05 Bbma3203 T1

Topic X Cost Volume
1 Profit Analysis
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define Cost-Volume-Profit (CVP) analysis;
2. Explain the significance of cost volume profit analysis;
3. Demonstrate the techniques for calculating break even point
(BEP);
4. Elaborate the approach in cost volume profit analysis; and
5. Identify the impact of tax in cost volume profit analysis.
X INTRODUCTION
There are different management accounting aspects used by management to
determine internal decisions. Various decisions have to be made, depending on
the purpose of such decisions. For instance, the management of a private clinic
often poses several questions regarding the business activities of the clinic, such
as:
(a) How many patients have to be treated to achieve break even point?
(b) What would the impact be on profit if the clinic area is widened?
(c) What are the effects of increasing treatment charges on the profit and
number of clinic patients?
All the above questions are related to changes in the activities of the company
which affect the costs and income. They are the fundamental questions in
business and must be answered to allow the management to see the impact of
each of the changes made, which in turn will assist the management in
conducting systematic and strategic planning, thus arriving at systematic and
sound business decisions.
Copyright © Open University Malaysia (OUM)
2 X TOPIC 1 COST VOLUME PROFIT ANALYSIS
Cost volume profit analysis (CVP) is a technique in management accounting

which helps to solve questions, such as those described earlier.
1.1 IMPORTANCE OF COST VOLUME PROFIT

ANALYSIS
Cost volume profit analysis (CVP) can be defined as follows.
Cost volume profit analysis is a method of analysis which determines the

impact of a change in activity levels on the cost, income and profit of the
company.
This analysis can be utilised to see how changes in selling prices, variable costs,
fixed costs, taxes and sales mix affect profits. Generally, cost volume profit
analysis helps the management to obtain an overall perspective of the effects of
different types of short term financial changes on cost and income.
In fact, this analysis plays an important role in helping the management to

construct a more systematic planning for making decisions with respect to:
(a) Setting the selling price;
(b) Determining the sales mix;
(c) Choosing the marketing strategy; and
(d) Evaluating the impact of changing costs.
ACTIVITY 1.1
A shop owner likes to talk about profit whenever he sells ice-cream in

his grocery store. He will calculate his profit by taking into account all
costs incurred. However, he is not aware that the profit calculation can
be simplified by cost volume profit analysis. What is the main
significance of cost volume profit analysis?

TOPIC 1 COST VOLUME PROFIT ANALYSIS W 3
1.1.1 Setting the Selling Price

In a perfect competitive economy, the process of setting a price can be very
difficult compared to that in a monopoly economy. Companies cannot depend
only on internal information, such as costs, capacity and efficiency of the
production, but must also take into consideration the macro factors, which
include competition, demand and materials supplies. Cost volume profit analysis
provides management with useful information for the process of determining
prices.
1.1.2 Determining the Sales Mix

As you are aware, a company will try to increase its profit by producing various
products. Producing a variety of products will, however, create problems to the
management when deciding the quantity of each product to be produced and
sold while ensuring the profit is attained.
By applying the cost volume profit analysis, the management is able to determine
the right sales product A and product B. The company cannot simply assume
that, in order to reach the maximum profit or to be just at the break even point, it
has to sell 2 units of product A and 1 unit of product B. On the contrary, the
company has to perform various analyses, and the simplest analysis is by using
the cost volume profit analysis.
1.1.3 Choosing the Marketing Strategy

Marketing strategy is also important in ensuring the success of a product in the
market. A company has to observe the most effective strategy to obtain
maximum profit. The cost volume profit analysis assists the management in
choosing an effective marketing strategy by providing information on the cost
benefit of each strategy to be used. Cost benefit requires the management to
make decisions in such a manner that each cost incurred will attain its benefits
accordingly (be paid off). For example, to increase its profits, a company may
need to change its marketing strategy, for example by cutting-down the expenses
on promotion or reducing the selling price per unit.
1.1.4 Evaluating the Impact of Changing Costs

