of cost
behaviour
Distinguish between fixed costs and variable costs
Use this distinction to deduce the break-even point
Explain why the break-even point is useful
Explain and apply the concept of contribution
Explain the concept of a margin of safety
Identify the weaknesses of break-even analysis
Make decisions using knowledge of the relationship between
fixed and variable costs

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

 The behaviour of costs

Costs can be broadly classified as:

Fixed = costs stay the same when
volume of activity changes
Variable = costs that vary with the
volume of activity

Both are associated with an activity

Important to understand their impact/quantity when making
decisions

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

Fixed Costs

As the volume
Fixed Cost Behaviour of activity
increases, the
fixed costs stay
the same

Figure 7.1
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Fixed Costs (continued)
Fixed costs are
likely to change due to inflation or general price
increases but not as a result of change in volume
of activity
almost always time-based
do not stay unchanged irrespective of level of output.
They often must increase to allow higher output
levels

This concept is visually demonstrated on the next slide

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

Fixed Costs (continued)
Graph of rent cost (R) against volume of activity

Figure 7.2
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
Variable Costs
These costs vary with the level of activity as illustrated
below:

Figure 7.3
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Variable Costs (continued)
Graph suggests that costs are linear, i.e.
normally the same per unit of production
irrespective of the number of units produced
In some cases the line is not straight
higher volumes of activity may introduce
economies of scale, thus changing the variable
costs line as production increases

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

 Semi-fixed (semi-variable) Costs
Have aspects of both fixed and variable
costs
Example: electricity costs for heating,
lighting and powering machinery.
largely fixed irrespective of production
activity, but for powering of machinery, it
would increase with production level

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

Semi-fixed (semi-variable) costs
(continued)
Electricity The slope of this line gives the
cost variable cost per unit
($) of activity

Fixed
cost
element
0
Volume of activity

Figure 7.4
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Break-even analysis
We have established that
increase in activity does not affect total fixed
costs
variable costs will increase on a per unit basis as
activity increases
This calculation
is
known as contribution
margin per unit
Break-even point occurs where:
total revenues equal total costs

Break-even point can be calculated as follows:

Fixed Costs
(Sales Revenue Per Unit Variable Cost per Unit)
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
Break-even Analysis (continued)

Figure 7.6
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Break-even Analysis contd
Example 7.1 (page 358)
Fixed Costs = $1,500
Variable Costs = $6 + $18 = $24
Sales revenue per unit sold (selling price per unit) = $30

$1,500
($30 - $24)

= 250 units per month

Note: Break-even point must be expressed

with respect to a period of time
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 The Use of Break-even Analysis
Determine activity level required to cover all
costs associated with the business

Assess activity level required to achieve profit

targets

Assess margin of safety - difference between

break-even activity and output, provides
indication of risks involved
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Contribution
Contribution margin total sales
revenue less total variable costs
Contribution (margin) per unit - Sales
revenue per unit less variable costs per
unit (bottom part of the break-even
formula)
Marginal cost - The addition to total
cost which will be incurred by producing
one more unit of output
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Contribution
Break-even point can be calculated as:
Break-even point = Fixed costs
Contribution per unit
Can incorporate desired profit into this
calculation, to determine the number of units
that need to be sold to cover all costs and
make a particular profit:
= Fixed costs + Desired profit
Contribution per unit

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

Profit-Volume Charts
Profit
($)
Break-even
point

0 Volume of activity

Fixed
cost

Figure 7.8

Note: you will not be expected to draw a profit-volume

chart in the exam!
Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia
 Margin of Safety and Operating
Gearing
Margin of safety = difference between output
activity and the break-even activity level

Operating gearing = the relationship between

contribution and fixed costs
- activity with relatively high fixed costs
compared with its variable costs is said to
have high operating gearing

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia

 Weakness of Break-Even Analysis

Non-linear relationships

Stepped fixed costs

Multi-product businesses

Atrill, McLaney, Harvey, Jenner: Accounting 4e 2008 Pearson Education Australia