In the business environment, changes in cost will directly affect the companyÊs
profit. For example, an increase in the cost of raw materials will reduce the profit
of the company, and vice-versa. By employing the cost volume profit analysis,

the management can evaluate thoroughly the impact of the changes in each cost
on the companyÊs profit.
1.2 ASSUMPTIONS IN COST VOLUME PROFIT

ANALYSIS
In management accounting, the information obtained is based on the future, and
hence requires several assumptions. Even though the information is based on
assumptions, it still has to be as accurate as possible. The cost volume profit
analysis can only be applied effectively if several assumptions are satisfied. Some
of the assumptions used in the cost volume profit analysis include:
(a) Selling price is constant throughout the period;
(b) All costs can be classified as either variable cost or fixed cost;
(c) Variable cost varies in proportion to the changes in volume;
(d) Total fixed cost remains constant regardless of the activity levels;
(e) Efficiency level of the operations remains unchanged, that is no profit or
loss will be incurred due to the efficiency factor;
(f) The total sales is equal to a constant sales mix when more than one product
is sold; and
(g) The contribution margin approach will be used in calculating profit.
1.3 BREAK EVEN POINT (BEP)

Break even point (BEP) is a point at which the profit is equal to zero. A
company is said to achieve the break even point if the total revenue is equal
to total cost.
In other words, it is a level of activity at which a company does not attain any
profit or incur any loss. In economics, this concept is also emphasised to assist the
management in making a decision on whether to continue competing or to exit
from the market.

Fixed Costs
BEP (in units) =
Contribution Margin Per Unit
or
Fixed Costs
BEP (in RM) =
Contribution Margin %
We will then verify the validity of a particular theory by using data we have
collected. If the data analysed verify the validity of the theory, then our economic
theory will become an economic law. This economic law will be embraced until
there is a competing theory that states otherwise.
Example 1.1
Atlis Company has sold 10,000 pairs of earrings throughout the month of May,
2003 at a price of RM20 per pair. The variable cost is RM12 for every pair of
earrings. The total fixed cost is RM80,000. The following income statement shows
that the total net income of the company is zero, which is at the break even level.
RM
Sales (10,000 x RM20) 200,000
Less: Variable Costs (10,000 x RM12) (120,000)
Total Contribution Margin 80,000
Less: Fixed Costs 80,000
Net Income 0
From the above example, we can conclude that the company will reach its break
even point if its sales activity level amounts to 10,000 pairs of earrings.
This information is vital for Atlis Company to plan the companyÊs future
activities and subsequently to answer questions that are usually asked by the
management. The concept of break even point also serves as a basis in the cost
volume profit analysis, where the company neither earns a profit nor incurs a
loss.

1.4 APPROACHES IN COST VOLUME PROFIT

ANALYSIS
For your information, in cost volume profit analysis, the marginal costing
approach will be employed more often than the absorption costing approach.
Absorption costing refers to a costing approach where the manufacturing

overhead cost is considered as part of the product cost and hence included in
the product cost. This implies that the overhead cost is an inventoriable cost.
Marginal (variable) costing refers to a costing approach where only variable

overhead costs are absorbed as product cost, while the fixed overhead costs
are charged as period cost.
A comprehensive understanding of marginal costing will help you better

understand the following discussions. In a nutshell, the format of the marginal
costing approach is as follows:
Sales Revenues ă Variable Costs = Contribution Margin
Contribution ă Fixed Costs = Operating Profit

Margin
There are three approaches which are used in the cost volume profit analysis,
which are:
(a) Contribution margin approach;
(b) Mathematical equation approach; and
(c) Graphic presentation approach.
The main purpose of these approaches is to answer the same kind of questions.
The advantage of this analysis is that it provides us with a wide range of options
to choose from and does not restrict us to only one approach or method in
solving questions such as the ones given at the beginning of this topic.
To simplify your understanding of this topic, we will use Example 1.1 again to
demonstrate how these three approaches solve each of the problems or questions
presented.

1.4.1 Calculation of the Break Even Point (BEP)

(a) Contribution Margin Approach
As mentioned earlier, contribution margin is the difference between the
sales revenues (incomes) and the variable costs.
Contribution Margin = Sales Revenues ă Variable Costs
When the activity level reaches the break even point, the total contribution
margin is equal to the total fixed cost. This means that at the point of
breakeven, the company does not incur any loss or earn any profit. Thus,
the contribution margin is only sufficient to cover the total fixed cost
incurred.
In the cost volume profit analysis, the contribution margin can be derived
in the form of contribution margin per unit or as contribution margin
percentage (ratio). Referring to the example again, the calculation of the
contribution margin is as follows:
(i) Contribution Margin Per Unit
Selling Price Per Unit ă Variable Costs Per Unit = Contribution Margin Per Unit
i.e. RM20 ă RM12 = RM8
(ii) Contribution Margin Percentage
(Contribution Margin Per Unit/Selling Contribution Margin

× 100 =
Percentage
Price Per Unit)
i.e. (RM8/RM20) x 100 = 40%
Once we determine the contribution margin, we can easily perform

the calculation for the breakeven point.
Assuming that X is an activity level (selling or production) in units,

then at the break even point, the fixed cost will be divided by the
contribution margin per unit or percentage, i.e.:

Fixed Costs
BEP (unit) =
RM80,000
=
RM8
= 10,000 units.
Or
Assuming that X is now the activity level (selling or production) in

RM, then the break even point is:
Fixed Costs
BEP (unit) =
Contribution Margin Percentage
= RM80,000 / 40%
= 100
RM80,000 ×
40
= RM200,000
(b) Mathematical Equation Approach

In this approach, the mathematical equation method is employed to obtain
the break even point. The break even point is derived by using the
following equation:
Sales = Variable Costs + Fixed Costs
Next, the equation is converted into a mathematical equation of:
HX = BX + T
where:
H is the selling price per unit,
X is the sales quantity,
B is the variable cost per unit, and
T is the total fixed cost.

Referring to the same example, the break even point, in units, is:
20X = 12X + 80,000

8X = 80,000
80,000
X =
8
= 10,000 units
or in ringgit (RM)
= 10,000 units × price per unit
= 10,000 units × RM20
= RM200,000
(c) Graphic Presentation Approach

Through this approach, we can clearly appreciate the meaning of break
even point. An accurately sketched graph will illustrate correctly the total
units and its value in RM for the company whose activity level has reached
the break even point.
Figure 1.1: Graphic presentation approach
The break even point is determined by a point of intersection between the

total income line and the total cost line. From Figure 1.1, the intersection
point is where the sales equal 10,000 units or RM200,000. The graph above
does not only illustrate the break even point for Atlis Company, but also
allows the management of the company to observe the impact of the
changes in sales volume on profit or loss.

For instance, if the companyÊs sales are less than 10,000 units, then it will
fall in the loss region and on the contrary, if the companyÊs sales are more
than 10,000 units, then it will generate profit.
1.4.2 Calculation of Sales for a Given Target Profit

(If Any)
Furthermore, by using the CVP, a company can easily compute the profit earned at
a specific activity level. It also helps the company to identify the level of activity
that produces the expected or required profit.
Referring to the example above, and assuming that Atlis Company is targeting a
profit of RM20,000, what is the level of sales necessary to achieve this profit? This
question can be easily answered by using the three approaches used previously
in CVP analysis to calculate the break even point.
(a) Contribution Margin Approach

If the management of a company sets a target profit, then we need to add
the previously given formula with the amount of profit required.
Sales (unit) = Fixed Costs + Required Profit

= RM80,000 + RM20,000
RM8
=
12,500 pairs
or,
Sales (RM) = Fixed Costs + Required Profit × 100

Contribution Margin Percentage
= RM80,000 + RM20,000 × 100

40%
=
RM250,000
(b) Mathematical Equation Approach

The amount of profit required must be added on the right side of the break
even point equation to give:
Sales = Variable Costs + Fixed Costs + Required Profit

i.e.
H X (in units) = BX + T +
20X = 12X + 80,000 + 20,000
8X = 100,000
X = 12,500 pairs
Or
X (in RM) = 0.6X + 80,000 + 20,000
0.4X = 100,000
= RM250,000
1.5 APPLICATIONS OF COST VOLUME PROFIT

ANALYSIS
Cost volume profit analysis is not only used to obtain the contribution margin
and sales level at the required target profit, but also for determining:
(a) The margin of safety;
(b) Change in fixed cost;
(c) Changes in contribution margin;
(d) Target profit; and
(e) Changes in various factors.
1.5.1 Margin of Safety

The margin of safety is the difference between the current level of operation,
whether in units or RM, and the break even point. In the case of Atlis Company,
if we assume that the company is operating at an activity level of 12,500 units or
RM250,000, then the margin of safety would be 2,500 units or RM50,000. The total
margin of safety can be determined by making the following calculation:
Margin of Safety = Current Operation Level ă Break even Point
= 12,500 units ă 10,000 units

= 2,500 units
or = RM250,000 ă RM200,000
= RM50,000

The margin of safety is crucial for the management to measure how far the
current operation level is from the break even point. This is illustrated in
Figure 1.2.
Figure 1.2: Margin of safety
The company is operating with a margin of safety of 2,500 units and can further
increase its safety margin if the companyÊs level of sales moves further to the
right from the break even point. The company also cannot reduce its sales
volume by more than 2,500 units if it does not want to incur any losses.
1.5.2 Changes in Fixed Cost

In reality, fixed cost and variable cost usually vary, and are not exactly as
expected or assumed. This may be due to the advancement of technology or
expansion of the business. When a fixed cost changes, the important question for
the management to ask is its impact on the break even point.
ACTIVITY 1.2
If the factoryÊs rental (one of the fixed costs) increases by RM4,000,

what will happen to the companyÊs break even point?
The above question can be directly solved by using the cost volume profit
analysis. You need to replace the fixed cost with a new amount, while other items
stay the same.
Let us look at the solution using the contribution margin approach (the
mathematical equation approach and the graphic presentation approach can also
be used).

Hence, it can be concluded that if the fixed cost increases by RM4,000, Company
Atlis needs to increase its sales volume by 500 units or sales amount by RM10,000
(i.e., 500 units x RM20) to reach the new break even point.
1.5.3 Changes in Contribution Margin

There are two factors that can cause a change in the contribution margin, namely,
a change in variable cost per unit and a change in selling price. One or both of
these factors will affect the business operations, in particular the break even
point. This is illustrated in Figure 1.3.
Figure 1.3: Change in contribution margin
(a) Changes in Per Unit Variable Cost

Assuming that the selling price is unchanged, an increase in variable cost
per unit will cause a fall in contribution margin, or the other way around.
For example, if the variable cost for a pair of Atlis earrings increases to
RM15 from its original cost of RM12, the consequences on the contribution
margin are as shown in Table 1.1.
Table 1.1: Impact of Change in Variable Cost per Unit on Contribution Margin
Original New
Selling Price RM20 RM20
Variable Cost RM12 RM15
Contribution Margin RM8 RM5
BEP (units) 80,000 / 8 = 10,000 80,000 / 5 = 16,000
BEP (RM) 200,000 320,000

The increase of RM3 per unit in variable cost has a significant impact on the
operations of Atlis Company. The company now needs to sell 6,000 pairs of
earrings more than before in order to reach the new break even point. Bear
in mind that the cost volume profit analysis is not a tool to solve the
problem above but rather to assist the company in conducting future
planning.
(b) Changes in Selling Price

A change in selling price will similarly have a significant impact on the
operations of the company. Assuming that the variable cost is unchanged,
an increase in selling price from RM20 to RM22 will affect the BEP in the
following manner, shown in Table 1.2.
Table 1.2: Impact of Change in Selling Price on BEP
Original New
Selling Price RM20 RM22
Variable Cost RM12 RM12
Contribution Margin RM8 RM10
BEP (units) 80,000 / 8 = 10,000 80,000 / 10 = 8,000
BEP (RM) 200,000 176,000
The increase in the selling price of RM2 has caused the BEP to fall by 2,000 pairs
of Atlis earrings. As a result, the company now needs to sell only 8,000 pairs but
at a higher price of RM22 so as to achieve the companyÊs new break even point.
1.5.4 Target Profit

Until now, the focus of our discussion has been on determining the sales volume
that can achieve the break even point or obtain the required profit. In addition to
these, the cost volume profit analysis can also predict the amount of profit to be
generated by a company, provided that information on sales volume,
contribution margin per unit and fixed costs are known. To explain this, let us
proceed by demonstrating the following example:

Example 1.2
It is given that the fixed cost incurred in a year for Atlis Company is RM80,000
while its variable cost is RM12 per unit. Based on research, a change in selling
price will affect the demand for Atlis earrings. The company predicts the impact
on demand if the price changes will be as follows:
Selling Price Per Unit Expected Demand (units)

RM20 15,000
RM22 14,000
The target profit can be calculated for each price set. To simplify the calculations,
the total contribution margin approach is used to subtract the total variable cost
from the total income.
Table 1.3: Target Profit
Price of Earrings
RM20 RM22
Total Income:
15,000 x RM20 RM300,000 RM308,000
14,000 x RM22
Less Variable Costs:
15,000 x RM12 (RM180,000) (RM168,000)
14,000 x RM12
Total Contribution Margin RM120,000 RM140,000
Less: Fixed Costs (RM80,000) (RM80,000)
PROFIT RM40,000 RM60,000
From Table 1.3, we can see that, at the price of RM20 per pair, the company will
earn a profit of RM40,000, but if the price is increased to RM22, the profit will
similarly increase by RM20,000. The difference is due to the increase in the
contribution margin per unit by RM2, exceeding the reduction in contribution
margin due to a decrease in demand.
If the fixed cost remains unchanged, then the difference in total contribution
margin will describe the actual difference in profits to be earned. This type of
information is important to assist companies in the price setting process.

1.5.5 Changes in Various Factors

From the previous example, we have noted that a change in the selling price will
affect the sales volume, hence having an impact on the contribution margin and
the companyÊs profit while the fixed cost remains unchanged. However, a change
in the variable factor will indirectly affect the fixed factor (i.e., fixed cost). This
section will discuss the effects on the companyÊs profit if there are changes in the
variable factor and fixed factor at the same time.
By using the example in section 1.5.4, an increase in the price of a pair of earrings
from RM20 to RM22 has resulted in a decrease in demand by 1,000 pairs. This
suggests that the company has to reduce its production by 1,000 pairs.
Suppose that all the machines used in producing the earrings are acquired by the
company through hire purchase. A reduction in the production will have an
influence on the number of machines used. If the company can save the cost of
hire purchase by RM10,000 per year as a result of reducing the number of
machines used, then the companyÊs profit will be as illustrated in Table 1.4
below:
Table 1.4: Changes in Various Factors
Price of Earrings
RM20 RM22
Total Income:
15,000 x RM20 RM300,000 RM308,000
14,000 x RM22
Less: Variable Costs:
15,000 x RM12 (RM180,000) (RM168,000)
14,000 x RM12
Total Contribution Margin RM120,000 RM140,000
Less: Fixed Costs (RM80,000) (RM70,000)
PROFIT RM40,000 RM70,000
The expected contribution margin is now higher by RM20,000 at the price of

RM22 compared to RM20, while the fixed cost is now lower by RM10,000. This
suggests that Atlis Company will generate an additional profit of RM30,000
(RM20,000 + RM10,000) if the earrings are sold at the price of RM22.

Situation 1.1
Zan Bun Berhad is the sole manufacturer of cakes in the Changlun region. The
company only produces a single type of cake that is sold at the price of RM10 per
piece. The cost of making a cake is RM5 while the fixed cost of the company
amounts to RM50,000 per annum.
You are required to:

(a) Determine the rate of the contribution margin and the contribution margin
for a cake.
(b) Determine the number of cakes which must be sold to achieve the
companyÊs break even point.
(c) Determine the sales income of the cakes required to achieve the break even
point.
(d) Calculate the number of cakes which must be sold to achieve a profit of
RM30,000 per year (use the mathematical equation method).
Solution:
RM
(a) Selling Price 10 100%
Variable Cost 5 50%
Contribution Margin 5 50% @ 0.5
Fixed Cost RM50,00 10,000
(b) Break even Point = = =
Contribution Margin RM5/piece pieces
(c) Break even Point = Fixed Cost = RM50,00
% Contribution Margin % Contribution
Margin
= RM50,000
0.5
= RM100,000
(d) Sales = Variable Cost + Fixed Cost + Profit

10x = 50x + RM50,000 + RM30,000
RM80,000
x =
5
= 16,000 pieces

or
x = 0.5 + RM50,000 + RM30,000

RM80,000
x =
0.5
= RM160,000
Situation 1.2
With reference to the information in Situation 1.1, you are required to solve the
following problems individually.
(a) By expecting the fixed cost to increase by 10% in the coming year, calculate
the new break even point for the company.
Solution:
Original New
RM RM
Fixed Cost = 50,000 55,000
Contribution Margin = 5 5
Break even Point = RM50,000 RM55,000
5 5
= 10,000 pieces 11,000 pieces
(b) During the year, the company managed to sell 15,000 pieces of cake. From
observation, if the company reduces the price of a cake from RM10 to RM9,
the demand for the cakes will increase by 20%. What is the break even point
for the company?
Solution:
Original New
RM RM
Selling Price 10 9
Variable Cost 5 5
Contribution Margin 5 4
Break even Point = RM50,000 RM50,000
5 4
= 10,000 pieces 12,500 pieces

(c) Based on the information in (b) how much total sales is required if the
company wants to earn a profit of RM30,000?
Solution
Sales = Variable Cost + Fixed Cost + Profit

9x = 5x + RM50,000 + RM30,000
x = RM80,000
4
x = 20,000 pieces
x = 0.56x + RM50,000 + RM30,000

x = RM80,000
0.44
= RM180,000
(d) What actions must be taken if the changes in (a) and (b) occur at the same
time? Explain.
Solution:
The answer to the above problem can be illustrated clearly if we prepare an

income statement.
Original (RM) New (RM)

Sales 15,000 units 18,000 units
Total Income:
15,000 x RM10 150,000 162,000
18,000 x RM9
Less: Variable Costs:
(15,000 x RM5) (75,000) (90,000)
(18,000 x RM5)
Total Contribution Margin 75,000 72,000
Less: Fixed Costs (50,000) (55,000)
PROFIT 25,000 17,000
Even though the increase in demand is rather high, i.e., by 3,000 pieces of cakes
as a result of a reduction of RM1 in selling price, the profit of the company
reduces by RM8,000. Thus, the company should not reduce the price as the profit
earned is higher although the sales volume is less.

1.6 IMPACT OF TAX IN COST VOLUME PROFIT

ANALYSIS
For your information, a company usually considers the profit after tax when
making a decision. The expected profit or target profit normally assumes that the
tax has been taken into consideration.
We can obtain the target profit by using the formula below:
Sales Target = Fixed Cost + Target Profit

Contribution Margin Per Unit (CM) @ CM%
If income tax is taken into account, the above formula has to be modified to
become:
Sales Target = Fixed Cost + { (Target Profit After Tax) / (1-Tax Rate) }
Ć Cost volume profit analysis is a useful tool for the company management. It
provides the management with important information which is vital for the
purpose of conducting future planning and business decisions.
Ć This analysis particularly, focuses on the problems of calculating the break

even point and target profit required by the company. It also explains the
effects on the sales volume and profit if there are changes in the cost and
selling price.
Ć To solve the fundamental problems in business, this analysis employs three

approaches:
ă The contribution margin approach;
ă The mathematical equation approach; and
ă The graphic presentation approach.
ă It is then up to the management to use the approach that it considers
suitable and is comfortable with.
Absorption costing Margin of safety

Break even point (BEP) Marginal (variable) costing
Contribution margin approach Mathematical equation approach
Cost volume profit analysis (CVP) Sales target
analysis
Graphic presentation approach
APPENDIX: GRAPHS AND THEIR MEANING

Figure 1.3 until Figure 1.8 show examples of graphs and their meaning.
Figure1.3: Demand curve
Figure 1.4: Supply curve

Figure 1.5: Market equilibrium
Figure 1.6: Indifference curve
Figure 1.7: Budget line

Figure 1.8: Consumer equilibrium ă maximisation of satisfaction

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Topic X Cost Volume

Cost volume profit analysis (CVP) is a technique in management accounting

1.1 IMPORTANCE OF COST VOLUME PROFIT

Cost volume profit analysis is a method of analysis which determines the

In fact, this analysis plays an important role in helping the management to

A shop owner likes to talk about profit whenever he sells ice-cream in

Copyright © Open University Malaysia (OUM)

1.1.1 Setting the Selling Price

1.1.2 Determining the Sales Mix

1.1.3 Choosing the Marketing Strategy

1.1.4 Evaluating the Impact of Changing Costs

Copyright © Open University Malaysia (OUM)

1.2 ASSUMPTIONS IN COST VOLUME PROFIT

1.3 BREAK EVEN POINT (BEP)

Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

1.4 APPROACHES IN COST VOLUME PROFIT

Absorption costing refers to a costing approach where the manufacturing

Marginal (variable) costing refers to a costing approach where only variable

A comprehensive understanding of marginal costing will help you better

Sales Revenues ă Variable Costs = Contribution Margin

Contribution ă Fixed Costs = Operating Profit

Copyright © Open University Malaysia (OUM)

1.4.1 Calculation of the Break Even Point (BEP)

Contribution Margin = Sales Revenues ă Variable Costs

(i) Contribution Margin Per Unit

i.e. RM20 ă RM12 = RM8

(ii) Contribution Margin Percentage

(Contribution Margin Per Unit/Selling Contribution Margin

i.e. (RM8/RM20) x 100 = 40%

Once we determine the contribution margin, we can easily perform

Assuming that X is an activity level (selling or production) in units,

Copyright © Open University Malaysia (OUM)

Assuming that X is now the activity level (selling or production) in

(b) Mathematical Equation Approach

Sales = Variable Costs + Fixed Costs

Next, the equation is converted into a mathematical equation of:

Copyright © Open University Malaysia (OUM)

20X = 12X + 80,000

(c) Graphic Presentation Approach

Figure 1.1: Graphic presentation approach

The break even point is determined by a point of intersection between the

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1.4.2 Calculation of Sales for a Given Target Profit

(a) Contribution Margin Approach

Sales (unit) = Fixed Costs + Required Profit

Sales (RM) = Fixed Costs + Required Profit × 100

= RM80,000 + RM20,000 × 100

(b) Mathematical Equation Approach

Sales = Variable Costs + Fixed Costs + Required Profit

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1.5 APPLICATIONS OF COST VOLUME PROFIT

1.5.1 Margin of Safety

Margin of Safety = Current Operation Level ă Break even Point

= 12,500 units ă 10,000 units

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Figure 1.2: Margin of safety

1.5.2 Changes in Fixed Cost

If the factoryÊs rental (one of the fixed costs) increases by RM4,000,

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1.5.3 Changes in Contribution Margin

Figure 1.3: Change in contribution margin

(a) Changes in Per Unit Variable Cost